by Paul Hoffmeister, Chief Economist
Vaccination numbers keep climbing; economies keep reopening.
Massive government support and the fading pandemic have contributed to a historic recovery.
That massive support may start to be unwound during the next year, threatening the equity outlook.
According to USA Facts, approximately 45% of the US population (nearly 150 million Americans) have received at least one Covid-19 vaccine dose; and 30% have been fully vaccinated. At the same time, economies continue to reopen. The most significant news recently came from the European Union, with its plan to welcome foreign tourists next month in time for the summer travel season.
All the while, the Federal Reserve is maintaining its zero interest rate policy (“ZIRP”) and bond buying programs, and the U.S. government has spent nearly $6 trillion, borrowing from the future to support the economy today.
The confluence of massive government support and the fading pandemic has contributed to an 89.2% rally in the S&P 500 from its closing low on March 23, 2020 through last Friday. And year-to-date, not including dividends, the S&P 500 is up 12.7%.
Aside from a new, unstoppable Covid variant, the biggest threat to equity markets may be the unwinding of the extraordinary economic support that we see today. That threat may not be imminent, but it could erupt within the next 12 months or less.
On the fiscal side, we are beginning to see the political limit to the outsized spending. Last week, Democratic Senator Joe Manchin, referring to the White House’s $2 trillion infrastructure proposal, said: "It's a lot of money, a lot of money.. Are we going to be able to be competitive and be able to pay for what we need in the country? We got to figure out what our needs are and maybe make some adjustments… We're at $28.2 trillion now, debt, so you have to be very careful. There's a balance to be had here.”
Note, with Democrats controlling 50 seats in the Senate, Manchin is the political margin, i.e. the critical fulcrum vote that will likely decide policy until the next Congress convenes in January 2023. For their part, Republicans have proposed a $600 billion counter-offer for infrastructure. The easy spending days appear to be over, for now.
On the monetary side, Federal Reserve officials are maintaining their dovish posture. On Monday May 5, Federal Reserve Governor Michelle Bowman said, “Despite the progress to date and the signs of acceleration in the recovery, employment is still considerably short of where it was when the pandemic disrupted the economy and it is well below where it should be, considering the pre-pandemic trend.” This dovetails Chairman Powell’s public statements weeks ago that the economy is not yet out of the woods.
But, the Fed’s median forecast for the unemployment rate is for a decline from 6.1% today to 4.5% by year-end. If that level is reached by December, it will not be far from the 3.8% rate of unemployment that the economy was experiencing just prior to the Covid outbreak and lockdowns.
Perhaps that will be the point where the economy will look to be “out of the woods”. This suggests that during the next 6-9 months, the Federal Reserve will begin to telegraph a monetary unwind – of its bond purchase programs and ZIRP.
Last week gave us a glimpse of what this threat may pose to markets today. Treasury Secretary Yellen said in a video released last Tuesday that interest rates may need to eventually rise to ensure that current fiscal ‘stimulus’ doesn’t overheat the economy. At one point that day, the S&P 500 was down nearly 1.5% from its closing level on Monday.
If such a seemingly innocent remark can cost the market that much, how much would an official departure from the current monetary posture actually cost? 10%? 20%?
Investors should reflect on the market tantrums of 2018 to gauge the risks ahead to assess possibly a worst case scenario. In both February and then the fall of that year, while the Fed was raising interest rates, it began to telegraph even more aggressive rate increases. As a result, we witnessed a nearly 10% and then 20% decline in the S&P 500.
In sum, the ”easy gains” in the equity market are very likely behind us – as the economy and financial markets experienced a historic natural disaster/recovery scenario -- and future gains may be much more difficult to come by. If anything, the risk-reward profile for equity investors today appears to be asymmetrically unfavorable.
Tax Update:
President Biden said last Thursday that he wants to see the corporate tax rate increased to somewhere between 25% and 28%. This is a soft backpedal from the 28% that the White House was initially advocating, and is likely due to pushback from within the Democratic Congressional Caucus. Senator Manchin is now on record, for example, to be in favor of a 25% corporate tax rate.
What’s unclear is where moderate Democrats stand on capital gains and estate taxes. President Biden has proposed raising the capital gains tax rate to the top ordinary income tax rate. Under this proposal, the top income tax rate would be raised to 39.6%, and therefore so would the capital gains tax. Adding the 3.8% Medicare surtax, the top capital gains tax rate would rise to 43.4%. Biden also proposes eliminating the stepped-up basis on estates passed to heirs. The backpedal on the corporate tax and quiet surrounding capital gains and estate taxes suggest that a new tax plan will not pass soon; it’s more likely that the plan will be passed during the fall.
DIAL IN FOR OUR MONTHLY
EVENT-DRIVEN CALL
Every 3rd Wednesday at 2:00pm EST
REGISTER FOR CALL
Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).
B219 // Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537
Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Any charts, graphs, or visual aids presented herein are intended to demonstrate concepts more fully discussed in the text of this brochure, and which cannot be fully explained without the assistance of a professional from Camelot Portfolios LLC. Readers should not in any way interpret these visual aids as a device with which to ascertain investment decisions or an investment approach. Only your professional adviser should interpret this information.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798
Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved.