We were happy to see a peaceful transition of power at the Presidential Inauguration today and look forward to unifying our country. In today’s update, I’ll cover the proposed stimulus bill and possible tax and infrastructure policies coming out of the new administration.
Biden Unveils $1.9 Trillion COVID Stimulus Plan
President Biden’s proposed stimulus plan includes a central promise for most Americans to receive direct payments of $2,000. However, it has been reduced by $600 from approval by the Congress and President Biden in December. President Biden is pushing for $350 billion in funding assistance for state and local governments plus $20 billion for public transit systems.
President Biden would also like to extend the unemployment benefits until mid-March. What was new with this proposal was that President Biden called for doubling of the minimum wage, from $7.25 to $15 per hour. The wage increase will seek to end the compensation structure for those in the service sector, who are largely compensated through tips and have a minimum wage of $2.13 per hour.
This $1.9 trillion economic package is largely in line with what was previewed by the press. But if you looked at the banks, they were expecting $750 billion to a trillion dollar range. We think a lot of that has to do with President Biden taking a moon shot for negotiation reasons. Not only will the Republicans balk at those numbers, it is probably even overly aggressive for centrist Democrats.
Centrist Policy Views
We have been using a lot of Goldman Sachs analyses, because we believe they have credible information and great visual representation. The graph below shows us the political spectrum that many people in the Senate are falling on.
In the center, we can see that there are more centrist Republicans than extreme Republicans. On the flip side, there are more extreme Democrats than centrist Democrats. Therefore, the Senate has more in common with that centrist Republicans than they do the extreme Democrats.
President Biden has said that he does not want to use the reconciliation process — which requires 60 votes — to pass this bill. Even if the bill were to use reconciliation with a 50-50 split in the Senate and very narrow margins of the house, it would require basically every Democrat to vote unanimously. That’s a pretty tall order, based on the chart above. Therefore, this is likely to constrain what Democrats might accomplish even via that reconciliation.
Second, the reconciliation process has never been used to pass discretionary spending. It appears that half of this proposal (including state and fiscal aid, education grants, and public health spending) will fall in this category where the centrist Democrats probably are going to push back and not pass the bill in its entirety.
Coronavirus Relief and Fiscal Stimulus Proposals
President Biden has released the details of his COVID-relief plan, which the transition team estimates to cost $1.9 trillion (8.6% of GDP). We do not expect all of the elements of the proposal to pass, with revisions in areas that have been contested for some time. Near-term fiscal measures from $750 billion (3.4% of GDP) to $1.1 trillion (5% of GDP). This is likely to be the first of two major proposals with a second proposal dealing with taxes, infrastructure, and benefit programs to pass around mid-year. Again, this is likely why President Biden is putting out such big numbers early on — so he can has negotiating power for a package closer to $1 trillion later in the year.
Will Personal Taxes Rise?
We’ve been getting a lot of questions from clients along the lines of, “With both the House and Senate now controlled by Democrats as well as President Biden, what will it look like under Democratic rule?” We don’t subscribe to dire straights people have put out there that things will be fundamentally different.
Upper-income tax rates will most likely increase to finance other personal tax reductions. But if you look at the graph below, you may be asking yourself who is going to bear the brunt of that at 0.1% or the top 1%? Well, 95-99% percentile and income is going to see a marginal increase in their taxes.
Congress will likely reverse some of the individual income tax changes that Congress passed in 2017, but a net increase in personal taxes is not expected. Specifically, Goldman Sachs believes the top marginal rate to go back to 39.6% from 37% and limitations on itemized deductions to return. However, since the changes the 2017 tax law made in both of those areas expire after 2025, this would only raise around $160 billion over ten years, according to estimates from the Tax Policy Center.
For more context, many of these 2017 tax laws were passed via the reconciliation process at the time. They were only able to pass with a number of timetables and sun setting clauses for when they expire. So, Democrats don’t even necessarily have to increase taxes at this point — they can just let the 2017 tax laws expire, and many of the changes would go away.
We do not think we need to have increases in taxes, but what we do think is more deductions for state and local income and property taxes. A higher income tax and other taxes were benefiting from the deductions. Having some type of slight increase in the taxes with a reduction in or bringing back those itemized deductions in some manner will probably be some type of tax increase.
There have also been questions regarding Social Security taxes. Biden's proposal is to apply 12.4% of Social Security payroll tax on incomes over $400,000, which would probably be the biggest tax increase seen in his policy. That's unlikely to go through, because it cannot be done via reconciliation and would need those 60 votes. Therefore, the item that is probably the largest tax increase is arguably the most unlikely to get pushed through.
