Over the weekend, there were two developments. The huge tanker stuck in the Suez Canal has been partially refloated, an encouraging sign that traffic can flow once again within a relatively short period of time. Supply chains, already stressed, can begin to recover, although they will take some time. Temporary shortages are likely. Where? It depends on what is in the 20,000 containers aboard the stuck vessel, as well as the hundreds waiting in line to get through the canal. But on Wall Street, temporary economic hiccups have very little long-term impact on values. There may be some second quarter disruptions, but they are likely to be overlooked.
The second development was the apparent collapse of a large Asian hedge fund. The first evidence was a dramatic drop in the prices of ViacomCBS and Discovery on Friday. There may be more to come. As risk taking rises, courtesy of massive monetary flows into markets, the unintended consequences keep appearing. The losers this time, in addition to the holders of the hedge fund, will be the banks and investment banks backing the fund. Once again, risk and leverage have a price.
This week we will start to see economic data for March as the calendar rolls into April on Thursday. Overall, there was some early impact from bad weather. But the residual impact of the first set of stimulus checks continued to help. The biggest second set is just making it out the door now. In addition, on Wednesday President Biden is supposed to deliver a major address outlining the next steps in his economic plan. Final details still are being developed. Whether it is one package, two or three, is still in doubt. In addition, there is the question of offsetting taxes. Some progressives want none, but the likelihood is that there will be some, almost all aimed at corporations and high net worth individuals.
Note that whatever the President puts on the table, this time passage isn’t a slam dunk. He would like to do some part of the next phase in a bipartisan fashion, but Republicans aren’t going to vote for either new taxes or massive spending. Other questions remain. Can 50 Democrats agree on a tax package? Passing spending increases is a lot easier, politically, than raising taxes. Will Democrats have to, or even be able to, dismantle filibuster and other related rules that will allow passage in the Senate with just 50 votes? And again, that assumes all 50 Democrats can come to some agreement.
Thus, what is asked for on Wednesday shouldn’t be viewed as any certainty. Indeed, it is likely that much of what is proposed won’t happen or will be changed significantly. In addition, there will be questions relative to rates and timing. For instance, should capital gains rules be changed, will they be retroactive to January 1, take effect as of the date legislation is introduced, or wait until the date a bill is signed into law? Wednesday’s announcements are simply a start. The shape of any legislation will take months to form and there could be radical changes along the way.
With all that said, an obvious question is how future tax and spending legislation will impact the stock market. Once again, the changing shape of legislation will matter. Markets not only price in facts, data already known, but they also price in consensus expectations. Remember that what moves stock prices are mostly related to interest rates and earnings. Thus, corporate tax rates are much more important to stock prices than capital gains rates. You may be impacted by a change in rules governing capital gains but corporate earnings will not be affected. Thus, while wealthy investors could be hit with additional taxes depending on the course of any potential legislation, the only items that matter to stock prices will be those items that impact earnings and capital investment (e.g., a change in investment spending tax considerations).
The Democrats will ask for an additional $2-3 trillion. This time almost none will relate to Covid-19 relief. There will be infrastructure spending proposals, green initiatives, and lots of efforts to correct income disparity. Again, this is a wish list. A lot is intended to placate the progressive wing of the Democratic Party. Undoubtedly a lot will have to be sacrificed to get across the finish line. And that assumes a finish line will ultimately be crossed. A pure partisan package will be hard to attain. If it is, it certainly won’t be anywhere near $3 trillion. When you need every Democratic vote, there will have to be some tradeoffs. Not every Democrat buys into the Bernie Sanders or Elizabeth Warren ideals. I only caution that the original headlines will look very different from the final product. If you remember the past two administrations, every budget proposal ultimately became an empty wish list. Congress couldn’t even pass a budget, let alone any major new initiatives.
Thus, as Q1 comes to an end, we roll ahead with lots of tailwinds provided by both the Fed and Congress. Indeed, the market’s biggest current problem seems related to the vast number of stupid pills naïve and inexperienced investors are taking. I listen to pundits/experts telling me why Bitcoin should trade at $5,000 or $500,000. None of what they say makes sense. Many of the world’s most sophisticated investors claim to be confused by Bitcoin but own it anyway. Huh? SPACs double and triple on a whim and then fall 50%. GameStop? This is what happens when too much money is sloshing around. So far, the craziness hasn’t infected the core of the market, but left unchecked, eventually it could.
What does seem to be happening in the core market is that the recovery in the stocks hurt most severely by Covid-19 (e.g., travel and leisure stocks) may be coming to an end. At least, most of the easy money has already been made. It’s nice to know that American Airlines is likely to survive, but it isn’t tomorrow’s growth stock. It’s the same old poorly managed airline that it was two years ago. But now it has more debt to service, and potentially fewer business travelers for some time to come. Thus, the key question becomes which companies lead the market forward from here. I suspect as we move further into the Covid-19 recovery phase, that leadership will gradually return to quality names, including many that led the market higher over the past decade.
Today, model Elle Macpherson is 57. My son Eric celebrates his birthday as well. I would tell you his age but it might also tell you mine.
James M. Meyer, CFA 610-260-2220