You wanna bet against Nancy?
Markets will be watching closely as the House speaker orchestrates reconciliation.
That much-awaited correction may come from the swamp. Democrats are working furiously on a multi-trillion-dollar reconciliation bill and the 81-year-old House speaker is orchestrating. She has said this is her last term at the helm and she views expanding entitlements as essential to securing her liberal legacy. In coming weeks, expect to see a Super Bowl of Washington policy—an effective date for higher capital gains taxes, decisions about the estate tax, a higher headline rate for corporate taxes, how international taxes will be structured, and health-care reforms such as drug pricing and Medicaid expansion. Pelosi is trying to jam through a final House committee markup before the Sept. 14 California recall election that polls show could go either way. If Gov. Newsom loses, it would be a political earthquake. Dems have yet to settle on the overall size of the reconciliation package—West Virginia moderate Manchin is balking at $3.5 trillion and says Dems should go lower and slower. If the final figure comes close to a still-gargantuan $2 trillion bill, Cornerstone thinks it’ll end up cramming in $3-4 trillion of new spending over 10 years through various budgetary maneuvers. Recent analyses suggest tax increases may shave 500 basis points off next year’s S&P 500 earnings growth, with minimal earnings benefit from the new spending since much of the hard infrastructure outlays are lagged and don’t come in 2022.
The debt ceiling also looms, and Republicans are dead serious about not voting to raise it. They have no interest in helping Dems “transform” government through an historic increase in its size. Reconciliation is an option for raising the ceiling, but the process is so arcane that Cowen says even intelligent people disagree on the intricacies of how it works. Originally created to fast-track difficult deficit-reduction bills, reconciliation has mutated into a highly partisan (but effective) tool to ram through legislation by avoiding the 60-vote threshold. Anything with a spending/revenue/debt component can be in it but must clear numerous “Byrd Rules,” so-called after the persnickety late senator from West Virginia. There’s an entire ecosystem of procedural phrases such as Byrd Bath (if the underlying bill is not deficit neutral, it must sunset after 10 years) and Byrd Droppings (amendments not germane to the deficit/revenues aren’t allowed, i.e., the minimum wage hike scratched from March’s reconciliation bill was a Byrd Dropping). Manchin’s protests aside (he hasn’t drawn any lines in the sand), Cornerstone doubts Dem moderates will put up much of a fight. It notes the “compromise” Pelosi pulled off to appease them simply split Biden’s agenda into two pieces: the smaller bipartisan hard infrastructure bill that was guaranteed its own vote, and the $3.5 trillion soft infrastructure resolution that moderates then went on to support. That Biden’s approval rating is plumbing new lows may increase Dems’ urgency to approve the legislation as history shows a party shifts into self-preservation mode whenever its leader is struggling.
Big policy intrigue and progressives’ push to replace Powell could make for an interesting September. Historically the weakest month for stocks, it arrives at a time the market keeps setting new highs. Yesterday marked the 54th record close for the S&P this year, nearing 2017’s 62 (1995 set the record at 77). Despite concerns over the delta variant and peaking economic/earnings growth, U.S. stocks beat all other asset classes in August, with the S&P having its best month since April (aided, again, by the heavy lifting of Tech stocks). The S&P has now gone 11 months without as much as a 5% pullback, and year-to-date performance is the sixth best since 1950. Returns historically have skewed positive after such a strong opening eight months, with seasonal consolidations/sell-offs typically buyable opportunities. Moreover, the market’s gradual climb higher has been slow enough to thwart overbought conditions and extreme bullish sentiment. The recent strong rally in small caps certainly is not evidence of a pending decline. There’s no question the melt-up continues to be led by forward earnings. While the growth rate is expected to decelerate dramatically from this year’s surge—Q2 earnings grew at the fastest rate since Q4 2009—2022 earnings are still projected to rise 9%, versus the 6% long-term trend. That’s before, of course, whatever the Dems do. Markets trade on earnings, and they have been spectacular. What’s going on in D.C. usually hasn’t mattered … unless it’s big policy.
- Looking past the headline jobs miss This morning’s unexpectedly small (relative to consensus) gain of 235K nonfarm jobs in August masked positives. Gains were revised up significantly to almost 1.1 million in July and 1 million in June, keeping the 3-month moving average around 750K, and last month’s misses were concentrated in retail and leisure & hospitality, where variant fears hit hard. Average hourly earnings rose 4.3% year-over-year (y/y), suppportive of spending (more below). Also, last week’s initial claims hit a pandemic low, indicating the worst has passed; Challenger job cuts fell to the lowest since 1997; and this morning’s ISM take on services came in better-than-expected, indicating the August lull in certain services may be short-lived.
- Problems factories are having generally good ones Companies and suppliers continue to struggle at unprecedented levels to meet increasing demand, the ISM said. In August, for example, new manufacturing orders rose to a very strong 66.7%, a 14th straight month above 60%. Production, meanwhile, increased to 60%, further widening the gap between new orders and production.
- Chill consumers still spending Shoppers flush with cash from jobs and stimulus have pushed foot traffic at stores back to pre-Covid back-to-school levels, with Redbook’s gauge of weekly sales rising nearly 19% the final week of August versus a year ago. The pickup belies two key surveys of their moods—Conference Board confidence tumbled more than expected in August, as did Michigan’s initial take on consumer sentiment, as the delta variant and higher gas and food prices weighed on psyches.
- Run up in home prices doesn’t look transitory Case-Shiller y/y prices accelerated 19%, an all-time high, and y/y FHFA prices jumped a similar amount, the most in that gauge’s 30-year history. Goldman Sachs expects historically tight housing supply—July pending home sales fell a second straight month as supply couldn’t match demand—and persistent constraints such as land-use restrictions will keep prices rising even as material shortages and other bottlenecks ease.
- Run up in manufacturing prices doesn’t look transitory With supply (production) still not meeting demand (new orders), pricing pressures look to persist in the near term. The prices paid component of the Chicago PMI, for example, hit a 42-year high in August. Other measures, notably ISM and Markit, reflected some moderation but off very high levels.
- Global hiccup The global manufacturing PMI slipped to a 6-month low in August on broad-based deterioration as supply-chain issues aggravated by the delta variant weighed on activity. However, global activity remained above trend and leading indicators across countries indicated the worst has passed, with global infection rates showing signs of improvement.
More help wanted Worker shortages are rife across industries, signs this morning’s disappointing number could prove fleeting. Business Insider notes one McDonald’s in Oregon is so desperate it’s actively recruiting 14- and 15-year-olds. The scarcity of workers pushed ISM factory employment to a 9-month low.
I’m old enough to remember the wage-price spiral Contrary to popular belief, factory pay is not particularly high along the wage spectrum. In terms of hourly wages, it’s third from the bottom, after leisure & hospitality and retail trade. So, as services businesses raise wages to lure and retain workers, manufacturers are having to do the same, creating the sort of upward wage pressures common in the 1970s when old-time union COLAs were rampant.
Tax hikes—another catalyst for capex? One of the biggest positives for this recovery, soaring capital expenditures, could get a boost as Dems push through corporate tax hikes. Higher capital gains and dividends taxes will raise the cost of distributing cash back to shareholders, Cornerstone notes, but 100% expensing of capital equipment is likely to stay in place, providing one place for companies to reduce their tax burden when corporate tax rates go up. Because the rapid expensing option expires at the end of 2022, Cornerstone thinks companies may kitchen-sink their capex needs into 2022.