Tax Inversions- Who’s Inverting & Why

Guest post, by Adam Sarhan
11.23.15
Earlier today Pfizer ($PFE) inked a record deal to buy Allergan ($AGN) for $155B.  The deal was primarily due to help Pfizer save billions of dollars every year in taxes (a.k.a. tax inversion). Pfizer is the latest in a series of high profile companies that are moving their headquarters overseas to take advantage of a corporate tax loophole that allows them to pay lower taxes on income generated aboard. Let’s take a closer look at tax inversions and a list of companies which have inverted recently.
What is a tax inversion?
The most common definition of a tax inversion occurs when a company becomes a subsidiary of a new parent company located in another country for the purpose of lowering their tax rates.
Why Invert?
The simple reason to invert is to save money by paying less taxes. In the U.S., the 2015 corporate tax rate is 35% which is one of the highest rates in the developed world. Meanwhile, Ireland’s corporate tax rate of only 12.5% which translates into billions of dollars a year.
The Loophole(s):
In addition to the 35% corporate tax rate, the U.S. is also one of the few countries that taxes its companies on their worldwide income. The current U.S. tax code allows domestic companies to defer the taxes owed on profits generated overseas until they bring the money back to the U.S. Meanwhile, other countries, like the U.K. or Canada only tax domestic profits. This means a company based in the U.S. can end up paying more taxes than an identical U.S. company owned by a foreign entity. The loophole allows U.S. companies to buy a foreign parent which allows them to escape paying Uncle Sam on their worldwide income. Another important loophole that exists is that once a company inverts, it can take advantage of the U.S. tax deduction on interest for payments to their own affiliates abroad. These deductions are only available with a foreign parent company and add up to serious dollars.
Tax Inversions – See the Data
The following data courtesy of Bloomberg shows which companies have inverted recently and that the pace of inversions has grown rapidly in recent years.
1332221corprorate inversiosn4

The following data is from the middle of 2015:
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222tadxxx
333tax
444tax

1 – For companies that have changed incorporation more than once, indicates latest place of incorporation.
2 – Xoma reincorporated from Bermuda to the United States in 2011.
Source: Data compiled by Bloomberg

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Lower Oil Prices Continue To Benefit Airlines

Lower Fuel Prices Help The Airlines

Over the last eighteen months, oil prices have plunged over 60% and remain in a ugly bear market. Certain industries benefit from lower oil prices, most notably the airlines. It is important to note that fuel is the biggest expense for the airlines and the fact that fuel prices have fallen sharply bodes well for their bottom line.

Indirect Tax On The Economy

Lower fuel prices also helps boost the economy. Keep in mind, higher energy prices serve as an indirect tax on both consumers and businesses. So lower energy prices leaves people (consumers and businesses) with more disposable income. When people have more money to spend, they tend to spend it and that boosts the economy.  A stronger economy means more people will travel and that is also bullish for the sector. Keep in mind, if oil prices turn and start heading up the story will change.
Take a look at the following charts:
Crude Oil:
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Doth protest too much

Major Disconnect Between Wall Street & Main Street
We have argued for a long time that there is a major disconnect between Wall Street and Main Street. Since the March 2009 bottom, Wall Street has enjoyed very strong gains for one simple reason: #EasyMoney from the Fed and every other major central bank in the world. Meanwhile, Main Street has largely been left behind, causing this “recovery” to be one of the weakest in history. The Fed knows that Wall Street may be ready for a rate hike but Main Street is not and that’s why they have kept rates at zero since 2008.
 
Where Are The Earnings?
For the past six years, stocks have steadily rallied even though earnings remain lackluster at best. Each quarter, we are given a different “excuse” as to why earnings fail to impress. First they told us that it is too early in the recovery for earnings. Then we heard companies are cutting costs. Then we were told that earnings will come when the economy gets stronger. Of course, don’t forget China, Greece, or the wind was blowing too hard on the Moon.
 
The Latest Excuse: A Strong Dollar
The latest excuse is that the US dollar is too strong. But a quick glance at the chart of the US dollar debunks this myth. The US dollar rallied sharply in 2014 and topped out in March of 2015. Since then (past 7 months), the greenback has been drifting lower and is now trading in the same place it was in January 2015. The Dollar hasn’t gone anywhere this entire year. Yet, we are told that Q3 earnings are adversely affected because the greenback is too strong. We know that in some industries there is a lag time in the exchange of currency but not for most. We just think that some of Wall Street is now in “doth protest too much” mode when it comes to the dollar. Remember, this entire 6.5 year rally on Wall Street has been due to #EasyMoney from global central banks, not organic earnings and economic growth. Be careful as we make our way through another tepid earnings season. We have found it best to avoid the temptation to get caught up with all the noise. Instead we pay attention to how the market and leading stocks react to the news.

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The Fed Is "Market" Dependent, Not "Data" Dependent

We are here to help you make better investment decisions, not bash the Fed (or anyone else for that matter). For years, we have argued that policy makers look at markets first and everything else second. 
 
