Stocks fell broadly yesterday as some economists lowered growth projections for the rest of this year, and signs that inflation might be more persistent than transient, gripped investors.
The good news is that the Delta variant seems to be near a peak. It is probably past peak in the South and Midwest, which were impacted the earliest. Now it is pressing northward just as schools reopen. While most schools are attempting a full reopening, that could require adjustment if cases surge among children. As for employers, many are deferring returning to the office until closer to the end of the year. Travel is taking a hit as airlines are feeling the pinch of increased cases. But as fast as the Delta variant took hold, history suggests it will fade almost as quickly once peaks are reached. As noted, that has probably already happened in parts of our country and will happen elsewhere within a month or two. With that said, however, coronaviruses, like Covid and the flu, seasonally peak in cold weather. Although Delta itself may fade over the next few months, it won’t disappear, and it will intermingle with upper respiratory infections and flu creating some degree of havoc this winter. Clear sailing is still some time off, although quarantines and closures aren’t likely.
The virus surge is certainly one reason for lowered economic forecasts. The other is the ongoing supply chain disruptions. For whatever the reasons might be, getting back to supply/demand equilibrium is taking longer and imbalances are spreading throughout more sectors of the economy. Grocery store orders to suppliers can’t be totally fulfilled. One week, it is a seafood shortage, the next could be mayonnaise and peanut butter. Restaurants lack plastic containers for storage and takeout. Car makers still lack essential chips with no end in sight. Every day we hear a new tale of supply shortages. Each explanation is different, but the bottom line is that everyone, every business, and every consumer, is scrambling to fill their needs. Needless to say, some don’t get met. The end result is lost sales.
Shortages are also symptomatic of a shift in pricing power from seller to buyer. Used cars sell for over their original list price because the alternative, new cars, aren’t available. Home prices are up 20%+, again because of a shortage of inventory. Some say we are 3-4 million homes short of equilibrium. Housing starts are roughly 1.5 million a year. Demolitions are 500,000 or thereabouts. The math says it may be as long as 3 years before balance is completely restored, 3 years until pricing power returns to the buyer. Before the pandemic, sellers were encouraged to accept the first reasonable offer. Now many homes sell for more than the asking price.
Restaurants are raising prices just to compensate for the costs of food, supplies, and labor. Some even must shorten hours for lack of labor. Ports on both coasts have container ships parked offshore. There aren’t enough workers to unload the boats. Covid-19 today seems more an excuse than a valid explanation.
And now, as we enter September, Democrats want to pass over $4.5 trillion in additional spending over 10 years with most of that front-end loaded. A good chunk of that will be paid for by increased taxes on those making over $400,000 per year and businesses. Businesses that can’t shift production overseas will pass the costs on to consumers. Remember, the seller has the pricing power. Taxes are no different than other import costs.
We have yet to see the details. The spending will support infrastructure, community college tuition, two years of pre-kindergarten, paid leave, child care, tax credits for lower and middle class workers, expenditures for childcare, broadband development for rural communities and a lot more. The offsets, and they will only be partial, are higher income taxes for the wealthy, increases in estate taxes, higher capital gains rates, and a whole lot more.
These are the asks. To pass, every Democratic Senator will have to vote yes. Only 3 Democrats in the House can vote no. There are only a few guarantees right now regarding the likely outcome. For one, no Republican in either the House or Senate will vote for the larger $3.5 trillion package, even if it is reduced substantially. Second, several Democrats won’t support the full package either. The final version will be substantially less than $4.5 trillion in total. While it is likely the Democrats can find common ground to appease their far left and right, nothing is guaranteed. The party’s views are diverse. Ultimately, it will be up to President Biden to find center ground.
What is clear is that Democrats want Government spending as a percentage of GDP to rise significantly. The Biden budget will increase Federal spending by more than 25% until at least mid-decade.
September also means the end of the Government’s fiscal year. Spending bills have to be authorized and the debt ceiling extended. Democrats have no reason to expect any Republican help. Raising the debt ceiling is always a thorny issue. Neither side wants to appear fiscally unfrugal, and be the cause for expanding Federal debt. Undoubtedly, Democrats will try to blame Republicans if a debt ceiling extension can’t pass. But they have the majority in both chambers of Congress, and they could pass a debt ceiling extension on their own. This time at least, blaming Republicans won’t pass muster.
As I have mentioned countless times, markets don’t like change. They don’t like transitions. To compound the dilemma, the combination of a lowered growth forecast and more persistent inflation is not welcome. We have a lot to deal with in September. The Democrats want to get the legislation package through the House in September and to the President before Election Day. Assuming there will be serious dissention within the party in both chambers of Congress, that timetable is aggressive. The Democrats must believe that whatever they are going to get accomplished has to be done soon, before Christmas. Next year is the mid-term election year. Little will pass. Today, there is a significant possibility that Democrats will lose their majority in one or both chambers of Congress. That means gridlock during Biden’s last two years. The recent disruptive exit from Afghanistan and the persistence of the Delta variant isn’t helping the Democrats with Presidential approval ratings now falling under 45%.
Thus, in September, we see indications of slower growth, higher inflation, and a spending/tax package that equity investors aren’t going to like. Perhaps third quarter earnings will restore confidence, but that won’t happen until the second half of October. History suggests the odds of a weak market between mid-September and mid-October are higher than normal. I don’t like to make short-term timing predictions, but the current setup of record stock market prices and deteriorating fundamentals isn’t a pleasant one.
There are two offsets. First, the Fed is still buying $120 billion of bonds every month, feeding buyers of all asset classes. If the economy continues to soften at all, the tapering plan could be deferred until next year, allowing even more fuel to flow into markets. Second, slower growth is still growth. The economy is healthy, and Covid-19 will likely ebb a bit in the months ahead.
It may not be time to be aggressive, but it isn’t time to give up yet. There is no recession in sight and 2022 will still see record earnings. Corrections are still likely to be viewed as buying opportunities.
Today, Delaware Valley native Pink is 42. Bernie Sanders turns 80.
James M. Meyer, CFA 610-260-2220