Hope lies in dreams, in imagination, and in the courage of those who dare to make dreams into reality. ~ Jonas Salk, developer of a successful polio vaccine (1914-1995)
The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy. ~ Martin Luther King, Jr., (1929-1968)
On the economy
2020 was hugely transformative, socially, politically, and of course, economically. The unexpected whiplash of this recession, which has looked more like a natural disaster than a traditional financial collapse, is now officially behind us. Millions in our country did very well last year, all things considered, but millions are still suffering. The federal government will carry into 2021 the stimulative fiscal and monetary actions that have spilled out money into the economy to try stem further damage. The full arc of the pandemic’s economic story will be years in the making and we are still in the early chapters.
At the start of the 4th quarter there was the glimmer of hope. Vaccine development by U.S., U.K., German and Chinese companies, a feat that usually takes five to ten years to develop, occurred in a mere 10 months and with extraordinary effectiveness. Although only two (from Pfizer/BioNTech and Moderna) are approved for use in the U.S., one from Johnson & Johnson appears on its way. It is worrying that the subsequent distribution to the public has been so complicated. With dozens more vaccine candidates in clinical trials or the final stages of testing, the way out of the crisis is modern science. No amount of fiscal stimulus or physical distancing will bring to this battle what inoculation can.
This winter is going to remain challenging, with jobless claims increasing now that the holidays are behind us. States need federal financial help as tax losses will continue into 2022 and beyond. Even if costs related to healthcare, unemployment and extra policing do not continue to be budget drags, income tax receipts, and therefore gainfully employed individuals, will not pick up the slack for years. Yet full year predictions for economic growth are rosy.
Overall U.S. growth is expected to be 4% for the year, a rate the U.S. has not hit in years. A side effect could be inflation, much spoken of but not seen in a decade. There may be a burst of inflation later this year when stay-at-home orders are lifted and spending on vacations and parties and anything out of reach in 2020 takes hold. More persistent inflation could be an issue for governments awash in debt and a stock market at all time highs. This is an important data point to watch.
While all the stimulus paired with vaccines will be a boon for Main Street, on the other side is the looming Biden Administration tax hike bill, which is not an “if” but a “when” kind of event. More on that below.
2021 seems set to be another transformative year but with positive momentum, despite the bifurcated economy.
On the markets
Last year’s rally in markets made for a head-scratching year. Once the lows in March were in for stocks, the market started its stumble, and then rush, back up in prices. Driven by the rock-bottom borrowing rates and the Federal Reserve’s asset purchases that propped up all companies, regardless of quality, there was nary a subsequent news headline that seemed to distract the rally. Investors bought stocks when jobs were lost and gained and lost again. They bought more when the vaccine success was announced. More so when in November it was believed that there would be a politically divided Congress. After January 5th there was more buying once Congress officially tipped ever so slightly Democratic. Now as the pandemic rages on, with more COVID-19 deaths the first week of January than in all of last year’s influenza season, investors are still buying.
At this point, when corporate profits still have much to recover after the lost opportunities of a shuttered economy, stock prices are buzzy. Now, we know that 2020 performance just “borrowed” from the earnings expectations of 2021 but also 2022. Of course, stocks always trade on future expectations. We saw “borrowing” in 2018 and 2019, where 2018 saw double-digit profit growth, in part spurred by corporate tax cuts, and flat market returns. 2019 got double-digit market returns and unimpressive profits. So it could happen like that.
Fourth quarter profits, to be announced any day now, will have likely bottomed out. By late 2021 the numbers are predicted to be much better.
Already the trend in hot stocks that have driven this remarkable rally is turning. Small cap stocks, which often prosper early in economic recoveries, are hot. The Russell 2000 Index, a small cap barometer, was up nearly 30% in the 4th quarter alone, easily outpacing the S&P 500 since the fall. Value stocks, under which category most dividend-payers fall, have also seen stronger performance into the 4th quarter, up 16%. These are areas that were behind in the recovery compared to the major indices, which were fueled by stunning price appreciation by the technology, healthcare and “stay-at home” companies.
Underneath the strong returns, some trends look very worrisome. For starters, the overall market does look very expensive compared to history. The chart below shows in blue the price-to-earnings ratio of the S&P 500 at 33.4 based on rolling 10 year earnings per share. We also know that margin debt is very high, a metric that peaked ahead of both the 2000 and 2008 bear markets. Then the excitement about buying companies with no revenue, often no product or business model, is dizzying. Investor enthusiasm for just about anything new and different, fundamentals aside has at a fever pitch. At the risk of repeating ourselves, we worry about much interest in companies with no product, plants or revenues, like Nikola and SPACs.
On personal finance
The Biden Administration is about to bring down the hammer on our current tax legislation. The slight Democratic tilt in Congress now gives President-elect Biden more opportunity to pass his tax initiative. At present, his plan is expected to raise over $3 trillion over the next decade if enacted in 2022, most of that from corporations.
According to the Tax Foundation, the Biden plan would impose the industrialized world’s highest income tax rate on businesses. U.S. corporate income is already taxed twice by federal and state governments; first the business pays tax on the profits and then the shareholders pay tax on dividends and capital gains. The Tax Foundation notes that the Trump tax cuts pulled corporate integrated rates down to an average 47.47% in 2020. To compare, the international average corporation rate is 41.6 %, based on the 37 country members of the OECD.
While there is always plenty to be discussed regarding companies paying their fair rate, and it is true that many pay nothing at all and receive generous government handouts at the same time, it is not the companies that always suffer. Workers do. Employees ultimately get stuck with the tab through lower wages, benefits and advancement opportunities.
Not so long ago the Obama Administration tangled with concerns about companies moving overseas to avoid onerous taxes. It was widely acknowledged as an unwanted problem. Through experience we know that higher taxes dampen wages but also investment, research and innovation. It drives people and businesses to friendlier tax havens.
Additionally, it is possible that long-term capital gains and dividend rates, which have been locked in at 15% for most everyone since the Bush Administration, may get a boost. (Other tax brackets exist; single filers making over $440,000 already pay 20%; those making less than $40,000 pay 0%.) Those gains would instead be taxed at ordinary income rates, which also will be subject to the Biden bump.
Given so many other pressing items, expect a bill to be passed this year with implementation in 2022 or later. Perhaps by then some more creative ideas will emerge that were not a part of the campaign trail rhetoric. In the meantime, it is wise to consider options to manage personal finances as necessary.
Disclosure
Statements and opinions on financial markets and economics are based on current market conditions and subject to change without notice. Due to the rapidly changing nature of financial markets, all information, views, opinions and estimates may quickly become outdated and are subject to change or correction. We provide information from reliable sources but should not be assumed accurate or complete.
Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
This information is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Serene Point Advisors and its affiliates do not give legal or tax advice. You are encouraged to consult your tax advisor or attorney.
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