It’s been a busy April for the markets and economy… Earnings season continues, with more companies beating earnings by more than ever before. The housing market continues to roar full speed ahead. And the only thing that caused the market to pump the breaks last week? The threat of higher taxes from President Biden’s latest policy proposals. For more market weekly updates, you can find all the previous Monday Market Update’s here. You can now also get the market weekly update every week on Finance Explained, my new podcast, along with a deep dive on a topic relevant to the week’s headlines.
Monday’s Market Weekly Update
The overall market sentiment throughout 2021 continues to be driven by two key themes, but last week highlighted a third leg to the stool…
- Stock market rallying on hopes of recovery
- Tempered by rising interest rates fueled by inflation concerns
- Threatened by unfavorable changes to corporate and capital gains taxes
Earnings Season Fuels Recovery Hopes
Last week, earnings season continued. According to FactSet, so far, with 25% of companies in the S&P 500 having reported, 84% have reported a positive EPS surprise, meaning the reported actual Q1 2021 earnings beat analyst and investor estimates. Most companies give guidance to set themselves up to succeed – on average, over the last 5 years, companies have beat earnings 74% of the time. The 84% for the current quarter is high, and if it holds through the rest of earnings season, will be tied for the highest surprise percentage since FactSet began tracking this back in 2008. It’s also tracking to be the largest earnings surprise season ever – with companies beating earnings by nearly 24% on average, vs 5-year average of 7%.
You can see this in the select companies that reported just last week alone.
This hard data demonstrating solid performance for Q1 2021 is supporting the stock market’s hopes for economic recovery. The average earnings growth rate for the S&P 500 so far is over 30%, driven by rising profit margins and easy 2020 comparisons. If this trend continues, Q1 2021 will have the highest earnings growth rate reported since 2010. So if you’re looking for an explanation as to why stocks are where they are, Q1 2021 earnings season is delivering the data to support it, at least somewhat.
Coming up this week? Nearly 900 companies are scheduled to report earnings, including 181 S&P 500 companies. Some of the biggest names to watch:
- Monday – Tesla
- Tuesday – Alphabet (parent company of Google), Microsoft, 3M, Starbucks
- Wednesday – Apple, Boeing, eBay, Facebook, GrubHub, Shopify, Yum Brands
- Thursday – McDonald’s, Amazon, Mastercard, Twitter
- Friday – Clorox, Chevron, Exxon, Barclays
Interest Rates Still A Headwind & Now Higher Taxes Too
The S&P 500 closed essentially flat for the week, down -0.1% vs. the week prior, and the first down week in a month. The market was mixed for most of the week, as interest rates also remained relatively flat ahead of this week’s FOMC meeting, before a sharp sell-off on Thursday following a leak of the President Biden’s plans to fund the second part of his plans, the American Family Plan, in part through doubling capital gains taxes on the wealthy. The market recovered most of the losses on Friday, to finish the week down just 0.1%, despite strong earnings reports.
With the down-tick in interest rates over the last month, we’ve also seen 30-year mortgage rates tick down as well, and last week they dropped below 3% to 2.97%, down another 7.0bps from the week prior, and still near historic lows.
I still believe interest rates softening over the last few weeks is just a temporary pause – not a trend expected to continue – given growth and inflation expectations. We are still seeing inflation expectations in the 10 Year Treasury to TIPS spread, and this month’s CPI numbers for March give us hard data confirming those expectations are valid. Ten-year TIPS yields are currently negative, meaning current actual long-term interest rates are lower than expected inflation. The Treasury spread to TIPS continues to hold steady well above 2%, ending last week at 2.32%. This spread historically has predicted inflation growth about a quarter ahead of time, and at current levels, estimates inflation of about 2% for the coming quarter (vs. latest level for March of 2.6%). It should be noted the Fed’s own estimates for 2021 inflation now sit at 2.4%. We will get an update from the Fed later this week, following their regularly scheduled FOMC meeting.
Last Week in the Markets
Last week, the pause in rising interest, and continued solid Q1 2021 earnings reports, both positives for the stock market, were offset by public policy concerns around President Biden’s plans to double capital gains taxes for those earning more than $1 million a year. He is expected to formally present the plan to Congress on Wednesday (4/28). Even more companies are scheduled to report earnings this week, and the Fed is also scheduled for an FOMC meeting – so lots of news that could potentially impact the market this week.
