Beyond Tax-Flation for Takeoff
From taxes to trends, market reactions to market gains, we'll use this space to share what's been on our mind, our perspectives, and why you should care. Pour yourself a cup of coffee — this is:
“The Market Foreward”
Larry Shover, Chief Investment Officer joins Founder and CEO, Alex Allison for D.Alexander’s, The Market Foreward.
Larry’s Take
I'm Larry Shover. I've spent 35 years in financial services, derivatives, trading, and residential real estate development.
In November 1789, Benjamin Franklin wrote a letter to French Scientist Jean-Baptiste Le Roy that affirmed:
“Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.”
Much has changed in the 200 years since Franklin wrote this well-known remark, but the certainty of death and taxes have not. However, there is definitely uncertainty around the rate of taxes that one will be expected to pay their government, and sudden changes to this rate can be a source of great grieve or gratification depending on the direction of change.
Capital Gains Tax Increase and Market Reaction
On Thursday 4/22 President Biden’s proposed capital gains tax increase hit the newswire. The knee-jerk risk off move follows intuitively from the specter of higher levies, to say nothing of the ongoing negotiations on an infrastructure plan and accompanying implications for corporate tax rates.
This said, the extent of the move left 10-year yields stuck at 1.55% while the S&P 500 dropped to levels last traded just two days earlier – said differently, what would have been a record equity market high at any point before April 8! At the end of the day, it appeared that no one really cared!
The response to President Biden’s announcement on Capital Gains Tax hikes was swift and negative. This chart from Bloomberg exhibits how investors reacted to the news in real time (Bloomberg)
Yes, financial markets suffered a one-day hit from news of the U.S. capital gains tax plan. However, the damage didn’t prove lasting, as the reality of its challenging approval process meant cooler heads prevailed. U.S. equities dipped only slightly on the week, interest rates were stable, finding support from generally solid earnings and sturdy economic data.
As a result, some coincident and leading indicators are at or close to all-time highs. Many are good portents while others are not (federal debt and deficits, equity valuations, margin debt and supply shortages). A large rebound in pre-tax earnings would ordinarily be a powerful bullish signal but this time it’s partially offset by rising inflation expectations, rising input costs, and rising corporate taxes.
Impact of Higher Taxes and Higher Spending
Increased government spending has been broadly telegraphed by President Biden and thus has been priced into the market for some time. However, markets are not pricing in much of an impact from corporate tax bills, maybe since there are still so many unknowns?
Another thought. Although infrastructure programs, even once congressionally passed, are notoriously slow to get going— there’s no such thing as ‘shovel-ready’— I am beginning to feel that a meaningful portion of the proposed $900 billion dollar net increase in the 10-year deficit, i.e., fiscal stimulus, will arrive in time for the November 2022 elections. Not a problem for today.
Post-Pandemic Liftoff
What are US markets focused on instead? Post-pandemic lift off! US spending potential that was accumulated by year-end is just starting to get deployed, strengthened by an explosion in the money supply.
Here’s what liftoff looks like in the US. Note how even pandemic-affected sectors (restaurant spending, lodging, air travel) are picking up sharply as full vaccinations approach 30%. The housing market continues red hot, with a collapse in inventories to all-time lows and surging lumber prices. Consumer spending patterns continue to exceed expectations, and the labor force resumes its healing.
However, we need to remain alert on the evolving levy landscape with a particularly wary eye on the capital gains tax and its implications for the ongoing performance of risk assets – domestic equities being the benchmark in this regard. Using the current persistent bid for stocks as an indicator, the market doesn’t appear to be overly concerned about higher capital gains taxes thus far.
What's (tax changes) Past is Prologue
Sometimes in society, the inexplicable swirls in and swoops up a time period. It’s flung into the clouds for a while, and then plopped in some remote farm field, unable to explain how it go there or why? Liken to the President's proposed tax increases, these time periods are not matching in size, strength, or pretext yet each is marked by a sudden burst of blazing, searing market action that cannot forever be sustained.
The 1960’s economy realized rising incomes, plummeting poverty, and a sturdy 106-month expansion. In the mid-1970’s – sandwiched between two steep recessions, flat economic indicators, and astronomical inflation – the economy managed to swell for well nigh five years. Dwindling oil prices and a spike in private investment ignited the “Go-Go 80’s” and along with it an economic expansion that persisted for 92-months. While a run-up to the dot.com bubble and 2.1% GDP growth commentated the 1990’s and an expansion that lasted exactly a decade – the longest increase since the American Civil War! One thing all of these periods had in common: They all had higher effective tax rates and capital gains rates compared to what is being currently proposed.
Our market is lived forwards yet only understood backwards. That saying adorns me like raiment from months and years and decades of real skin-in-the-game. As a CIO I am more the frumpy dad who craves quiet at home – one who strives to be deeply confessional and achingly sincere. My style is stripped to the core, and as a result, I have embraced my limitations by accepting that little is to gain predicting market events, let alone timing them.
I’d prefer to find a way to help investors hedge them!
Alex’s Take
A visionary brand builder and creator of inventive behavioral and pioneering economic modeling, Alex Allison is the Founder & CEO of D. Alexander & D. Alexander Capital. His work is centered around developing, aligning, and forecasting value equations and evolutionary market forces that adhere to the future of living — for mainstream consumption and adoption.
There's a lot to unpack in Larry's take. But here is my initial reaction:
We [D. Alexander Capital] view the market as a giant tapestry woven together from many strands including economic momentum, credit conditions, tax implications, and relative levels of macro-movements. I have found it is only when I examine the tapestry as a whole that it will or will not make a convincing pattern.
Creating a tapestry is a communal experience of what kinds of arguments and evidence are likely to impact the future of living. Weaving an investment tapestry helps me from shunning the value of secret or smart market information as the important stuff. It enables us to view the traditional market with a different perspective, identifying trends and new asset classes.
Dynamic times and new conditions present unique opportunities… inventive, asset-backed models like ours add diverse value equations, built for market conditions like these. Optionality, flexibility and consistency will lead the way.
To learn more about D. Alexander, visit www.dalexandercapital.com.
