Total Clarity Wealth News

POLICY RISKS LOOM BUT CLARITY AHEAD

Barry Gilbert, PhD, CFA, Asset Allocation Strategist, LPL Financial

Lawrence Gillum, CFA, Fixed Income Strategist, LPL Financial

Jeff Buchbinder, CFA, Equity Strategist, LPL Financial

Several policy-related risks loom in September and October that may lead to an increase in market volatility. The debt ceiling needs to be raised (likely by mid-October), the government needs to be funded to avoid a shutdown by the end of September, and the Democrats are trying to pass two major spending bills and will need to provide greater clarity on tax increases over the next several weeks. We believe the greatest risks come from the debt ceiling and taxes, but expect neither to have much near-term impact on the general trajectory of the bull market.

There’s always something going on in Washington, but with summer behind us, policy debates are heating up with an unusual number of high-profile policy issues looming for Congress and President Joe Biden in September and October. Those include the debt ceiling; the fate of the bipartisan infrastructure bill; clarity and potential progress on the much larger American Families Plan (AFP) spending package emphasizing Democratic priorities (also known as the human infrastructure bill); and, not to be forgotten, simply funding the government. These very well could be the peak policy months of President Biden’s first term, akin to the months leading up to the passage of the Affordable Care Act under President Barack Obama and the Tax Cuts and Jobs Act under President Donald Trump. This week we break down what market participants should be watching, possible sources of risk, and our expectations.
 

LOOMING DEADLINES FORCING THE ACTION

September and October aren’t important policy months simply because there’s a lot going on—looming deadlines are forcing the action. Keep in mind that Congress is notorious for not acting until the last possible moment and even pushing back deadlines whenever it can, as different members of Congress try to squeeze one more concession out of negotiations. This will create a lot of noise and increased uncertainty, but is unfortunately the norm for how Congress operates. While every maneuver may be of genuine political interest, as an investor, it’s important not to get too caught up in Congressional drama. Here’s a quick overview of where we are right now and what may be coming next:

• Bipartisan infrastructure bill – The bill, which includes about $550 billion in new spending over the next eight years and $1.2 trillion in total spending, was passed by the Senate on August 10. Since then, Democratic House leadership has been holding out on a vote, using the delay for political leverage to pull moderates on board for the larger spending package. On August 24, in exchange for voting in favor of the budget resolution needed for the AFP to progress, moderate Democrats were given a non-binding promise on infrastructure reaching the House floor for vote by September 27.
   
• American Families Plan – The August 24 budget resolution was needed for Democrats to pass a large spending package under the reconciliation process, which requires only a simple majority to pass in the Senate. The budget resolution set a soft target of the bill moving out of committee by September 15. To date, Democrats have remained vague on how the bill will be paid for, but the House Ways and Means Committee will need to provide a concrete proposal by September 15, assuming the timeline holds up. In other words, by September 15 we’ll start getting clarity on who is getting taxed and how much. That’s when things start to get interesting.
   
• Funding the government – A partial government shutdown takes place on October 1 unless a continuing resolution is passed to fund the government. That resolution would fund the government only for a limited specified time, at which point we do it all again. Often, the continuing resolution is made part of another bill that is hard to vote against, or it could get passed as part of the AFP using the reconciliation process.
   
• The debt ceiling – At some point, if Congress does not raise the debt ceiling the government would technically default on its current obligations. We don’t know exactly when that point will be, but it will likely come in mid-October. The government has been using extraordinary measures since early August to conserve cash so it can meet its obligations for as long as possible.

With deadlines forcing the action, what will market participants be watching? Primarily the debt ceiling and taxes. The two present contrasting risk profiles. Congress is extremely unlikely to let the U.S. default on its debt since it would likely have significant negative consequences for markets and the economy. On the other hand, Congress is very likely to raise taxes, driven by (slim) Democratic majorities in both chambers. But, based on history the immediate market impact is likely to be negligible, with the biggest risk around the hit to corporate earnings due to a higher corporate tax rate. On the other hand, taxes help contain deficits—it’s how you pay for what you spend, and for deficit hawks it’s preferable to borrowing. Best to spend wisely and tax lightly, but no president since 1960 has been able to achieve that except Bill Clinton. In the absence of that approach, paying for at last some of what you spend may be preferable to pushing the national debt even higher.

DEBT CEILING

The debt ceiling is the maximum amount of debt that the Treasury Department can issue. The Treasury uses the money it borrows to pay its obligations. The amount is set through Congress and has been regularly increased as needed over the years. The consequences of not raising the debt ceiling are far from trivial. Not only would the U.S. government not be able to cover its expenses, it would also default on its debt—which could send shockwaves throughout the financial system.