The clearest market move last week? Commmodities continue to rally, as inflation-fueled price increases continue. Almost all commodities – from ag and lumber to metals and energy, are at or near 52-week highs, with prices up double digits, and in the case of petroleum products, iron, copper, corn and lumber – triple digits. These moves in input prices have already translated to higher prices on consumer goods, with companies reporting more planned price increases in 2021 as they report Q1 2021 earnings. Companies have to raise prices when faced with higher input costs in order to preserve profit margins and earnings. This is inflation.
Select Consumer Goods Companies Reporting Planned Price Increases So Far…
- P&G will raise prices on baby care, feminine care and adult incontinence products in September due to rising commodity costs
- Kimberly Clark annouces price increases effective in June for baby and child care, adult care and Scott bathroom tissue
- Coca-Cola will raise prices on its drinks to combat the impact of higher commodity costs
- JM Smucker raised Jif peanut butter prices back in August due to lower peanut yields
- Pepsico plans to increase prices through smaller packaging
- Nestle CEO warns company could raise prices later this year or early next to offset pandemic-related inflation
- General Mills has indicated it will raise prices by a “significant margin” in Q2 2021, after gross margins took a hit in Q1 due to cost inflation
After a few weeks of tech and growth rallying, last week we saw a bit of return to the earlier trends of this year – with tech and growth in a holding pattern, as value, small cap outperformed again. This could be a pause ahead of major tech earnings releases this week, as well as disappointing outlook and headwinds for companies like Netflix, which reported earnings last week. While Netflix had good results for Q1, these big tech companies that benefitted signficantly during the lockdown last year, are some of the few to face more difficult growth comparisons this year leaving investors with a lukewarm feeling about thier outlook going forward.
In the bond market, you can see a similar outperformance of higher risk securities year-to-date, as investors have sought higher sources of return. High Yield bonds, with lower credit and higher interest rates, have significantly outperformed Investment Grade and Treasury bonds year to date, though all bond indices are mostly flat to down year-to-date, as rising yields drive prices down. As mid-to-long-term rates have softened in over the course of April, we’ve seen bond market performance take a bit of a pause. For more on the inverse relationship between bond yields and bond prices, see 10+ Different Types of Investments under How Bonds Work.
Mid and long-term bond yields peaked at the start of April, and you can see the difference in the yield curve today vs. 2.5 weeks ago above. Just that little bit of softening, mostly due to investors’ beliefs that the Fed will hold off on raising rates for now, has given the market room to run over the last few weeks.
The rise in the longer-term end of the current yield curve since the start of the year has driven the price of bonds down significantly year-to-date. The more steeply upward sloping yield curve is representative of a more normal, growing economic environment, but also a result of inflation expectations and expectations of more government borrowing in the short-term. Compare it to the yield curve last March, an inverted curve, when long-term Treasury rates hitting their lowest levels ever, which is predictive of a recessionary environment.
Concerns over inflation, and the rapid growth in the money supply, have fueled the rise in more speculative investments, like commodities and cryptocurrencies, like Bitcoin. Want to know more about what’s driving inflation concerns? Check out this post on Higher Inflation.
I mentioned last week the flash crash in Bitcoin last weekend… well it spurred a continued sell-off thorugh last week. It ended the week down 18%, and down nearly 20% from it’s prior week high. There’s lots of speculation as to why Bitcoin is selling off, including:
- Plans by countries around the world for increased regulation and/or ban of cryptocurrencies entirely. Increased regulation is anticipated by the US Treasury Department, though the timing is still unclear.
- More competition – many countries are also launching or evaluating the launch of their own digital currencies, including China, England and the US. Last week, many investors were bidding up Dogecoin too, and last week’s IPO of Coinbase, a dedicated cryptocurrency exchange, makes all cryptocurrencies more accessible to investors
- Biden’s Capital Gains tax hike: all those Bitcoin “millionaires” may be locking in gains now ahead of a tax hike
But this highlights two key issue for cryptocurrencies in general: 1) increased volatility – you don’t get triple-digit annual price increases without some double-digit swings along the way and 2) no underlying fundamental basis. The value of Bitcoin is solely based on whatever its holders believe it is worth. There are some shaky hands out there, and any signs of weakness are likely to send those investors to the exits.
