Weekly Investment Update (05/07/2021)
Economic Strength Shines Through Global PMI Readings, Especially in Developed Markets
Final readings of Markit manufacturing and service sector PMIs for the month of April were released in recent weeks. On a global level, the services sector is expanding, with the U.S. posting the strongest reading. In contrast, the eurozone’s service sector remains more challenged as it recovers from the most recent set of COVID-19 restrictions. Nonetheless, as COVID-related policies are relaxed and vaccines continue to proliferate throughout populations, we expect service sector PMIs to catch up, especially in more affected countries.
One the other hand, manufacturing sector PMIs have not been as adversely affected by COVID-19-related restrictions. For example, the eurozone is home to some of the strongest manufacturing PMI readings, many of which exceed that of the U.S, despite the rise in COVID-19-related business and mobility restrictions. Looking ahead, we expect manufacturing PMIs to remain elevated within expansionary territory as pent-up demand from consumers is released with broader reopening of economies.
Amid Stronger Activity Readings, Global Central Banks Begin to Taper Asset Purchases (Gently)
While the Fed and Jay Powell note that it is too early to “talk about talking about tapering [asset purchases],” the Bank of Canada began to reduce its weekly bond buying pace in April, and the Bank of England announced a reduction in its bond purchases at Thursday’s meeting. Additionally, Norway’s central bank has said that it will probably raise rates in the second half of this year. While these are very small moves against a backdrop of extremely accommodative monetary policy, policy is likely to tighten gradually at the margin barring a setback on the COVID-19 recovery trajectory.
Clearly, the macroeconomic trajectory remains on positive footing; manufacturing sector PMIs continue to indicate economic expansion across all major economies apart from Mexico and the Philippines while high-frequency mobility measures continue to improve. Consumer demand remains extremely robust, and business inventories will need to be rebuilt, which will provide an ongoing boost to growth as the year progresses. As service-related industries reopen along with economies, this piece will also add to a positive trajectory for economic growth.
However, the underlying health of labor markets remains strained. When we consider that people who have been unemployed for over 27 weeks (“long-term unemployed”) comprise over 43% of those unemployed in the U.S., it’s clear there is a lot of work ahead before the labor market returns to “normal.” Nonetheless, it’s worth dissecting the data; while the total number of unemployed persons continues to decline, the number of long-term unemployed persons remains relatively static. This differs from the 2008-2009 financial crisis, when both measures moved together. We believe the divergence this time around may be the result of several low-wage jobs failing to return in a post-COVID-19 world. As a result, the Fed is likely to remain focused on the long-term unemployed data and maintain a healthy level of accommodation for a long time regardless of achievements noted in manufacturing or services PMIs.
Friday’s jobs report surprised economists and markets on the low side; the addition of 266 thousand jobs to the U.S. economy was over 400 thousand jobs below the lowest projection in the survey of economists. Leisure and hospitality jobs rose 331 thousand, but several other sectors saw declines. What is clear from the (volatile) jobs data that is subject to many revisions is that the Fed is unlikely to talk about tapering asset purchases in the near term.
Proposals to Increase Taxes for the Wealthy
On April 28, President Biden announced the American Families Plan, a $1.8 trillion package focused on healthcare, childcare, and education spending over a 10-year period. Funding for the programs will partly come from tax increases, with several proposals aiming to increase taxes on the wealthiest Americans. Most notable are proposals to increase the top federal income tax rate from 37.0% to 39.6%, increase the top long-term capital gains tax rate from 20.0% to 39.6% for people with taxable income over $1 million, and to eliminate the step-up in investment cost basis at death.
If all of these proposals are passed in their current forms, they will have a meaningful impact on most of our clients’ investment portfolios. However, given the razor-thin margins that Democrats have in both the House and the Senate, we currently believe that the actual changes to the tax laws will be substantially less significant.
Also, historical data has shown that increases in the long-term capital gains tax rate have had little, if any, negative impact on subsequent U.S. equity market returns. Over the past 90 years, the U.S. equity markets have achieved their best returns when the top long-term capital gains rate was between 20% and 30%. While many forecasters do expect some increase in the capital gains tax rate, most do not expect the rate to exceed 30% in the finalized legislation.
We recognize this is a fluid situation and many of these proposals could go through several iterations before they are finalized. We will continue to closely monitor these developments and evaluate the likelihood of various proposals passing as the situation evolves.
— Bessemer Investment Team
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