Build Back Bust

12.20.2021: West Virginia Senator Joe Manchin dropped a bomb on the Democrats and blew up President Biden’s Build Back Better (BBB) legislative initiative over the weekend, snuffing a plan that, according to the White House, would:

  • Provide universal and free preschool for all 3- and 4-year-olds
  • Assist more than 35 million households with up to $3,600 in tax cuts per child per year by extending the American Rescue Plan’s expanded Child Tax Credit
  • Deliver affordable, high-quality care for older Americans and people with disabilities in their homes, while supporting the workers who provide this care

The bill was anticipated to spend roughly $300 billion annually, on average, through 2025, according to the Committee for a Responsible Federal Budget. That equates to about 1.2 per cent of GDP annually. Net of taxes and other fees, BBB was estimated to boost government spending by about 0.5 per cent annually for the next five years, according to Moody’s Analytics. Applying a modest multiplier effect, it could have boosted real GDP growth by as much as 1 per cent annually.

Graph 1, Market Commentary, 12.20.21

Economists are reducing their economic growth projections in response to the news. Goldman Sachs slashed its Q1/22 growth forecast from 3 per cent to 2 per cent, and knocked down its full-year growth forecast as well. The reduction in fiscal spending will reduce growth, but it will also reduce the inflation pressure that built up this year.

Arguably, taking hundreds of billions of incremental spending off the table would mean a need for less Fed restraint. Chairman Powell last week telegraphed an accelerated tapering schedule that includes three rate hikes each in both 2022 and 2023. That might be too much, considering last weekend’s revelation. Bond investors continue to anticipate three rate hikes next year, according to Fed Funds futures trading this morning, although they’ve shaved their inflation forecast. The 5-year breakeven inflation rate ticked fractionally lower in this morning’s action. Both could be reduced if they believe Build Back Better is dead.

Graph 2, Market Commentary, 12.20.21
Graph 3, Market Commentary, 12.20.21

Equity investors are taking the news hard. All 11 economic sector groups are losing ground as of this writing: economically sensitive sectors, like financials, materials and energy, are suffering the most; defensive sectors, like staples, utilities and health care, are faring relatively better. The largest 100 stocks in the S&P are outpacing their smallest 100 brethren by 1.3 per cent so far today, as investors reach for size and quality. Equity investors, it appears, are not yet giving up on the possibility of spending legislation in a smaller form getting enacted next year.

While one day doesn’t a trend make, the uncertainty surrounding legislation, re-elections, variants and vaccines underscores our quality bias as we enter 2022. Quality companies outperformed the averages this year and we expect that trend to continue in 2022. Feel free to ask your Cresset advisor about our Large- and Small-Cap Quality Equity portfolios.

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About Cresset

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