The Economic Weekly Market News
This week’s major economic releases included:
- Thursday: Weekly Jobless Claims, Mortgage Rates & Fed Balance Sheet Data
- Housing Market: Existing Home Sales & New Home – Starts & Sales
Weekly Jobless Claims
While the monthly employment report gives us far more insights into demographics and industry breakdowns of the labor market, Weekly Jobless Claims gives us more real-time data on the labor market’s progress. On Thursday, weekly jobless claims for the week ending 4/17 dropped to 547,000, a decrease of39,000 from the previous week’s upwardly revised level. This is a good sign, but I want to see these lower levels continue to drop for several weeks before I say we are truly seeing continued labor market recovery – which has mostly been stalled since November – especially since continued claims under all programs ticked up again last week.
Total insured unemployment, under regular state programs, is down to 3.7 million people, an insured unemployment rate of 2.6%. However, this remains only a fraction of those covered under the expanded pandemic and emergency programs at both the state and federal level.
Total insured unemployment under these programs for the week ending 4/3 (this comes at a longer lag) is far greater – 17.4 million, this week up by 0.5 million continued claims vs. the week prior. This total has bounced around a lot in recent weeks, as benefits expired and were then extended both at the end of 2020, and again in March. The American Rescue Plan Act officially passed into law last month extended benefits to the end of August, so I expect all changes in these numbers to now be actual people truly going back to work, and not just exhausting their benefits.
Explanation of Various Unemployment Insurance Programs
It’s been a while since I broke this down and had some follower questions about it last week, so I wanted to explain some of the categories you see in the table above and chart below, specifically to two programs that are newly created due to the pandemic and supported by federal funding.
- Pandemic Unemployment Assistance (PUA)
- Eligibiilty is for those who do not qualify for regular unemployment compensation, including those who are self-employed, seeking part-time employment, or unable or unavailable to work due to health or economic consequences of the pandemic
- As of March 14, 2021, PUA was extended from 50 weeks of eligibility to 74 weeks and ends the week of September 4, 2021
- Pandemic Emergency Unemployment Compensation (PEUC)
- You are eligible for PEUC if you have exhausted your regular state or federal unemployment benefits
- As of March 14, 2021, PEUC was extended to 49 weeks of PEUC benefits until the program ends on September 6, 2021
Both of these programs did not exist before the pandemic. They are federally funded and are designed to address and fulfill shortfalls of normal unemployment benefits – like for those who are self-employed or part-time, as well as providing extended benefits for a longer period of time due to the impact of the pandemic.
In addition to both of these extended, Federal programs, the Federal government is also funding an extra $300/week unemployment benefit for all those receiving regular state benefits, as well, also through September 6, 2021.
Big picture: this is really what insured unemployment looks like. Even with the solid drop in continued claims at the end of March, insured unemployment is still solidly in double digits.
Weekly Mortgage Rates
Let’s chat about mortgage rates… with the housing market on fire, lower mortgage rates continue to support increased demand and make higher priced homes more affordable. Freddie Mac publishes the results from its Primary Mortgage Market Survey every Thursday, giving the weekly US average for 30 Year Mortgage rates. As of 4/22/2021, the average 30-year rate was 2.97% with 0.7 points, but still up +0.30% since the start of the year.
I talk a lot about what’s happening with interest rates – and I’ve included the 30-year Treasury yield on these mortgage charts to help you see how overall market rates truly impact what we pay in interest as well. The 30-year treasury rate is 99.5% correlated with mortgage rates – meaning, as Treasury rates go, mortgage rates do too, almost always. And historically, the spread, or the difference in rate between 30-year treasuries and mortgage rates, has been fairly consistent as well. But note in the second chart, how much the spread has narrowed since the start of the year.