Through a bipartisan budget act in 2019, Congress suspended the debt ceiling through July 31, 2021, which allowed the government unfettered access to capital markets. As seen on the chart, when the suspension was enacted, total debt outstanding was $22 trillion—but current debt levels have risen to $28.4 trillion, which is the new debt ceiling level [Figure 1]. The debt ceiling will need to be raised soon or the U.S. Treasury will likely run out of its “extraordinary measures” to fund government activities. Treasury Secretary Janet Yellen recently said this would likely occur in October.
 

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August 30, 2021

POKING THE BEAR

Ryan Detrick, CMT, Chief Market Strategist, LPL Financial

Jeffrey Buchbinder, CFA, Equity Strategist, LPL Financial

Scott Brown, CMT, Senior Analyst, LPL Financial

First and foremost, this week’s commentary should not be construed to suggest that we are saying stocks will go up forever. We are also not saying that stocks are immune from a pullback in the final four months of 2021. Corrections are a normal part of investing and the S&P 500 Index has yet to pull back even 5% so far this year, something that happens on average three times per year. However, we remain steadfastly bullish and this week want to explore five things that some bears believe that do not worry us.

BEAR ARGUMENT #1: EQUITIES HAVE GONE TOO FAR, TOO FAST

2021 has been an amazing year for stocks, with the S&P 500 up approximately 20% for the year without so much as a 5% pullback. Additionally, it has made 52 new all-time highs so far. To put in context how rare this is, only 1964 and 1995 saw more than 50 new highs before August was over. In fact, the all-time record for new highs in one year is 77, set in 1995, and this year is on pace to come very close to that record.

August 23, 2021

WHY STAGFLATION ISN’T IN THE CARDS

Jeffrey Buchbinder, CFA, Equity Strategist, LPL Financial

Ryan Detrick, CMT, Chief Market Strategist, LPL Financial

Scott Brown, CMT, Senior Analyst, LPL Financial

The term stagflation has been circulating increasingly in the financial media as inflation readings have risen sharply in recent months. The term is often associated with the 1970s, which saw runaway inflation—largely driven by sky-high energy prices—and lackluster economic growth. Stagflation and a return to the weak equity markets of the 1970s would be understandably scary. However, when looking at the data, we remain skeptical that either runaway inflation or low growth are right around the corner, much less both at the same time.

THE MISERY INDEX

One way to gauge stagflation is to calculate what is commonly referred to as the Misery Index—inflation plus unemployment. As shown in Figure 1, the Misery Index today is nowhere near the extreme levels of the 1970s. In fact, the level of “misery” is very close to the long-term average near 10—despite the highest inflation readings we’ve seen in over a decade.

August 16, 2021

CORPORATE AMERICA DOES IT AGAIN

Jeffrey Buchbinder, CFA, Equity Strategist, LPL Financial

Ryan Detrick, CMT, Chief Market Strategist, LPL Financial

August 9, 2021

COVID UPDATE: DELTA VARIANT MARKET IMPACT

Barry Gilbert, PhD, CFA, Asset Allocation Strategist, LPL Financial

The highly transmissible Delta variant of COVID-19 now makes up an overwhelming majority of the new cases in the U.S., bringing with it a rise in cases and hospitalizations. Widespread vaccine distribution and distancing measures have helped limit the variant’s impact, but we could still see some drag on economic growth as some restrictions are reintroduced and consumers potentially become more cautious. While we may see an increase in market volatility due to the Delta variant, we believe the S&P 500 is still likely to see more gains through the end of the year.

THE DELTA VARIANT MAY DRAG ON ECONOMIC GROWTH

Despite the increased transmissibility of Delta and the increased health threat for those who aren’t vaccinated, our understanding of the measures needed to contain COVID-19 is in an entirely different place than it was in 2020. Above all else, we have not just one but several vaccines, which drastically reduces the risk from the variant, although it can’t completely eliminate it. We understand the effectiveness of masks in limiting transmission. Treatments have improved. We also know that the virus is not easily transmitted by touching surfaces—especially with simple good practices around handwashing—limiting the need for certain restrictions. Because of that, deaths from COVID remain near the lowest level of the pandemic despite the pick-up in cases [Figure 1]. Much of that is due to the vaccines’ ability to limit serious cases, though health risks remain high for those who aren’t vaccinated. We are also seeing some strain on healthcare systems in regions with low vaccination rates.

