Markets are slightly lower than even for the week after reacting to higher COVID case counts in India & Japan and potential tax hikes from the Biden administration. The global growth outlook took a hit earlier in the week based on renewed COVID worries. However, the re-opening/reflation trade is not done by any long shot. Yesterday, investors became worried over a higher capital gains tax rate and what that might mean for markets. Here's what we're seeing this week:
Economic Picture Continues to Improve. The economic releases have been on the light side the week, with Monday through Wednesday being largely devoid of releases. Today, Weekly Jobless Claims surprised the market to the downside for the 2nd consecutive week. The market was looking for the claims to come in at 617,000, but the numbers came in lower at 547,000 indicating the labor market is continuing to heal. Existing Homes Sales were lower than expected (6.01 mil vs 6.19 mil expected), but the US Leading Index, which measures economic peaks & troughs. March's number came in at 1.3%, which is the highest since August of last year. Meanwhile, the Kansas City Fed's Manufacturing Index for April came in at 40 versus the March reading at 23. This morning, the flash readings for Markit Manufacturing & Services indices for April showed continued economic expansion and the numbers on New Home Sales surprised to the upside (1.02 million new homes vs 886k expected). Lastly, the Chicago Fed's National Financial Conditions Index continues to improve, most recently showing a reading of -0.69, which is the lowest reading since January of 2020, before the pandemic took hold. On the corporate earnings front, so far 88% of companies that have reported through Wednesday have beaten earnings expectations. If this trend continues, it would prove to be a record-setting quarter for earnings.
Tax Hikes on the Way? The markets were unsettled by reports of tax hikes, primarily on the Capital Gains rate (currently 20%) going up to 39.6% for wage earners over $1 million. First, it is curious why this would unsettle markets at this point, since President Biden ran on this very proposal during the 2020 campaign. Second, we do not believe that the President's plan will be approved by a divided Congress. Goldman Sachs has already reported that they believe a modest increase of 28% is more likely. The implications of a tax increase on higher wage earners could mean liquidations of stock holdings in 2021 in anticipation of the higher rate in 2022 (to potentially lock in a lower tax rate on gains). What is an equal concern for us is what such a tax increase would do to economic growth. In the 1970s, significantly higher capital gains tax rates contributed to worse economic conditions. The 1970s were also rife with higher inflation and higher interest rates. On top of that, real tax revenues received by the government are actually less when capital gains tax rates are high than when they are lower. It will be interesting to watch how this battle develops in Congress over raising capital gains taxes.
Lather, Rinse, & Repeat. It seems every few weeks we get worrisome headlines from the media that COVID is not over and that it could get worse. The latest concerns seem to be coming from a spike in cases in India & Japan. While Japan has seen a rise in cases over the past few weeks, India seems to be experiencing a large spike in cases. On Wednesday, there were 888,000 new COVID cases globally and India accounted for over 35% of the new cases. The good news is that India leads the world in one of the lowest COVID mortality rates (1.2% vs. 1.8% for the U.S.). Why the low mortality rate? The global vaccination efforts show that the U.S. & India lead the world in the number of people who have been vaccinated. As a percent of the population, however, India has some work to do (only 1.3% vaccinated vs. 24.3% for the U.S.). When the data is accurately analyzed, panic over COVID should be at a minimum. Meanwhile in the U.S., the numbers on cases and deaths continue to decline, despite a few hotspots. The vaccination of Americans continues as a steady pace. Vaccinations are averaging slightly more than 3 million doses per day, but administration has slowed over the past week since the pause was announced on the J&J vaccine. On Tuesday, Europe's health regulator announced that they were resuming the rollout of the J&J vaccine across the continent. This is good news for the rollout of the J&J vaccine in the U.S., as domestic regulators are likely to make a change soon. In fact, the CDC & the FDA will meet today to make a recommendation on the resumption of the rollout of the J&J vaccine in the U.S. and we expect the rollout to resume.