Since the late 1970s, the average spread has been 1.38%… it’s currently only 0.70%. Why? Because the Fed has stepped in as a major buyer of Mortgage-Backed Securities (MBS), holding mortgage rates lower than they might otherwise be. However, recent weeks show their open market purchase activity may be starting to slow.
Lower rates should be a good thing for buyers… but it has an unintended consequence too. The Fed can use open market activities, acting as a large buyer in the market, to lower interest rates, but it can’t force banks to lend at those lower market rates. So while lower rates are making more expensive homes more affordable to buyers, and increasing demand for mortgages, it’s also causing banks to tighten their lending standards. With interest rates very low, banks are less willing to lend to higher risk borrowers, so they limit their exposure by tightening lending standards, limiting mortgage availability to only the most creditworthy of borrowers…. this encourages the Fed to buy more MBS to loosen the credit market, and the cycle repeats itself.
March Housing Market
Ahead of this week’s housing data release, I gave a detailed update on the housing market and the forces driving the current demand and price increases in the housing market here, as well as in last week’s podcast deep dive.
Related Post: Is this a Good Time to Buy a House?
The data released last week – both for the existing housing sales reported by the National Association of Realtors, as well as by the Census Bureau on Housing Starts and New Home Sales – confirmed much of what we were already expecting – lower inventories faced with high demand driving further price increases.
On the new housing front, we similar trends… but we are also seeing a big increase in new construction as well. New housing starts increased 19% vs. February, and are up 37% vs. March 2020, to 1.7 million starts, on a seasonally adjusted basis. This is the highest level since late 2006, with the last 6 months being the first time since the Great Recession that we’ve seen starts consistently at or above median levels in well over a decade.
But they are playing catch up with demand… in March, over 1 million new homes were sold on a seasonally adjusted annualized basis, up nearly 70% vs. March 2020, as homes for sale are less than a year ago, driving up the median price on new homes sold to over $330,000.
Calling All Realtors & Mortgage Experts…
I will be hosting a second LIVE Q&A this Spring and would love for you to share your expertise and what you are seeing in your local markets as the Spring selling season gets underway.
FRIDAY, 5/21 – 9:30AM ET
If you are able to join, please sign up here!
The Political Update
The major political news that moved the stock market last week surrounds a “leaked” proposal coming from the Biden administration to double the capital gains tax rate on the wealthiest Americans. I say “leaked” because this shouldn’t come as a surprise to anyone – it was front and center as part of his campaign platform, and I even talked about it when I outlined the potential economic impacts of the election. The table below outlines the proposals now President Biden campaigned on that I originally published back in October – so again, this should not be news, as it is merely him making good on his campaign promises.
However, it will be front and center again this week on Wednesday when President Biden presents his $1.8 trillion American Families Plan proposal to a joint session of Congress. (Mind you Congress still hasn’t passed legislation and is still debating his $2.3 trillion American Jobs Plan – you can find the detailed breakdown of the Jobs Plan, aka Infrastructure Plan, here.) While the Jobs Plan is intended to be funded by a hike in corporate taxes, the Families Plan intends to raise personal income taxes on the wealthiest Americans, including doubling the capital gains tax rate for those earning more than $1 million annually, to pay for it.
I’ll give a full breakdown of the American Families Plan next week once the White House actually releases the full details, and we have more than just speculation and heresay to go on, but it is focused on initiatives like childcare, universal preschool, paid family leave, and free community college.
Capital Gains Tax Increase
Ahead of that release, I wanted to provide some data points on capital gains taxes, and why they are generally viewed unfavorably.
Higher Capital Gains Taxes Will Reduce Investment
First, from a government revenue perspective, capital gains taxes are the most volatile and least reliable of all tax revenue sources. They ebb and flow with the economic environment, and are highly controlled by investor behavior. This makes them far less consistent than income taxes. While income growth may slow or decline by single digits in a recession, the stock market, as we saw last year, can decline by double-digits when faced with a recession. And when the market tanks, capital gains taxes dry up, at the very time the government needs revenue. This also makes any forecasting for what they may produce in terms of tax revenue going forward highly speculative and contingent on future market performance.
