How Have Stocks and Other Asset Classes Performed?
Economic Environment Characterized by Pent-Up Demand
As things start to open up in the economy, there’s a lot of pent-up demand. And a lot of this pent-up demand is going to get unleashed as people do some of the things that they’ve foregone over the past 12-13 months. And as that occurs, and this pent-up demand is unleashed, economic growth is going to pick up significantly.
Now remember, there’s still a lot of cash sitting on the sidelines. According to the Federal Reserve, there is still $4.8 trillion sitting in money market accounts earning pretty close to zero. And that’s a lot more than what was there pre-pandemic. So I think it’s pretty reasonable to think that some of that money is going to come out and get invested in other assets, rather than staying in money market accounts. Some of this pent-up demand is priced into the market, but not all of it is. So, we can expect maybe some more upside.
Potential Economic Headwinds Ahead
But we’re also getting closer to some potential headwind for the markets. The two that we’re focusing on are potentially higher inflation and potentially higher taxes.
I’ve been pretty sanguine about higher inflation for a long time because there have been secular changes in our world and the economy that has kept inflation low. The biggest one is probably demograhics. I mean, we’re an aging society. Many of the developed countries in the world are aging and that tends to keep a lid on inflation. But we also have a situation where we have the Amazon effect where we can get real-time prices on anything right on our cell phone. And that ability to compare prices – that also keeps a lid on inflation.
$1.9 Trillion Stimulus Bill’s Impact on Labor and Inflation
But we also had a massive stimulus bill that was just passed — $1.9 trillion. And except for about 8 ½ percent of that which is going toward vaccine distribution and development, it’s all transfer payments. So that is hitting the economy at the same time that the economy is starting to really recover quite rapidly.
And if you think about the stimulus package, one of the big transfer payments in there is enhanced unemployment benefits that will last through the Fall. So, if you are in Virginia, and collecting unemployment, you’re collecting about $35,000 per year in benefits. And if you get the Child Tax Credit and so on, you’re getting a lot more in benefits. And this is at the same time when lot of employers are seeing their businesses pick up and they want to hire people. But there’s really a disincentive for people that are collecting that much on unemployment to go and work for even potentially a lower amount of money.
So, when I was a Freshman at Penn State a long, long time ago, when I took Econ 101, I learned that when your aggregate demand is increasing, when your demand curve is shifting out, but the supply of labor is not shifting, that means higher prices, not lower prices. And higher inflation is definitely not good for long-term bonds, but it probably would also be not good for stocks, it probably would be not good for real estate and most other asset classes. Whether it is going to be transient or not, we don’t know, but we are certainly keeping an eye on that.
Proposed Higher Taxes May Be Problematic
Higher taxes are also something that’s going to be a potential headwind. The Biden Administration has proposed a litany of higher taxes to pay for an infrastructure bill, to pay for a lot of other pet causes and I’m really going to focus on two. One is the higher corporate income tax and the higher capital gains tax because really both would provide a disincentive for saving and investment.
The US used to have the highest corporate – or among the highest – corporate tax rates in the world at 35%. That was reduced to 21% in 2017 and the Biden Administration is proposing to raise it to 28%. And while it may be appealing to many to tax faceless corporations, there have been numerous studies that show that higher corporate taxes really fall on workers through lower wages, investors through lower dividends and also for consumers in higher prices. And it would really be a disincentive for companies to invest more in human capital and in other areas.
The Biden Administration has also proposed that if you’re making over $400,000 per year that long-term capital gains would no longer be taxed at a maximum rate of 20% but rather would be taxed at 39.6% — which is a big jump. And as an aside, there’s a serious marriage penalty in there because a couple who is earning $200,000 each would be subject to that – the same as an individual who is making $400,000. But, that aside, you know, if you’re in Virginia, for example, your effective tax rate on long-term capital gains is going to rise to over 49%. You’re going to have 39.6% Federal, 5.75 % State and 3.8% for the net investment income tax. And if you’re in a higher tax state, like New York or California, that’s going to be 55-60%.
And to depress you even further, if the step-up in basis is eliminated, which is another proposal, then capital gains and people’s estates could be taxed at upwards of 100% or more. So, we really don’t know where this is going to end up, but if the markets view this as credible, then that could really be a disincentive for future investment.
I’ve been very pleased to share with you some of our thoughts for the Spring of 2021. If you have any questions, please contact me or your financial strategist at Agili, or if you want to learn more about our current thinking, please follow us on Twitter, or go to our website, AgiliPersonalCFO.com. Thanks and have a great day.