Investment strategy

September 19, 2021

How will the impending US fiscal drama impact markets?

September 19, 2021

David Bailin

Chief Investment Officer and Global Head of Investments

Steven Wieting

Chief Investment Strategist & Chief Economist

SUMMARY

US tax and spending negotiations will deliver plenty of drama in the months ahead from COVID legislation to a debt ceiling vote. The aftermath may create potential winners in specific sectors but is unlikely to see either falling market interest rates or another cyclical surge.

The administration and Congressional Democrats have already scaled back the scope of several proposed tax hikes affecting corporate income, capital gains and carried interest, with more changes likely. However, prediction markets place the probability of passage of some form of sweeping tax legislation at 70%.

Equities most impacted by potential tax changes have rebounded, perhaps relieved by the absence of a corporate minimum tax in House legislation. Statutory corporate tax rates would rise just 5.5 percentage points after a 14-percentage-point cut at end 2017 (and likely even less on an effective basis). Individual income taxes – including a lower threshold for the top tax rate – carry a larger share of the revenue grab.

Partisan conflict could turn the annual debt ceiling ritual into one of the more troubling episodes. However, unlike 2011, Democrats control both houses of Congress, and could likely pass a debt ceiling increase by folding it into their reconciliation legislation with a simple majority.

The proposed gross fiscal expansion of $3.5 trillion over 10 years is modest compared to the nearly $5 trillion in emergency spending measures during the past two years.

Of course, government support for the economy will not come “cost free” for investors. Certain industries will see outsized benefits and costs from the redistribution of resources. Higher spending on US infrastructure and alternative energy may reinvigorate the performance of related shares.

US equity returns have been rapid year-to-date with the S&P 500 advancing over 20% following a similar gain in 2020. As we discussed last week, the rally has been strongly supported by what is likely to be 45% EPS gain this year. In 14 cases during the past seven decades, US equities fell in years featuring tax increases only once.

We would not alter our equity and bond allocations around US tax issues alone. That said, we will watch keenly for further clarity on potential winners and losers from resulting from legislation and other important market drivers.

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How will the impending US fiscal drama impact markets?

SUMMARY

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