So much for sleepy Summer days. I guess they just don’t exist anymore. I can’t be the only one that thinks that, right?
There were a number of really important developments this week. They were definitely Market moving. It keeps us on our toes. I’ll attempt to cover the events and their significance below in another rapid rundown.
I wrote about the crisis in Afghanistan and what it might mean to the Market last week. It got worse this week. Stocks were for sale all day Thursday and accelerated to the close in the wake of the terrorist attacks in Afghanistan. What happened in Kabul was simply tragic. A moment of silence took place Friday morning before the open and flags were raised at half-staff, in honor of the fallen. The economic impact from Afghanistan is negligible. The geopolitical and human impact is immeasurable. It’s tragic. It’s long-lasting too.
The Market is already looking past Afghanistan with its focus on what took place in Jackson Hole. The Market has been heavily influenced by the Fed since the Covid Crash in 2020. Fed Chair Jerome Powell gave his highly anticipated speech, virtually. He didn’t even make the trip. The big question was whether the inflationary pressures we Americans have experienced are sustainable or temporary. The Fed word for temporary has been transitory. What he said, the Market liked. What he said was not much different from what he’s said all along. The Fed Chair doubled down on inflation being transitory.
The question about taper still looms. Remember when the Fed wasn’t even thinking about thinking about raising rates? Well, they still aren’t. But they have been thinking about tapering the $120 Billion in monthly asset purchases set forth 18 months ago at the peak of the crisis. It was unprecedented emergency monetary stimulus. It worked, big time. Stocks shot up like a geyser after the crash. It launched the quickest Bear-to-Bull Market reversal in history. 17 months later, with the Stock Market continuing to hit fresh, all-time highs, the Fed is still doing it. They’re thinking about tapering the purchases. Some thought that might begin in September. Fed Chair Powell indicated it will be closer to December. Again, the Market liked what he said.
The Federal Reserve, an independent agency of the government, has what’s known as a dual mandate. The Fed’s focus is on price stability and maximum employment. It’s been that way for years. But politics have seemingly permeated everything in modern America. The pandemic and highly divisive political landscape have brought other issues to the central bank like economic inequality, mask-wearing and climate change. The Fed Chair tries to dodge them, but they keeping circling. There’s no sign of that going away anytime soon. I just wonder how Greenspan and Volcker would handle today’s environment. That’s for another day.
Economic growth has been slowing. The Delta variant spread has cooled American spending. Chair Powell has been assertive in his belief that most pricing pressures are temporary in nature. The Fed Chair pointed to the most elevated prices being a direct result of the pandemic. Spiking Lumber and used cars fit that description. Demand outstripped supply, sending prices sky-high. They have since come down considerably. Not all prices have come down though. Gas prices haven’t. Food prices haven’t. Rising prices take more money from people’s pockets. It’s like a phantom tax. But Chair Powell said he sees inflation settling back down to its desired 2% target. Not everyone agrees with his conclusion. He emphasized it’s an ongoing issue that continues to receive scrutiny from the central bank.
US Gross Domestic Product is basically flat since 2019. Clearly, there was a massive drop followed by a record spike during the pandemic. But for over 18 months, the US Economy has not grown. Employers are still struggling to find workers to meet demand. This is particularly an issue for restaurant owners who have been forced to offer signing bonuses for the first time in perhaps ever. Wages have risen as a result. But the rise has come at the lower-skilled levels and an increase in the labor pool this Fall could see wage growth plateau. That’s what the Fed seems to be waiting for; That and the virus. The People of Planet Earth are watching the virus.
We expected this Jackson Hole summit to be a whole lot of nothing in terms of new information. The virtual nature sort of signaled it. It wasn’t even in Jackson Hole. But the virus spike in August has had an immediate impact on economic activity. It has slowed. It’s clear to us that the Fed wants and needs to see more data before they make a move. That data will start coming in next week with the August Job Report. There’s also the issue of extra unemployment benefits that come to an end in September. People staying home instead of working are about to get a pay cut. Perhaps that gets them off the couch. But the virus isn’t going away. That just might keep people at home longer, particularly if kids have to go back to school on Zoom.
The Chairman of the Federal Reserve said the central bank plans to provide support as long as needed for a sustainable recovery. The Fed Chair said the test for inflation has been met. The asset purchases will subside by year-end, as long as the Economy continues its growth path. He wants to see maximum employment. It’s getting closer. But not there yet. What remains crystal clear, there are no plans for raising interest rates anytime soon. That might not come until 2023. Rate hikes come with a much higher standard than tapering. The Bond Market seems remarkably calm with everything going on.
Back in Washington, the House passed a Budget Resolution, which is basically an outline of what’s referred to as the Democrat-driven $3.5 Trillion “Human” infrastructure bill. The outline includes budget targets but no specific policy proposals. The drafting of the document with details is expected in the coming weeks. Of significance, House Speaker Pelosi committed to voting on the $1.2 Trillion bipartisan infrastructure bill, passed in the Senate, by September 27. Considering the crisis in Afghanistan and President Biden’s campaigning on bipartisanship, this infrastructure bill is expected to pass. It might not happen in September, but it seems very likely this year. President Biden cannot afford to be denied by his own party. As I stated last week, the White House needs a win.
As it applies to the $3.5 Trillion House bill: What’s on the table seems highly unlikely to pass. Our Washington sources believe that ultimately, the bill will be in the $2 Trillion neighborhood. That’s still a really big number, something that stokes inflation. The Market knows this. It’s been our sense all along that Corporate taxes would increase to 25% from the current 21% passed in the Trump Tax cuts, but not to the 28% rate as proposed by this White House. We are also hearing that the top individual income tax rate will increase to 39.6% from 37%. That doesn’t seem to get much pushback from anyone not in the top bracket. Importantly, we are hearing that the top Capital Gains taxes might get an increase to 28% from the current 23.8%. This would be a huge win for investors and the Market since the original proposal was to treat capital gains as ordinary income for people earning over $1 Million. The other significant item we are hearing from our sources in Washington around tax is the likelihood of a change to the rules on stepped-up basis upon death have shrunk. That is a major one that impacts all investors and asset owners. We are staying on this. We had an internal strategy session on these potential tax changes yesterday. We are following developments closely and will circulate an update to our thinking after Labor Day as the issues continue to evolve.
Back to the Market: This week’s rally fits with the consistent resilience of this Bull. No matter what’s thrown in its way, it keeps charging higher. The S&P 500 hit a new, all-time high again to close out the week. Buy-the-dip has worked for 18 months. With such low interest rates, the attitude continues to be there’s no alternative to stocks. These themes are supported by excessive central bank liquidity, vaccines over variants, the reopening of America, strong and sustainable earnings growth, a corporate buyback boom, and the potential for more fiscal stimulus. That’s quite a list. It’s all very bullish. That said, much has already been paid forward.
There’s a lot that needs to happen in September. There’s another Fed meeting. More economic data is coming. Will Back-to-School make a U-turn Back-to-Home? Let’s hope not. Then there’s this: both the House and Senate will be out for much of the month. Congress is really good at one thing; Kicking the can down the road. The Debt Ceiling is going to be used as leverage again in what’s become typical seasonal political games. It sure seems likely that there will be a series of Christmas cliffs this Holiday Season. This was quite a week. With all that’s going on and no clear answers, this is setting up to be a September to remember.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
