Stocks started out positively yesterday, keying off of several very strong earnings reports from the likes of Facebook, Apple, Caterpillar, and Google, to name a few. As the day progressed, however, we saw a “sell the news” sentiment creep into the market.
This week also heralded two key events: the end of a two-day FOMC meeting and a speech from President Biden outlining another potential large scoop of fiscal stimulus. The result: The U.S. Central Bank will keep short-term interest rates close to zero for a while and will continue to buy back $120 billion of bonds each month. From the President, a new Families Plan was proposed that includes $1 trillion in new spending and $800 billion in tax credits. That is on top of the recently proposed $2.3 trillion Infrastructure Plan and the $1.9 trillion Covid Relief bill that was already signed. 90 million stimulus checks were sent out in March alone.
The Fed will stand pat as long as inflation does not exceed 2% for too long and the U.S. economy marches back toward maximum employment. We still have 8.5 million people out of work since before the pandemic hit. Inflation is expected to rise as we progress through this year, though Fed Chairman Powell suggested that the coming price increases would most likely be of a passing nature and not a persistent problem that would force the Fed to begin raising interest rates sooner than expected. I guess Fed Chairman Powell is “still not thinking about thinking about tapering.” So far, the 10-year Treasury rate is hovering around 1.7% and 30-year mortgage rates remain under 3%.
In terms of the President’s speech, Biden outlined spending for many items including: universal pre-K, federal paid family and medical leave programs, efforts to make child care more affordable, free community college for all, and expanded subsidies under the Affordable Care Act. The plan would also extend key tax breaks including the child tax credit, the earned-income tax credit, and the child and dependent care tax credit. How to pay for it? The President proposed increasing the marginal income tax rate for the top 1 percent of income earners to 39.6 percent from 37 percent. He would also increase capital gains and dividend tax rates for those earning more than $1 million a year and eliminate a provision in the tax code that reduces capital gains on some inherited assets. The Infrastructure Plan alone may require 15 years of higher taxes on corporations to pay for eight years of spending.
This reminds me of ice cream. Some may remember a unique chain of 120 ice cream parlors across the country called Farrell’s. It was a loud, boisterous place with banging drums and player-piano music. On the menu was a huge ice cream sundae called “The Pig’s Trough.” If you were bold enough to finish the sundae yourself, they would quiet the entire restaurant, make you stand up (if you still could) and force you to read aloud the following statement: “I made a pig of myself at Farrell’s.” As with an overloaded dessert, we are continuing to add large scoops of fiscal stimulus to an already rebounding economy. Meanwhile, the Federal Reserve is adding whipped cream and a cherry on top through low interest rates and $120 billion in monthly bond purchases. Some members of Congress will likely stand up and say no to the continued fiscal scooping. Whether the right amount of government spending will be implemented, or way too much, remains to be seen, but for now the party continues until the Fed takes away the ice cream bowl. (A side note: Farrell’s Ice Cream Parlor was eventually burdened by too much debt and closed all of its stores. The last one, in Brea, CA finally closed in 2019).
Do we require all of this additional stimulus if the economy is bouncing back just fine? Unemployment at 6% is still too high and marginally attached workers exceeds 10%. However, GDP grew 6.4% in Q1 and is projected to grow faster throughout the year. The second quarter should be the easiest comparison versus the depths of the Covid pandemic shutdowns last year. GDP is now within 1% of the peak reached in late 2019. Shoppers are returning to stores, home prices just hit a 15-year high creating a positive wealth effect, and consumer confidence is nearing pre-pandemic levels. Hot fudge anyone?
One area to watch, however, is the reaction of individual stocks and the overall market to quarterly earnings reports. Whether good news is greeted well and stocks go up or whether investors sell on positive news bears monitoring. Beating the last quarter’s earnings estimates is one thing, but the outlook for the year and beyond is ultimately more important. While the government spending spree will most likely be scaled back, many companies have been exceeding expectations handily and offering robust outlooks for continued growth. Facebook, with a market cap near $900 billion and over $100 billion in sales, reported a 48% revenue increase versus the prior year in Q1 and sees growth continuing in Q2 and for the year. FB rose 7% on Thursday. Apple reported a 54% revenue increase year over year and beat expectations significantly, but the stock rose less than 1%. We would note that easy comparisons will get much more difficult in the second half of the year and will get discounted in stock prices accordingly. Price increases by companies related to raw material inflation and supply chain constraints lie ahead as well. Markets may take a pause after a strong start to the year. In the meantime, fiscal and monetary accommodation provide plenty of fuel for economic growth and a sugar high in the short term. The tug of war between higher interest rates and increasing corporate earnings will continue. The bill that eventually arrives at the end of the feasting is another issue entirely.
Today Gal Gadot turns 36, Travis Scott turns 29, and Isiah Thomas turns 60.
Christopher M. Crooks, CFA®, CFP® 610-260-2219