The Fed’s Third Mandate: Markets
Everyone wants us to believe that the Fed has a dual mandate: Help the economy (jobs) and keep inflation near 2%. We argue that the Fed’s third (real) mandate is to create policy that helps markets. Don’t believe us? Let’s look at the facts:
 
Markets Dictate Fed Behavior
The 2008-2009 financial crisis sent stocks and the overall economy plunging. The U.S. stock market fell into a vicious bear market and the U.S. economy plunged into the “Great Recession.” So on November 25, 2008, the Fed announced QE1 – which was a massive program to flood the system with liquidity and began printing billions of dollars everyday to help stabilize markets and the economy. That wasn’t enough, stocks continued to fall. Then, in December 2008, the Fed lowered interest rates to zero and shortly thereafter, in March 2009, stocks bottomed. That ignited this 6.5 year bull market. 
 
Print Baby Print
In 2009 and 2010 stocks soared. Then in April 2010 stocks topped out and fell 11%. Then the Fed announced QE 2 which began on November 3, 2010 and once again, stocks soared. Stocks placed another intermediate term top in May 2011, one month before QE 2 ended on June 3, 2011. Then stocks fell 21% from May 2011 to the Nov 2011. What happened? You guessed it the Fed announced Operation Twist from September 21, 2011 to December 12, 2012 and stocks rallied. At the end of 2012 stocks hit a wall and once again the Fed announced QE 3 in September 2012. Stocks didn’t rally so they doubled up in December of 2012 and stocks soared for all of 2013 until QE 3 ended in October 2014. Then the QE trade evolved and other central banks began printing gobs of money to stimulate markets. Stocks shot higher at the end of 2014 and moved sideways for most of 2015. As the Fed toyed with the notion of raising rates by a quarter point. 
 
September Fed Meeting:
At the beginning of the year the Fed told us they will raise rates in June or September. June came and went and nothing happened. Then the focus shifted to the September meeting and the markets moved sideways. Then, in late August, a few weeks before the September meeting, stocks plunged and the Fed blinked. Instead of rallying, stocks fell last week when the Fed decided in a 9-to-1 vote to hold rates near zero. Then one-by-one several Fed officials came out and reversed their stance and said the Fed should raise rates in 2015. That culminated yesterday with Dr. Yellen’s speech when she said the Fed will likely raise rates in 2015. They want us to believe that a 9-to-1 vote was reversed in a week. Forget the Fed dots, we’ll let you connect the dots. 
Quick Look At The Market
Stocks fell last week as the major indices continue to move sideways to consolidate their very steep late-August sell-off. We do find it interesting that with all the volatility we have seen since the late-August decline, the S&P 500 and Dow Industrials have had relatively “tight” closes over the past 3 consecutive weeks. Here are the past three weekly closes for the S&P 500: 1961, 1958 and as of noon on Friday the S& P500 is trading near 1947. At this point that simply means that the market is comfortable trading near these levels and is “setting up” for the next move. The longer the major indices spend below their important 50 and 200 DMA lines, the weaker the market gets. A new downtrend began when the S&P 500 sliced below 2040 on August 20, 2015. Therefore, the bears remain in control until the S&P 500 trades back above 2040. To be clear, we expect this sloppy/sideways trading range to continue with first level of resistance near 2020 and support for the S&P 500 near 1867. Clearly, the Fed is “market” dependent, not “data” dependent. Want more? Consider Joining FindLeadingStocks.com

How To Find Leading Stocks During Corrections… & 3 Leaders For Your Review

1111SBUXHow To Find Leading Stocks During Corrections…
Our longstanding readers know that one of our favorite ways to make money on Wall Street is to find and own leading stocks. We keep things simple and define leadership by looking at the strongest performing stocks in the market at any given time. Why? Because, by definition, those are the stocks that the big institutions are accumulating. History shows us that the strongest performing stocks in the market refuse to budge when the market falls and are the first to rally when the market moves higher.
How To Find Leaders – Look For Strong Relative Strength
A great way to find leaders is to find stocks that exhibit strong relative strength. Relative strength simply means that stock A outperforms its peers and the major indices. These stocks, by definition, are the strongest performing stocks in the market and are typically trading at/near new high ground even if the market is moving sideways or in trouble. The stocks that exhibit the strongest relative strength tend to be the biggest leaders when the correction is over. It is important to note that the rules change in a bear market.
Lots of Setups – Even In A Weak Tape
2015 is a great example of a narrow group of leaders acting well even as the major averages are not acting well. The major indices moved sideways from Jan-August with support  near 2040 in the S&P 500 and resistance near 2134. During time, leadership narrowed considerably but the stocks that were “leading” acted very well and enjoyed very nice gains. Then on Thursday, Aug 20, 2015 – (the Thursday before the Monday 8/28 crash) the S&P 500 sliced and closed below support 2040 – and plunged considerably over the next few days. Since the huge Aug 28, 2015 sell off the market has moved sideways to digest that big decline (normal action).
Conviction Leaders List – Get List Now
Right now, we have a list of 50 leading stocks that look GREAT – even though the major indices are in trouble. Our conviction leaders list is sent to members at FindLeadingStocks.com.  Next week is end of month and end of quarter -barring some unforeseen sell-off, we would not be surprised to see an end of month or end of quarter bounce (window dressing) from here. No positions at the time of this writing.
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10 Reasons Why The Fed Will Not Raise Rates Next Week

​​Where’s the Data?  & Would You Place This Trade? 