Note also the impact of human behavior. Look how realized gains spike ahead of a tax rate increase (1985, 2012)… and are then followed by a dearth of realized gains after, resulting in far less tax revenue than would have been projected by a rate increase. Investors choose when they want to realize capital gains and pay taxes. You can bet the more likely it looks like this will happen, the more will choose to realize gains this year ahead of a doubling of the tax rate… and after, they will limit realizing as many gains as possible. This also means they will be less likely to sell existing investments going forward, to free up additional capital to invest in new opportunities.
On the flip side, look what happens when the maximum tax rate on capital gains is reduced – 1981, 1997, 2003. Look at both the subsequent market performance as well as the resulting realized capital gains and tax revenues generated.
Investors care about the after-tax value of their investment returns. They expect to realize a specific level of after-tax returns for the risks they are taking. If you double capital gains taxes, you cut the after-tax returns to investors by 25%, which means one of two things, both of which produce the same end result – 1) investors will take fewer risks when investing or 2) they will demand a higher pre-tax return to end up with the same after-tax results – leading to less investment overall. Not enough opportunities will meet their return objectives. This means less venture capital investing, less investment in innovation, less entrepreneurship – all of which are what drive future economic growth and jobs.
Makes US Less Attractive Place to Invest vs. Rest of World
It also makes the US less favorable to investment relative to the rest of the world. There are, in fact many OECD countries that have a capital gains tax of 0%, because they know taxing capital gains impeded investment, hindering future economic growth. The OECD weighted average top marginal tax rate on capital gains as of 2015 was just over 23%, pretty close to where the US is today as well. Our top marginal capital gains tax rate is 20% for those filing jointly making just under $500,000. It was reduced to 20% from 25% under the 2018 Trump tax cuts. There is an additional net investment tax of 3.8% which was added back in 2013 to support the funding of the Affordable Care Act, for a top federal marginal tax rate on capital gains of 23.8%.
President Biden proposes setting the top capital gains tax rate to be the same as ordinary income rates for those earning over $1 million per year, or 39.6%. With the additional funding for ACA, that would make it 43..4% – the highest marginal tax rate on capital gains in the entire developed world, and nearly twice the OECD average.
Capital is fully mobile. Investors – both US-based as well as international investors – will put their money wherever after-tax returns are most attractive. And with a doubled capital gains rate, the US becomes a less attractive place to invest.
But It Only Applies to the Wealthy…
Now, this is allegedly only going to apply to those who make over $1 million a year, so you may think, this will never apply to me. But here’s the thing – the wealthy are who invest. You’re impacting the behavior of the significant majority of investors, albeit less than 1% of all taxpayers.
Those who make over $1 million a year fall somewhere between the top 0.1% and 1% of all tax filers in the US… the majority of their income, unlike the bottom 99%, is driven by capital gains. And they account for more than half of all the realized capital gains, with the top 1%, representing 2/3s of all capital gains, while the remaining 99% represent just 1/3. So you are talking about impacting the majority of investors in the United States, even if it impacts less than 1% of all taxpayers.
Why Should Capital Gains Be Taxed Less Than Other Income?
So why are capital gains taxed at a lesser rate than ordinary income? It’s not just this way in the US – nearly all developed economies provide favorable tax treatment for investment income – so there has to be a reason for it.
There are several reasons for this historically:
- Investment gains are viewed as double taxation
- Investment gains are primarily driven by inflation
- International competitiveness (as I already alluded to above)
- Incentivizing investment for future economic growth
First, many view taxing investment income at all as double taxation. You earn ordinary income, you pay taxes on it, and then invest it… only to be taxed on it again when you realize gains. Or, conversely, a company earns income, pays taxes on it, and distributes part of that earnings to shareholders as dividends, and shareholders get taxes on the investment income. From whichever side you look at it, it is money being taxed twice.
Second, as we’ve seen over this last year more clearly than ever before, the actions of our own government – both by the Central Bank lowering interest rates and printing more money in a single year than in the entire last decade combined, as well as the significant increase in government spending, is driving higher inflation. This is also part of what is fueling investment returns, as investors try to offset the loss of their dollar’s purchasing power. The capital gains realized are not real returns – they are impacted by inflation. A lower tax rate is viewed as an adjustment for the impact of inflation.
