There are only 2 things certain in this world
Taxes are one of them. Increases to fund infrastructure could prove disruptive.
President Biden came to my hometown this week, bearing a new populist mantle and a bag stuffed with stimulus. The symbolism was hard to miss. Rust Belt Pittsburgh, once the world’s largest producer of steel and now a center for Eds and Meds, and Pennsylvania, Biden’s home state that sealed his Electoral College victory. What he hopes to pass is the most consequential policy shift since Ronald Reagan in the 1980s. There’s been no GOP input. Biden and the Democrats are swinging for the fences—$2.3 trillion on broadly defined infrastructure, and another $2 trillion or so to come for a social agenda. The colossal plans include the broadest and biggest tax increase since FDR and one of the biggest expansions of federal spending in decades. Unlike other presidential wish lists, this might be financeable given current low interest rates, the political will to raise taxes and the belief by some on the Left that such a chance comes along rarely in American history. Once it’s all out there, TIS Group expects to see free community college, kindergarten and child-care centers. Universal health care. An 80-year support system for every person in America. Highly energy efficient housing. 500,000 electrical vehicle charging stations. New transmission lines to move new renewable energy to the market. And a lot of taxes. On every mile driven (vs. on gas). On capital gains. On individuals and/or households (unclear at this moment, actually) earning above $400K. On corporations. But borrowing is likely to be the signature policy, raising questions about how much higher it can go without breaking the U.S. bank. The nation’s borrowing capacity is already near the Congressional Budget Office’s $30 trillion target for the decade.
Worries over massive new issuance and inflation saw the Treasury market post its worst quarter since 1980. But even after their Q1 run-up, yields on longer-dated government bonds are still historically low, real yields remain negative across most of the curve and the longest yields have started to flatten. This suggests once the Covid crisis and stimulus sugar high fade, the economy may grow no faster than it did in the post-financial crisis (GFC) years. This also may help explain why consumer staples have outperformed recently (that and the fact they were the last holdout in past year’s Covid relief rally—the tape is broad). Still, Evercore ISI thinks we may be headed for an enduring cycle of higher inflation than was the case in the post-GFC years. This, after all, is what the Fed wants. It’s shown no interest in moving to rein in the 10-year. During 2013’s taper tantrum, the real 10-year yield jumped 160 basis points in five months; it’s up only 50 basis points so far. In this uncomfortable balance between inflation fears and negative real yields, Strategas Research thinks the latter will give. If it’s right, this could further narrow equity risk premia—the extra return above Treasury rates investors demand to take on risk—that already are near GFC lows. Tack on higher corporate taxes the market doesn’t seem to be pricing yet (estimates on the impact on 2022 S&P 500 earnings-per-share are all over the map) and tougher seasonality come along May, and the market could be setting up for a correction. If it comes, Ned Davis sees strong support at 3,700, with the pullback offering a buying opportunity into a market that’s still relatively early in the cycle with stronger macro fundamentals ahead.
We are now at a point in the cyclical recovery where P/E multiples should start to contract. But Strategas Research believes the push/pull between the fiscal stimulus and potential tax increases adds an unknown variable, with the fiscal drag from higher taxes mattering less than in normal times due to the economy’s reopening (it thinks the U.S. could create 1 million jobs per month in coming months) and due to the massive build-up in personal savings (Americans hold more than $2 trillion in savings currently). Even with a flattish to declining P/E, the market is being driven by earnings, with the S&P topping 4,000 this morning on the back of an improved EPS outlook. All three of the major indexes (Dow, S&P and Nasdaq) rose in Q1, when $78 billion flowed into equities, exceeding the total additions for all of 2020. Small caps posted the best absolute gains. And value led in March as last year’s stay-at-home winners gave way to this year’s cyclical value names, with energy and financials at the top. Biden’s determination to press ahead with tax increases surprises some. Political prudence suggests putting them off lest they slow growth and harm Dems with their slimmest of majorities in the midterm elections. But Biden is proving to be a populist and is emboldened by polls showing a majority of Americans support higher corporate taxes. Who’s up next to sit atop the Wall of Worry? Forget Covid “impending doom’’ (the new CDC director’s worry in the race against vaccines and rising cases), private offices blowing up, inflation/yields, Suez crisis, meme stocks or valuations. As Daddy used to love to say, “There are only two things certain in this world—death and T-A-X-E-S.’’
- 'Big mo' in the factories March’s ISM manufacturing PMI jumped to a 37-year high, adding to soaring regional reads in Chicago and Dallas, with the Windy City barometer its highest since July 2018.
- 'Big mo' in the workplace March jobs that come out tomorrow are expected to be a blowout, and ADP private payrolls rose 517K, the most in six months. Improving labor market conditions and household finances (the ratio of household financial assets to disposable personal income is at a record high) helped push Conference Board consumer confidence to a 1-year high.
- 'Big mo' on the ground and in the friendly skies ISI’s trucking survey returned to a 21-year high, its homebuilders’ survey hit a new high and airlines’ forward revenues rose a sixth straight week to their highest level since the pandemic started. For the first time since ISI began asking the question last May, clients’ comfort level with getting on a plane was viewed as “comfortable.”
- A formula for inflation? Pending home sales plunged in February by the most since last year’s lockdown, dropping year-over-year (y/y) sales into the red for the first time in nine months. While winter storms hurt, the biggest factor was record-tight housing inventory.
- Blame the weather Construction spending fell in February after an upwardly revised gain for December and January, with private residential and non-residential outlays falling sharply as winter storms brought activity to a halt.
- Bracing for temporary (fingers-crossed) inflation The prices-paid indexes in this month’s regional manufacturing surveys rose to an average 66.8, the highest in their history going back to mid-2004, versus 4 a year ago, when demand collapsed amid the first wave of pandemic shutdowns. The next few months are expected to see similar y/y impacts in the CPI, PPI and PCE reports.
Seriously not letting a crisis go to waste! From the opening paragraph to Biden’s infrastructure plan: “… This is no time to build back to the way things were. This is the moment to reimagine and rebuild a new economy. The American Jobs Plan is an investment in America that will create millions of good jobs, rebuild our country’s infrastructure, and position the United States to out-compete China…. [It] will invest in America in a way we have not invested since we built the interstate highways and won the Space Race. …”
Newly prudent meme stock losers, perhaps? When stimulus recipients were asked for their four top priorities for spending it, savings accounts scored highest at 46%, followed by paying debts (34%), groceries (30%) and an emergency fund (26%). A Robinhood account came in 11th with just 7%.
A good reason to buy that classic car, perhaps? With U.S. stocks at an all-time high compared to U.S. housing, bonds at an all-time high compared to diamonds and commodity returns at multidecade lows, real assets such as real estate, precious metals, wine, art and cars arguably are cheap and, Bank of America notes, can act as a nice hedge against inflation.