Markets

Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.

Hedge funds are bailing on stocks that would benefit most from President Donald Trump and Republicans' promised tax cuts, suggesting that Wall Street's so-called smart money no longer thinks betting on lower corporate taxes in the near future is, well, smart.

Consider W.W. Grainger Inc. Grainger, which is based in Lake Forest, Ill., makes industrial machinery and parts. It has one of the higher federal tax rates in the S&P 500 Index. Last year, the company made nearly $1.1 billion in pretax profits in the United States and paid $310 million in federal income taxes, for a rate of 29 percent. A drop to 20 percent, the proposed rate in the plan being pushed through Congress, would have saved Grainger roughly $95 million and boosted its profit by 13 percent. What's more, the House and Senate tax bills include a provision to allow companies to immediately write off the full cost of capital expenditures, like industrial equipment, which now typically have to be deducted over time. That, in theory, should also boost Grainger's sales.

Tax Sales
Hedge funds sold shares of W.W. Grainger in the third quarter even though the company stands to benefit from the Republican tax plan
Source: Bloomberg

Nonetheless, according to data compiled by Symmetric Information, which tracks and ranks top investment managers, hedge funds have been ditching Grainger's shares. Collectively, they sold $365 million in the third quarter. The biggest seller was one of Wall Street's hottest hands, quant hedge fund firm Two Sigma. Funds run by the firm sold more than $180 million in shares of the stock. Another big seller of the stock was Renaissance Technologies, which until recently was co-headed by one of Trump's biggest backers, Robert Mercer. Mercer stepped down from the fund earlier this month.

Just a few weeks ago, the common wisdom on Wall Street seemed to be that corporate tax cuts were not only likely but inevitable by the end of the year. A survey last month from Bank of America found that 68 percent of investors thought a corporate tax cut would happen by the end of 2018. That's a big part of the reason the stock market is up nearly 15 percent this year. In the past week, a consensus has been growing that a corporate tax cut this year, or even next, might now be a long shot, compounded by Senate Republicans' effort to repeal the Affordable Care Act’s requirement that most people have health coverage or pay a penalty. The stock market fell again on Wednesday in part on worries that tax overhaul might stall.

Rate Spikes
Stocks and high-yield bonds have sold off this month on fears that Republican efforts to cut corporate taxes could be delayed
Source: Bloomberg

But hedge funds began to have doubts earlier than that. They were net sellers of stocks with high tax rates in the third quarter, according the data from Symmetric. The roughly 200 hedge funds followed by the firm sold $37 billion worth of shares of companies that were among the 100 firms with the highest tax rates in the S&P 500. Among the high tax stocks stocks that hedge funds dumped were drugstore owner CVS Caremark Corp., train company CSX Corp. and automotive parts retailer O'Reilly Automotive Inc.

Hedge fund performance hasn't been all that spectacular for the past few years. But at least for now their bet against the tax plan is looking more and more prescient.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Stephen Gandel in New York at sgandel2@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net