Charges

by Larry Levin

I was speaking to a friend over the weekend about the health care bill that was just passed and he wanted to know if there were any immediate impacts on the economy. He wanted to gloat - expecting nothing at all to change in any part of the economy. When I explained how major corporations were taking huge charges on their balance sheets due to the new bill, he was upset; his thoughts of nirvana were dashed.

Since then I came across the following article from Karl Denninger that covers this exact subject at

http://market-ticker.denninger.net/archives/2129-Consequences-Of-Health-Care-Valuations.html

Consequences of Health Care: Valuations

Yeah, I know, Obama has said that there would be no "material" impact to finances until 2014.

Liar.

Truth: Caterpillar and John Deere already announced non-cash charges of $100 and $150 million, respectively, for this year based upon the impact of this bill on forward retiree health care costs.

The law says you must account for such changes when you become aware of them, and that would be now.

But today a 100-kiloton device landed on AT&T's (NYSE: T) balance sheet - they announced a one billion dollar non-cash charge:

On March 23, 2010, the President signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (HR 3590). Included among the major provisions of the law is a change in the tax treatment of the Medicare Part D subsidy. AT&T Inc. ("AT&T") intends to take a non-cash charge of approximately $1 billion in the first quarter of 2010 to reflect the impact of this change. As a result of this legislation, including the additional tax burden, AT&T will be evaluating prospective changes to the active and retiree health care benefits offered by the company.

Oh, there won't be any material impacts until 2014 eh?

I told you that was BS, and now you're seeing it. If you're wondering how this stacks up, AT&T had revenue of $123 billion and a reported profit margin of 10.19%, for a net profit of $12.54 billion.

This represents about 8% - for this quarter.

Caterpillar (NYSE: CAT) reported $32.4 billion in revenue and a 2.76% profit margin, with a net income attributed to common of $895 million. Their $100 million charge amounts to 11% of that income.

John Deere (NYSE: DE) reported $22.8 billion in revenue, a 4% profit margin and $912.80 million in net profit; their $150 million charge amounts to 16% of net income.

Still think this is no big deal eh?

I will note that "EPS", or Earnings Per Share, is how we value stocks. These valuation "hits", if they are somewhat representative, imply that stocks instantly became overvalued by somewhere between 10-15% when President Obama's pen hit the paper.

I hope (1) you have enjoyed the market rally and (2) have hedged yourself, as the efficient market hypothesis says that this new information will shortly appear directly in stock prices.

PS: The impact gets worse as current employee costs ratchet upward - these charges are only against retiree obligations for existing retired workers that remain as liabilities to the firm.

To expect that the total impact could easily reach 20% or more of net profits over the next couple of years is not at all farfetched, and the market should soon start discounting that too.

So Karl believes the market needs to reset share prices lower due to the health care bill. Clearly that would be true - if the market was rational. With the Fed's ZIRP (zero interest rate policy) it is no longer rational. Moreover, I still believe that the market will trend higher this week due to both the tradition of marking-up stocks at the end of a quarter and the aforementioned ZIRP.

If the market reaches 1,200.00 or so this week, then maybe the whole idea that stocks must go up every day will be challenged.



Previous Day's Trading Room Results:

Trade Date: 3/26/10

E-Mini S&P Trades*
(before fees and commissions):


1) OTF buy @ 10:05 at 1167.00 = +.50 & b/e (2 lots)

2) Algorithm positions (7)

3) "Reading the Tape" positions (15) ...combined Secret's, Algo, & "Reading the Tape" total...-3.00



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