By Jan Faure
More stimulus out of the US increases market volatility.
It has been a case of good news is bad news for equity markets of late. There is concern that stimulus measures and pent-up consumer demand (due to Covid-19 delaying consumer purchases) could drive inflation upwards and force central banks to hike interest rates. US 10-year treasury bond yields, seen as a gauge of future interest rate policy, have almost doubled this year.
Besides weakness in bond prices hurting conservative income investors, higher yields continue to shake up equity markets. Since interest rates affect equity valuations, it is the most expensive stocks (on a PE basis) that have suffered the most. The Dow Jones Index, with more value stocks in its composition, gained 6.6% in March while the tech-heavy (higher PE) Nasdaq increased by only 0.4%.
The US Congress passed the much anticipated $1.9 trillion Covid-19 relief package. The plan will send direct payments of up to $1,400 to most Americans and extend or expand various other measures. Republicans opposed the bill, arguing that much of it is unnecessary given improving economic indicators.
And the money just keeps coming. President Joe Biden unveiled a $2.3 trillion infrastructure spending plan to be spread over eight years. The infrastructure plan will be funded mostly through a corporate tax hike, partially reversing ex-president Trump’s corporate tax cuts. Trump had previously reduced the corporate tax rate from 35% to 21% and Biden’s plan will see this rise to 28%. It is certain to upset Republicans and will rely on the slim Democratic majorities in the House and the Senate in order to pass (which certainly isn’t guaranteed in its original form).
Republicans argue that high corporate taxes make US companies less competitive globally and reduces job growth. On the other hand, Democrats see the infrastructure spend as creating jobs and boosting the US economy long-term. In the end, the success of any legislative change lies in the execution. Tax cuts and/or infrastructure spending plans can boost the economy and create jobs (direct or indirect) but have their own nuances.
On the tax front, the US Treasury is seeking a global agreement on international taxation of companies through the Organisation for Economic Co-operation and Development (OECD) that would create a global minimum tax. US companies are known for merging with foreign companies in order to claim their country of residence and achieve a lower corporate tax rate, despite substantial operations in the US.
During the Covid-19 pandemic the US has made a concerted effort to support economic growth through ultra-loose monetary policy and massive stimulus measures. This has resulted in elevated economic growth expectations for years to come. The huge increase in US debt, needed to facilitate the recovery, cannot be ignored. The magnitude of the US’s debt is something to behold at $28 trillion, or 130% of US GDP (up from 107% a year earlier).
Debt can either be gradually inflated away or paid for by tax payers (usually a bit of both). In America’s case, the sheer size of the debt burden plus the Democratic government’s tendency to spend, could prove challenging to manage over time. If something is going to have to give it will be the US dollar which would speed up America’s move to second place behind China as the world’s most dominant nation.
An interest piece of research out of HSBC looked at the impact of the coronavirus on population growth and the implications thereof. Measures limiting social contact combined with economic stress to prevent and dissuade people from having babies. Europe is seeing its lowest birth rates since World War II, while China is experiencing a significant drop in baby registrations.
Aging populations is already a growing problem in parts of Europe and Asia. Young tax payers are needed to fund growing government debt (significantly worsened by Covid-19) and fund public pension systems. HSBC forecasts that two decades from now 10% to 15% fewer adults may join the workforce. Whether that materialises or not, the future looks ominous for many developed countries. Falling population growth negatively affects economic growth while at the same time aging populations require increased spending on pensions and healthcare, so it’s a double whammy.
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