We know anything is possible but based on the “data” we don’t see a powerful reason for the Fed to raise rates when they meet on Thursday and here are 10 reasons why:
  1. First and foremost – The Fed is data dependent – Where’s the “data” that warrants a rate hike right now?
  2. The Fed has a dual mandate (help the economy/jobs and keep inflation near 2%). Right now neither one of their mandates are being met so why would they raise rates next week? 
  3. The Global economy remains lackluster at best and is slowing (even with rates at zero)
  4. Japan, Canada, Australia (major trading partners) are already in a recession
  5. Commodities are in a bear market (forecasting a recession)
  6. Transportation stocks are in correction territory (forecasting a recession)
  7. Deflation remains more of a threat than inflation – across the globe (even with rates at zero)
  8. The IMF and other important economic entities have publicly asked the Fed not to raise rates in 2015
  9. The Fed has placed the perfect hedge by saying they are data dependent. We’ll raise rates when the data improves… But if the data gets worse – we are open to either A. Not raising rates or B. Printing more money (QE 4) to stimulate both Main St and Wall Street…
  10. Risk/Reward: What’s their downside to waiting? Inflation? Doubtful… On a simple risk/reward basis- the “data” suggests the upside to waiting greatly outweighs the downside. Especially given the “bearish” action we are seeing in so many asset classes.
Bottom Line: If you were a voting member for the FOMC: Would you place that trade? 
2 Bullish Reasons The Market Can Rally AFTER the Fed Meeting
We could easily see a “bullish” outcome next week:
1. The Fed does nothing and stocks rally because easy money is here to stay.
2. The Fed raises rates by a quarter point (which is really symbolic in nature) and stocks rally because that is already “priced in.” Meaning, late August’s sell-off priced in a Fed hike.

We don’t believe the Fed will raise next week but of course we are open and know anything is possible. In the short term, the next level of support is 1867 in the S&P 500 and the next level of resistance is 1993. By definition, until either level is breached we expect this sideways action to continue. To be clear, if 1867 is broken, we expect another big leg lower to follow.
 

FindLeadingStocks Update: Sideways Action Continues…For Now & 3 Bullish Points To Keep In Mind

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Market Outlook…
The following is an excerpt from a FindLeadingStocks.com intra-week update… The market continues to “pause” and “digest” late August’s steep sell-off which is perfectly “normal” and “healthy” especially after a big move. So far, our call that the market placed a near term (potentially long term) top on Aug 20, 2015 remains in play.  
 
Sideways Action Continues Until These Levels Break
By definition, we expect the market to move sideways until the benchmark S&P 500 closes above near term resistance (1993) or below near term support (1867). Stepping back, the market is weak and the fact that it can’t bounce from deeply oversold levels leads us to believe it wants to move lower from here. Of course, the giant elephant in the room is the Fed. They are scheduled to meet on 9/17 and hold a press conference which is always fun. 
 
The Fed’s Dual Mandate
We don’t believe they will raise rates but with the Fed, anything is possible. Remember, the Fed has a dual mandate: Help the economy/employment and keep inflation near 2%. Right now, the global economy remains lackluster at best and deflation remains more of a threat than inflation. So if neither one of the Fed’s mandates are being met: why would the Fed raise rates next week? 
 
3 Bullish Points To Keep In Mind
To be clear, the market is in correction territory and has formed a new downtrend. But if the market turns higher (enter any positive headline the market wants to focus on) -we can easily move higher from here. Here is the “bullish” case for stocks to rally:
1. Fairly Valued: We do want to note that they S&P 500’s P/E ratio is in the mid teens and we haven’t seen a major market top with the P/E below 22 in the past several decades. That doesn’t mean we can’t top out with a lower P/E ratio – It just means that it hasn’t happened in the last few decades.
 
2. Rates Are At Zero: Secondly, rates are at zero- we haven’t seen a big top in U.S. equity markets when rates are at zero anytime in recent history. Again, that doesn’t mean we can’t top out with rates at zero – it only means it hasn’t happened yet.
 
3. “Only” 8.5% Below A Record High: Even with all the negative headlines, heightened volatility,  and steep selling, the S&P 500 is “only” -8.56% below its record high!  One would think we are down much more. Just some food for thought in case we decide to rally from here. 
 
Bottom line: For us, we need to see the S&P 500 jump above 1993 and then back above 2040, then 2050 before we will turn bullish on the market. As long as we stay below 2040 – by our rules – we have to expect this sloppy sideways-to-lower action to follow.  

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