Will Capital Gains Taxes Increase?
What about capital gains taxes? Capital gains taxes are unlikely to rise as much as President Biden has proposed. During the presidential election campaign, President BIden proposed that long-term capital gains and dividends should be taxed at the rate of ordinary income tax – 39.6% for any individual whose income was over $400,000. It's harder to roll out any tax increase on capital gains and dividends. However, if the Congress does re-raise the rates on capital gains and dividends, it is a good thing to point to.
Will Corporate Taxes Rise?
Continuing with Goldman’s analysis, they expect that corporate tax increase to be no more than 25%. This is in line with the corporate tax rate that President Biden campaigned on. There is not going to be sufficient support for congressional Democrats to implement these proposals, but there will be enough support amongst centrist Democrats to raise the corporate tax rate, probably around that 25%.
One thing to note is that each percentage point increase will generate a $100 billion in additional revenue, according to models (we all know an increase in taxes would also change behavior). This would increase about $400 billion over the next 10 years. This shows you how much more spending is happening vs. additional revenue.
The infrastructure plan is likely going to focus on taxes, infrastructure, and renewable energy. The believed price tag is at $3 trillion. We won’t get deep into this yet, since we haven’t even seen a proposal (which will likely come at the end of summer). For the infrastructure build to be proposed, there has to be some type of consensus to the moderate Democrats with some of the Republicans.
The money supply is the green line. We can see that it is above the money supply growth all the way back to 2012. A lot of it is the $600 stimulus checks that are starting to hit people's banks account and we still have the $1-2 trillion package that is being presented for the next stimulus package.
Fed leadership has been pushing back against premature tapering, which could constrain the money supply growth. They want to see a 2% inflation for a year before raising rates. Why is that important? Usually once it hits an annualized 2%, the central bank would begin to slow the money supply growth because you do need to get ahead of inflation. If you let it continue on for a full year you risk runaway inflation. Fed Chair Powell said the economy is far from the Fed’s employment and inflation goals. Therefore, it is not the time to be talking about exiting the market with a aggressive monetary policy.
Q4 Earnings Begin in Earnest
Earning season is wrapping up this week, even though it is a short week. We are going to see 43 companies in the S&P 500 to report.
The consensus expects the S&P 500 to report the fourth quarter year over year earnings percentage growth of -11% as virus restrictions still are tampering the growth of cyclical sectors.
U.S. Consumer Prices Rise for 7th Straight Month
Now we’re back to our inflation theme. We’ve seen prices rise for seven straight months, a rate we haven’t seem for some time. Consumer price has all items in that basket. There’s still a drag on services, because restaurants and service companies are not moving up. However, we are beginning to see that roll off as well. Commodities are leading the charge (think food bills — we’ve all seen that), but gasoline is beginning to move up as well. A lot of the things that have been holding the Consumer Price Index back, but now have a stabilized based and are beginning to move up.
Price Points for Dollar Cost Averaging
Let’s look at price points. The market continues to trend up. We can see that long-term trend — a slope of about 10% annualized. We expect to see long-term rates around 6% for equity returns after adjusting for inflation. With 10% you're going to have pullback to dampen that slope as well as inflation pulling some of that off. We are certainly in line with how the market continues to react.
A lot of people are worried about market valuations with the amount of stimulus that is being produced, both fiscal and monetary that the market is acting in a rational way, and it is not significantly overvalued. Everything is certainly priced to rich premiums. However, when you consider other options, we think equity markets are attractive, and that is why they continue to move up.
U.S. Dollar Index
If we look at the dollar index the last couple of weeks, we have seen a stabilized price and the dollar, though we are near lows. We ultimately expect the dollar to push further below and we will move into a cycle where the dollar has been declining relative to other currencies, after it has been strong for so long.
Near Term Relative Strength
Despite severe headwinds for small companies, large businesses increase taxes with a possible increase of the minimum wage, which would certainly hurt the smaller companies. They have a lot of bumps in the road, but nonetheless these companies are outperforming the other sectors. This has been an area that continues to outpace. Just during this time frame, the S&P 500 is the leading index up 6.33% for the year, but obviously things will continue to change.
We expect to see a number of changes over the next 100 days of the Biden administration. We don’t see anything extraordinary that will impact the market negatively, but we are always ready to address black swans.
What’s more important than unknown risk are the unknowable. For now, we believe the market and economy will move forward throughout 2021.
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss. Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.