July 26, 2021

SIX SURPRISES SO FAR IN 2021

Ryan Detrick, CMT, Chief Market Strategist, LPL Financial

Jeff Buchbinder, CFA, Equity Strategist, LPL Financial

Thomas Goulder, CFA, Senior Analyst, LPL Financial

2021 has been a very strong year for both stocks and the economy, but that doesn’t mean there haven’t been some surprises. Below we take a look at some things that have happened so far in 2021 that have surprised the LPL Research team.

SURPRISE 1: YIELDS AREN’T HIGHER

Interest rates have surprised us twice this year. While we expected interest rates to increase this year, the strength of the move higher in the first quarter of 2021 was the first surprise. But reversing course and steadily falling since March may be an even bigger one. Put them together and the 10-year Treasury yield is still about 0.35% above where it was at the start of the year. Incredibly enough, we’re still in a rising rate environment. But the more recent decline is what’s on investors’ minds.

We don’t think there’s a simple explanation for why rates have fallen since March. A lot of factors have contributed: outsized inflation expectations coming down; short covering from crowded bets on higher rates; foreign buying; the drawdown of the Treasury General Account balance; and rising economic concerns about the impact of the Delta variant have all contributed. Part of the story is just one surprise correcting another. The 10-year yield had likely risen too far too fast in late 2020 and early 2021 and a course correction was natural, even if the pullback has been stronger than expected.

What’s the outlook for the rest of the year? Despite four months of falling rates, growth and inflation expectations still point to higher rates. Plus, don’t forget that the 10-year yield is still higher this year and we wouldn’t be at all surprised to see it resume its climb.

FIVE THINGS TO KNOW HEADING INTO AUGUST

Ryan Detrick, CMT, Chief Market Strategist, LPL Financial

Jeff Buchbinder, CFA, Equity Strategist, LPL Financial

Barry Gilbert, CFA, Asset Allocation Strategist, LPL Financial

Last week was a huge news week, from the Fed, to gross domestic product (GDP), to a giant week of earnings reports. Below we review the big events from last week, while also looking ahead to what could be an eventful August for investors.

EARNINGS CONTINUE TO SOAR

Last week was a very busy week for quarterly earnings reports and as we wrote in Midyear Outlook 2021: Picking Up Speed, we expected strong earnings growth to support further gains for stocks in the second half of 2021. Well, the second half is only a month old, but corporate America has sure delivered so far this earnings season. With only about half of S&P 500 Index constituents having reported so far, earnings growth is tracking to a year-over-year increase of 85% (source: FactSet), more than 20 percentage points above the consensus expectation when earnings season began and well ahead of our optimistic upside target in the mid-to-high-70s. We thought the bar had been raised too high for that much upside. Clearly we were wrong.

Growing earnings from the depressed year-ago quarter while much of the economy was shut down is not very impressive on its own. But blowing away analysts’ estimates after they’ve been consistently raised since last fall is very impressive, especially when considering ongoing challenges around COVID-19, supply chain bottlenecks, labor and materials shortages, and input cost pressures.

The strong momentum doesn’t appear ready to stop anytime soon. Estimates have been rising as companies have shared their outlooks. The consensus estimate for 2022 has increased 1.7 percentage points since July 1, a strong result given the history of estimate reductions during reporting season and the fact that about half of the index has yet to report.

July 19, 2021

MIDYEAR OUTLOOK 2021:

PICKING UP SPEED

Ryan Detrick, CMT, Chief Market Strategist, LPL Financial

Jeffrey Buchbinder, CFA, Equity Strategist, LPL Financial

Scott Brown, CMT, Senior Analyst, LPL Financial

It is hard to believe we have passed the halfway point of 2021. After a 2020 that would never end, the first six months of 2021 flew by. With the second half underway, we have updated our views of the markets and economy in LPL Research’s Midyear Outlook 2021: Picking up Speed. Below we provide a summary of those expectations covering the economy, policy, stocks and bonds.

ECONOMY: SPEEDING AHEAD

The U.S. economy has surprised nearly everyone to the upside as it speeds along thanks to vaccinations, reopening, and record stimulus. The growth rate of the U.S. economy may have peaked in the second quarter of 2021, but there is still plenty of momentum left to extend above-average growth into 2022. Despite the natural challenges of ramping back up, the recovery still seems capable of providing upside surprises.

We forecast 6.25–6.75% U.S. GDP growth in 2021, which would be the best year in decades. Last year’s 3.5% drop in GDP, the worst year since the Great Depression, may not be forgotten—but it has been left in the dust of 2020.

We continue to watch inflation closely but believe recent price pressures are transitory and will begin to work their way off gradually later in the year. As shown in Figure 1, the average U.S. expansion since World War II has lasted five years and much longer over the last few decades. There’s nothing on the horizon to indicate the current expansion can’t reach that mark.