Delays ... don't you hate them?
Dem plans for corporate tax hikes look favorable but there's a ways to go.
With Democrats racing against the clock and themselves, it looks like President Biden’s $3.5 trillion plan could shrink to $2.2 trillion in projected revenue increases. The opening salvo on tax changes to pay for the package started near where Dem moderates indicated they wanted to be. So, perhaps even lower from here. This is good news for corporate profits. When asked if Dems could reconcile their differences on the reconciliation “soft” infrastructure bill by Sept. 27, the date for voting on the separate bipartisan $1 billion “hard” infrastructure bill, Sen. Joe Manchin, a critical swing moderate, responded, “There’s no way….” Compromises could take weeks, even months, in part because leadership must shift gears to focus on securing votes to raise the debt ceiling. Such a vote is almost certain to get no GOP support. The Treasury Department says the deadline for action is sometime in October, though some believe it can go to early November. This suggests it may take until late fall before everything gets done. Headline risk could make for volatility even with favorable seasonality ahead. Based on the lower-than-expected opening salvo, Wall Street estimates for the hit to corporate earnings from higher taxes are now coalescing around 3-5%. Wall Street would be fine with that.
Are warnings from early-cycle companies about supply chain disruptions and labor shortages as tapering gets set to start a sign of risk to earnings and margins? Bank of America thinks so. It draws a parallel with fall 2018, when companies in Q3 calls warned about tariffs and slowing macro conditions. A hawkish Fed rate hike quickly followed, sparking a 20% decline in the S&P 500 (and a rapid Fed reversal). But there’s a big difference between taper and rate hikes, and the Fed has made clear the latter will be delayed. We may find out next week when taper will begin, with the market betting it’ll be this year. Whether inflation has peaked or not (more below), there’s not much evidence to suggest run-ups in prices are equity bearish until the Fed acts on rates. The response from 10-year Treasury yields—there really hasn’t been one—should provide comfort to those worried inflation is about to go off the rails. A record 75% of S&P constituents saw pre-tax margins rise in Q2, with consumer cyclical stocks’ share nearly 80%. Cornerstone Macro doubts margins are about to crash simply because they soared during the pandemic recovery. If anything, high operating leverage tends to beget more of the same. Margin compression will be delayed.
Q3 is seeing some economic moderation off elevated levels. But there are signs activity is reaccelerating (more below). With household wealth up $20 trillion from pre-pandemic levels, consumers’ cumulative free cash flow $2 trillion higher, jobs and wages rising (recent evidence suggests the August jobs miss was a fluke—this week’s continuing claims fell more than expected even as new claims rose on weather-related disruptions) and corporate capital expenditures on a roll, the macro outlook is consistent with a continued if not strengthening expansion. Bear markets typically coincide with recessions and Fed hikes. Delayed and delayed. To be sure, it remains a tricky tape. The S&P keeps testing its upward sloping 50-day moving average, while under the surface, less than half of issues are above their 50-day moving averages. There’s churn, with every sector in momentum purgatory and consensus expecting a 5-10% correction. Scary enough for a Halloween costume? (Hah!! I outfit my Maltese in a pope costume, actually; trumps all neighborhood kids’ costumes.) This was a good news week for those of us who worry about corporate taxes. Markets love a delay.
- Consumers have money and are spending it August retail sales surprised, jumping 1.8%, the most in five months, if autos are excluded, and 0.7% at the headline level. Consensus had expected significant declines on both fronts. There were across-the-board increases except for food and drinking places (where the delta variant weighed) and automakers (where inventory shortages kept buyers away).
- Peak inflation? From your lips ... Consumer prices surprised—August’s 0.1% increase in core CPI was the smallest since February, dropping the year-over-year rate to a 3-month low—and August import prices fell for the first time since last year. Large drops in used-car prices, auto insurance premiums and air fares drove CPI moderation, while a 17% plunge in building prices, and even larger decline in lumber, lowered import prices.
- Things looking up all over September’s New York Empire index nearly doubled, and the Philly Fed’s gauge jumped as well. The reports countered moderating manufacturing activity in August’s industrial production report, caused in part on softness due to Hurricane Ida. Evercore ISI’s weekly trucking gauge, which has the highest correlation to GDP of all its sector surveys, jumped to a near-record high. And, led by the U.S, Q4 hiring outlooks topped 10-year+ highs in 14 countries in Manpower’s quarterly survey. Overseas, the OECD global leading indicator rose to a 3.5-year high.
- Peak inflation? Not so fast ... Rents and owners’ equivalent rent—the largest and most cyclical components of CPI—continued to rise above norms in the August report and potentially could more than offset services and goods prices that have moved off the boil. Elsewhere, the percentage of NFIB respondents planning to hike prices reached its highest level since the late (and inflationary) 1970s. And if BMW’s and Daimler’s plans are any indication, larger companies may try to maintain higher prices by limiting volumes.
- Watch what you wish for One reason the Fed said it was adopting average inflation-targeting was to prevent inflation expectations from falling back below the 2% level that plagued the post-global financial crisis recovery. Might it be succeeding too well? The Atlanta Fed says half of businesses now expect cost increases of 3%+ over the next 12 months, and the New York Fed’s survey of consumers put median 1-year and 3-year inflation expectations at 5.18% and 4%, respectively, both records.
- Big pharma’s big headache While a handful of Dem moderates are resisting, the health-care portion of the Dems’ reconciliation bill may end up being larger than the Affordable Care Act itself, with the new spending offset by cutting pharma reimbursements. The changes could cut $700 billion from one industry. To put that in context, the bill has $900 billion of total corporate tax increases.
That largest-generation-ever needs to settle down somewhere Mortgage purchase applications surged 7.5% in the past week, a sign this year’s so-so home demand may be picking up. Rising income and wages, strong household balance sheets, growing household formation rates, the flood of millennials entering prime home-buying age and mortgage rates near record lows are offsetting lingering issues of high prices and limited supply.
Another reason to think small caps They’re the only asset class to outpace inflation every decade since the 1930s. A key factor: smaller firms tend to be willing and able to increase prices more quickly.
It’s much easier for me to negotiate an iPhone Studies show working from home can induce feelings of stress, burnout and isolation, with popular remote-work applications such as Zoom and Teams contributing to the problem. One option that reportedly could help: an old-fashioned telephone.