Yesterday we laid out the reasons why French bank SocGen unveiled a surprisingly contrarian forecast, according to which the S&P would tumble from its current level over 2,600 to 2,000 in 2018, representing a more than 20% bear market drop the drop catalyzed by rising interest rates pressuring P/E multiples, a late cycle economy nearing recession, equities trading at record valuations, and with everyone short vol begging for a vol short squeeze. 

Not surprisingly, SocGen’s unspoken advice was to get out now.

And while many of the negative factors highlighted by SocGen had already been discussed here in the past, there were two we warned to bring attention to: the market’s multiple expansion since Trump’s election, and the narrow leadership in the S&P.

As we noted yesterday, contrary to the widely accepted narrative, while the S&P 500 has risen 24% since Trump’s election, only half of this performance has been driven by earnings growth; the other half is from P/E expansion. But why would P/Es rise at a time when the Fed is tightening? As SocGen speculated, assuming that analysts have not factored tax reform into their earnings forecasts, tax reform expectations have been the driver of P/E expansion. There is a problem with this: while the S&P 500 index tax rate is currently 26.6%, assuming that US companies generate 43% of their profits abroad (here) and pay 35% of their US profits on taxes (i.e. with no loopholes for US profits), the average tax rate outside the US would be 15.5%. A decrease in the US tax from 35% to 20% as planned by Trump’s tax reform would thus theoretically boost earnings by 8.5%. The 12-month forward P/E has risen 12% over the last 12 months. In other words, roughly 150% of Trump’s tax cuts have been priced in.

However, another especially interesting observations goes to the leadership of this 24% rally since Trump’s election, which – while hardly a surprise – was largely driven by a handfull of companies, or ten to be precise.

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