Also, as I outlined above, capital can easily be invested anywhere around the world. Keeping capital gains rates low makes investing in the US more attractive relative to the rest of the world. Increasing capital gains rates makes it increasingly likely we will see investment outflows – as investors liquidate US investments in favor of more tax-favorable, international markets.
Finally, investment is the growth engine of our future economy. When investors realize gains, they typically redeploy most of them into new businesses, new technology, or new entreprenuerial endeavors. Studies show that higher capital gains rates reduce funding for start-ups, as well as entrepreneurship. Remember, the vast majority of investors fall into the $1 million a year income bucket – which means the vast majority of funding for start-ups and entrepreneurs come from that bucket – and President Biden is proposing to double the taxes they pay, reducing the funds they have to reinvest, as well as reducing the risks they are willing to take, given the prospect of lower after-tax returns.
Former Fed Chairman Alan Greenspan, who led the Fed for nearly 20 years from 1987-2006, serving under 4 different Presidents, once said:
If the capital gains tax were eliminated, that we would presumably, over time, see increased economic growth which would raise revenues for personal and corporate taxes as well as the other taxes we have. The crucial issues about the capital gains tax is not its revenue-raising capacity. I think it’s a very poor tax for that purpose. Indeed, its major impact is to impede entreprenuerial activity and capital formation. While all taxes impede eeconomic growth to one extent or another, the capital gains tax is at the far end of the scale. I argued that the appropriate capital gains tax rate was zero.”– Alan Greenspan, February 1997 Senate Banking Committee Testimony
And in fact, as of 2021, many European countries have no taxes on capital gains, including Belgium, the Czech Republic, Luxembourg, Slovakia, Slovenia, Switzerland and Turkey.
Where would you want to invest?
The Virus Update
Concerns over a potential 4th wave here in the US have started to subside as vaccinations among younger age groups increase, and we are starting to see new cases fall again. New cases for the last week were down -11.7% vs. the week prior, and deaths were down as well, both trends in the right direction after several weeks of increases. Meanwhile, 53% of Americans over 18 have now received at least one dose of the vaccine. and 35.9% over 18 are fully vaccinated.
We also saw vaccinations start to slow down last week. This is likely due to the pause in the distribution of the J&J vaccine which temporarily reduced overall supply. Last Friday, an FDA advisory panel voted and the CDC heeded their vote to lift the recommeded pause on the J&J vaccine folloing a thorough safety review, determining the “the vaccine’s known and potential benefits outweigh its known and potential risks.” That should alleviate any supply slowdown going forward… however, there could be another cause for the slowdown.
With vaccines now officially available to all US residents in every state over the age of 16, we may be starting to hit up against the population who is more hesitant to be vaccinated. We will need to watch how vaccinations progress over the coming weeks to see how quickly we can reach herd immunity levels, or if we are able to ever fully get there, given members of the population who are hesitant or refuse the vaccine.
Despite those headwinds, we saw a near 10% in vaccines distributed and 8% in vaccines administered last week (down from double-digit growth the weeks prior), and are still vaccinating over 3 million people daily. Note that vaccination data continues to be updated for up to a week, so expect the most recent week’s data to increase. So far, over 93 million people are now fully vaccinated, representing 28% of the population. Many experts believe we need to get to 65-80% vaccinated to achieve herd immunity, which would allow life to resume with some level of normalcy.
The Week Ahead
It’s another big week for economic data, as well as the peak of earnings season. Over 900 companies are scheduled to report Q1 2021 earnings this week (4/26-4/30). On the economic front, we also have lots of data coming this week:
- Wednesday – FOMC Press Conference (Fed’s interest rate decision)
- Thursday – Weekly Jobless Claims, Mortgage Rates & Fed Balance Sheet data, First estimate for Q1 2021 GDP
- Friday – Disposable Income & PCE Price Index
For More Information…
For a more detailed history of all the metrics shared, check out When Will the Economy Recover, which I previously updated monthly through 2020, and gives a more detailed overview of market and economic indicators, as well as their historical context. Questions? Feel free to leave them in the comments below, in the weekly question box in my Instagram stories, or now you can leave me voice messages for the Finance Explained podcast too!