Pricing In Tax Reform

US stocks opened mixed this morning, trying to recover from a modest pullback last week. At the moment, the S&P 500 is flat on the session, sitting about 2% from its record intra-day high set back on September 2^nd. On the other hand, the Dow is up 200 points this morning on strong gains for UnitedHealthcare (UNH) and Boeing (BA). WTI crude oil climbed back to $70/barrel, pushing energy stocks higher. Part of that move is due to weather events (i.e. Tropical Storm Nicholas). Also, OPEC’s monthly report predicts global oil demand will rise 4.3% to 100.8 million barrels per day next year, which is higher than pre-Covid levels. Bonds are trading broadly higher in price today, with yields ticking lower. Safe-haven Treasuries are faring the best. The iShares 20+ Year Treasury Bond fund (TLT) is up .5% at the moment.

Despite a synchronized global economic recovery and growing conviction that the Federal Reserve will soon begin to pull back on monetary stimulus measures, we’re seeing fairly strong demand for low-paying but safe Treasury bonds. Last Friday’s Treasury auction drew strong interest from investors, even for 30-year bonds. Why? Is confidence in the stock market rally and economic recovery fading? Are investors using these Treasuries to hedge? Are bond traders betting that bond yields are going even lower? Is this a sign that 4-5% inflation is temporary? Bloomberg News says investors are hedging amid a “long list of shocks” like Hurricane Ida, China’s crackdown on technology corporations, and Covid’s Delta variant. And with the stock market having climbed 14-18% this year without so much as a 5% correction, we can expect some volatility as markets price-in these near-term headwinds.

Investment strategists at Morgan Stanley and Goldman Sachs say the more important longer-term risk is tax reform. While the market seems to have more or less priced-in at least another $1 trillion in fiscal stimulus, it has not priced-in President Biden’s higher $3.5 trillion package, or his proposed tax hikes. Clearly, investors don’t believe Mr. Biden will get exactly what he’s asking for. A couple of moderate Democratic senators have questioned the need for another $3.5 trillion in stimulus as well as some parts of the tax hike proposal. The House Ways and Means Committee just released a brief of its own proposal that according to Bloomberg News “falls short of President Biden’s ambition” and is “slimmed down to appeal to business-minded Democrats.” For example, the highest corporate tax rate would rise to 26.5%, not 28%. The highest rate on capital gains would rise to 25% rather than 39.6%. To get the final bill passed, Democrats need 100% loyalty in the Senate and can only afford 4 defections in the House. So there isn’t much wiggle room.