by Franklin J. Parker, CFA
- It is Fed week! The Federal Open Market Committee (FOMC) meets to debate ongoing policy as well as set the target Fed Funds rate. We expect no change in policy at this month’s meeting. However, investors will parse the Fed’s language to gauge when the they might begin to slow their current pace of asset purchases (known as tapering).
- Stimulus checks are expected to post to accounts this week. A survey by Deutsche Bank indicated that about a third of these checks would flow into stocks (an inflow of about $170 billion). Those inflows will probably be concentrated in “meme stocks” (like AMC and GME). MSFT is another benefactor of the stimulus package: nearly 1/3 of the funds directed toward cyber security are expected to flow to the software giant (some $150 million).
- Biden is expected to unveil a tax bill in the coming week or two. Among others, we expect to see an increase in corporate tax rates from 21% to 28%, increasing income taxes for people earning more than $400,000/year, and treating capital gains as income for people who earn more than $1,000,000/year. Once the bill is presented, I would expect investors to re-price shares in direct proportion to the new taxes. This would be a short-term repricing, though a protracted political battle would add to market volatility.
Tax policy is obviously a highly political issue. Because of its politically-charged nature, it can be difficult to garner clear analysis of its effects on markets. As investors, our first job must be to develop expectations which are as dispassionate and as accurate as possible, and since such analysis is difficult to find, I spent some time looking at markets in 1992—the last time tax rates were meaningfully increased. Some disclaimer here is warranted: there are always many factors influencing market prices. It is, therefore, very difficult to tease apart the effects of tax proposals from other macroeconomic factors that were in play at the time.
The story in 1992 is pretty simple, and coincides with our expectations. In February of 1993, Bill Clinton proposed increasing the top income tax bracket from 31% to 39.6% and higher brackets for corporate taxes (from 34% to 38%). Markets trended down about 6% over the following months, then traded sideways as the bill was debated in congress. It was a contentious proposal, and there were shifts in sentiment as the debate progressed. It seems reasonable to attribute some of the market selloff to investors adjusting their portfolios in anticipation of the coming tax changes.
When the bill became law in August of 1993, markets again adjusted. However, these adjustments were relatively short-lived, and markets found their footing in October of 1992, rallying to end the year 6% higher. And, of course, the 1990s would go on to be one of the best decades in stock market history.
In the end, tax policy does matter. Like any other factor, investors will adapt and adjust to accommodate it. However, it is not the only factor that matters to markets. Indeed, there are more powerful effects which can overshadow any tax policy effects (like economic growth and monetary policy). While investors should be cognizant of tax policy, it should not loom too large in portfolio decisions. As with anything, we must keep it in perspective.
The lessons of 1992 seem to indicate that policy debates can add to market volatility as investors jostle portfolios in anticipation of tax adjustments. However, that volatility tends to be short lived as tax policy fades into the background and other macroeconomic factors become top-of-mind.
Chart of the Week
We get data on industrial production this week. A look at the quarterly change in total productivity tells the story of who is working where. Much of the recent recovery in jobs has been in the services sector, which tends to be more labor-intensive than manufacturing—that is, the leverage of technology is more pronounced in manufacturing than in services, so a manufacturing worker is considerably more productive per hour of work than a services worker. From a metrics perspective, then, as services become a greater component of an economy, the economy appears to grow less productive.
In the most recent quarter, economic productivity contracted at the fastest pace since 1981, but this was after expanding at the fastest pace on record. The productivity expansion two quarters ago was driven by the re-opening of manufacturing capacity, while the recent decline is the story of re-opening the services sectors.
This is, in fact, good news, though it may appear to be bad. It is always important to dig into why a data point is what it is, rather than simply accept it at face value.
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