10/13/20: The S&P 500 posted a 3.8 per cent gain last week, its best weekly showing since July. Small-cap stocks, which are more sensitive to projected economic activity, surged 6.4 per cent last week, their strongest weekly gain since June. While most newspaper ink spilled last week credited an increasing possibility of a second stimulus package, we believe two other factors were the more likely source of the market’s optimism.
First is the tangible effectiveness of COVID-19 treatments. President Trump recovered rather quickly from his COVID-19 diagnosis thanks to an experimental antibody drug by Regeneron Pharmaceuticals. That’s impressive considering his risk factors: the president is 74 years old and technically classified as “obese” with a BMI of 30.4. The other factor propelling equities, however, was a growing belief among investors of a Democratic sweep on election day, in which Vice President Biden wins the election and Democrats control both Houses of Congress. Under that scenario, Democrats would pass the original $3.4 trillion Heroes Act in January, a bill that passed the House in May. That program would be expected to boost growth next year. “Blue Wave” as a search term has been expanding in popularity, according to Google Trends data, with a strong increase since September 30.
Investors’ main cheerleader, Federal Reserve Chairman Jay Powell, is clamoring for fiscal stimulus, as the Fed’s monetary dry powder is running low. Seventeen million more people lack access to sufficient food compared to last year, a 50 per cent jump, according to Feeding America, an organization that operates 200 food banks. As of August, 27 per cent fewer Americans were employed in jobs paying less than $16/hour, according to Bureau of Labor Statistics data. Meanwhile, the CAREs Act, a federal stimulus bill that added $600/week to unemployment benefits paid by states, expired in July. That would explain why consumer spending rose 1 per cent in August while personal income fell 2.7 per cent. If investors were anticipating imminent stimulus, they weren’t wildly disappointed when President Trump unexpectedly broke off negotiations last Tuesday. Odds of a Democratic sweep have spiked 13 percentage points since the end of September, from 47 per cent to 60 per cent, according to data from PredictIt, a political outcome futures market. The recent tilt also reduces the likelihood of a contested election, a scenario that most investors dread. A fall in longer-dated options implied volatility, for example, suggests foreign exchange markets are growing less fearful of a contested election. Traders worry that uncertainty and potential chaos would prompt dollar selling as global confidence in the US deteriorates. Beyond $3-plus trillion in stimulus, investors increasingly believe that Vice President Biden’s tax and spending proposals could result in a higher economic growth trajectory than a continuation of Trump’s Republican tax-cutting programs. Last year, with the economy at full employment, corporate tax collection represented 1.1 per cent of GDP, among its lowest share of the economy ever reported. Total tax revenues, at 16 per cent of GDP last year, were among the lowest in 50 years as a share of the economy, according to The Wall Street Journal. The bulk of the tax savings were paid out to shareholders who stashed most of the windfall in savings. That helps explain today’s low-growth, low-rate environment, fueled by a savings glut. Meanwhile, fixed investment ex-housing, an indicator of capital expenditure, has trended lower since 2017, when President Trump’s Tax Cuts and Jobs Act was signed into law. A slowdown in capex could impair productivity growth, a key ingredient in America’s potential growth rate.
The Biden tax plan would raise tax collection to 19 per cent of GDP by the end of his first term, by restoring the top individual tax rate to 39.6 per cent for households and ratcheting up the corporate tax rate to 28 per cent from its current 21 per cent. Despite the increase, Biden’s tax target falls short of the 21 per cent of GDP recommendation of the bipartisan Bowles-Simpson fiscal commission proposed in 2010. The Vice President’s plan calls for recycling the revenue into childcare incentives, education infrastructure and green energy programs. Biden’s proposals, like Trump’s, would boost the budget deficit and expand our nation’s debt over the next 10 years, according to the Committee for a Responsible Federal Budget. Their base-case forecast for President Trump’s campaign plan would increase the debt by $4.95 trillion while Vice President Biden’s plan would increase the debt by $5.6 trillion.
Whether investors are bullish about prospects for COVID-19 treatments and potential vaccines, or the market is swept up in the prospect of a “Blue Wave”, equities are responding to improving growth outlooks, and more and more stocks are participating in the rebound. Fifty-eight per cent of NYSE stocks are trading above their 200-day moving average, up from 38 per cent as recently as three weeks ago. Over the last two weeks, the average stock in the S&P has outpaced the tech-heavy capitalization-weighted index, suggesting the investor optimism covers a broader range of companies, particularly those that are sensitive to economic conditions. It’s even possible we could witness a decline in the S&P 500 Capitalization-Weighted Index even if the S&P 500 Equal-Weighted Index advances as investors rotate from their mega-tech holdings into a broader array of smaller, more cyclical names. In that case, we would have to ignore the headlines and look at what’s going on beneath the surface. A broader market advance would be cathartic.