As the second quarter kicks off, the market’s focus is on the important events that will shape policy for the next few years. Aside from the ongoing COVID-19 virus and the border fiasco, the new “elephant” in the room is the President’s tax policy hidden within a large infrastructure spending bill. All eyes are watching the emergence of the Biden tax plan.
Before sharing any concerns or opinions about the tax plan, we have to share our optimistic prognosis for markets and the economy considering the known factors that are already in place. The vaccine effectiveness will add additional GDP and earnings growth to an already rapidly healing environment. The move to normalization will buoy spirits and profits along with it. If left alone, we believe the economy is capable of growing at a 5% annual clip this year. Corporate earnings for the S&P will easily increase by 10% over last year’s earnings levels. This is good stuff for the markets; so, we begin our analysis there. Unfortunately, the folks in Washington will not likely leave this economy alone.
The Biden $1.9 trillion spending plan that was pushed through has already affected interest rates and bond investors negatively over the last few weeks. Fears of inflation emanating from the carefree spending attitude in Washington has spiked interest rates, creating a positive yield spread for our currency when compared to most other currencies. The stronger dollar that results from this positive carry has hurt the price of precious metals in the market place.
Higher interest rates have also hurt technology stocks, effectively pushing down price/earnings ratios for these high fliers.
Industrials with adequate production capacity and lots of earnings leverage took up the slack this quarter and provided the market with new leadership. The likes of Caterpillar and Deere and some railroads led the change, pushing the Dow Jones Industrial Average above 33,000. Fortunately, we began rotating to these names in the fourth quarter of 2020, so we kept growing portfolio values throughout the quarter.
Along with additions toward more cyclicality, like Cummins Engines, Tractor Supply, Home Depot, and W. W. Grainger, we pared back holdings of Apple, Microsoft, gold miners and the gold ETF. In our view the current portfolio is structured properly for the environment that we see immediately ahead.
What comes next?
Now we have to address the elephant in the room—Biden’s tax plan.
Unfortunately, there are no positive economic effects that can come from any one part, combination of parts, or the adoption of the entire plan. The corporate tax increase will hurt corporate earnings, the individual tax plan will diminish savings for investment and directly diminish investment returns. Same goes for the inheritance tax changes. There is no positive message anywhere for investors.
Additionally, Treasury Secretary Janet Yellen has introduced a global minimum tax for consideration by other nations. The logic here is to have all foreign countries at an equally high tax rate as the United States in order to discourage American business from leaving the U.S. for a more attractive foreign domicile. All in all, pretty negative stuff for the global economy as well. We can only watch to see if there are any takers in foreign countries.
We are already studying the effects of the proposed tax increase on our investments and are looking for other opportunities that may exist should the proposals become enacted into law. Unfortunately, that’s about all that we can do at this point in time. We are making plans, but are putting nothing in place until we see actual change enacted. The process promises to be torturous, but in the meantime, the economy and the market will have their own lives. We will be monitoring all of it.
Once again, we thank you for your trust and loyalty.