Economy
2021’s Big Surprise: A Booming Economy and a Tepid Stock Market – Barron's
An abnormally bad year brought abnormally large gains for the stock market in 2020. A return to normalcy, however, could bring disappointment.
The
Dow Jones Industrial Average
has advanced 5.8% in 2020, to 30,179, after gaining 0.4% this past week. The
S&P 500
is up 15% this year, to 3709, after rising 1.3% for the week—even though
Tesla
(ticker: TSLA), which has soared 731% in 2020, won’t join the index until Monday. The
Nasdaq Composite
has jumped 42% in 2020, to 12,756, after gaining 3.1% for the week. Even the
Russell 2000
has gotten into the act, climbing 18% in 2020.
These gains came despite the slew of bad news that hung over the year: The coronavirus that shut down the economy and killed more than 300,000; the nonstop attention to politics, which made every tick of the stock market a referendum on the election; and the death of George Floyd and the protests that followed. It’s a reminder that the market doesn’t have emotions, doesn’t respond to cues that individuals might, and values what might happen over what has happened.
Next year promises to be less traumatic. Just this past week, people in the U.S. started getting vaccinated against the coronavirus, with some expecting 100 million Americans to have received the shots by the end of the first quarter. The return of daily life to something that more closely resembles normal should provide an incredible boost to the economy, one that finally helps the U.S. escape the slow-growth malaise it was stuck in under both Barack Obama and Donald Trump, when U.S. gross-domestic-product growth had trouble getting to 3% in any given year.
In fact, the biggest mistake investors might be making is looking at the past decade and extrapolating into the future. The last recession was stoked by a financial crisis that left banks with wounded balance sheets, muted risk appetites, and stagnant growth, thanks to the lack of major fiscal stimulus and a Federal Reserve that was too worried about inflation that never arrived.
This time around, trillions of dollars in fiscal stimulus was doled out immediately—and more is likely on the way. The Fed also seems to realize the mistake it made following 2008’s financial crisis and has promised not to tighten monetary policy until 2023.
Most important, the current recession isn’t due to too much risk-taking, but rather to a virus that forced a shutdown. That means the recovery should be faster and stronger than the one that began in 2009, says Christopher Harvey, U.S. equity strategist at
Wells Fargo
Securities. “It’s not a J, K, X-Y-Z, or whatever letter you want to throw at it recovery,” he argues. “It’s a V-shaped recovery.”
That’s certainly not the consensus view. Economists predict the U.S. economy will grow at a 4% clip in 2021, faster than what had been customary from 2010 through 2019, but not enough to undo the damage done by the coronavirus recession until 2022 or 2023. There’s a good chance economic growth will be much faster than that, says Michael Darda, chief economist at MKM Partners, who estimates that GDP will expand by 4.5% to 6.5% next year, while inflation will average 2.5% to 3.5%.
“The second half of the year should be very strong, as vaccine rollout and stepped-up therapeutics ramp reopening efforts,” he says. “The multi-trillion buildup of liquid assets in the household sector will be ‘run down’ as households spend on many services (leisure and hospitality, etc.) they could not spend on during 2020.”
But as we’ve heard so many times in 2020, the economy isn’t the market. It’s not that growth isn’t good for stocks—it absolutely is. A booming economy means that S&P 500 earnings next year could grow by 15% to 20%, Darda says. But strong growth could also cause Treasury yields to rise, and that would put pressure on market valuations, particularly those of high-priced growth stocks in the tech, communications-services, and consumer-discretionary sectors. Investors use Treasury yields as a risk-free rate, and the higher they go, the more valuations for growth stocks can fall. “The market will be flat to up/down single digits, as multiples contract with higher discount rates,” Darda says.
Wells Fargo’s Harvey agrees. He predicts that 2021 will see investors rotating out of highflying big tech and into cheaper, more economically sensitive stocks. But tech is an enormous part—28%—of the S&P 500.
Apple
(AAPL) alone makes up nearly 7% of the index, and
Microsoft
(MSFT), more than 5%. If these stocks were to tread water or—gasp!—even drop, the index could have trouble making a lot of headway.
“If they’re not going to work, it will be a big weight on the index,” says Harvey, who has a year-end 2021 target of 3850 on the S&P 500.
His advice: Buy stocks with high “Covid beta”—the ones most sensitive to the market’s rise and fall, based on good or bad coronavirus news—because they will benefit the most as life returns to normal. They include
Darden Restaurants
(DRI), which gained 3.1% this past week despite providing a downbeat revenue outlook,
MGM Resorts International
(MGM), and
Whirlpool
(WHR).
Sure, there will be reasons to doubt that the rotation is real. This past week, the Nasdaq beat the Dow by more than two percentage points. Just remember, that’s normal too.
Read more Trader: Dogs of the Dow Stock-Picking Strategy Didn’t Work This Year. It Could in 2021.
Write to Ben Levisohn at Ben.Levisohn@barrons.com
Economy
Biden's Hot Economy Stokes Currency Fears for the Rest of World – Bloomberg
As Joe Biden this week hailed America’s booming economy as the strongest in the world during a reelection campaign tour of battleground-state Pennsylvania, global finance chiefs convening in Washington had a different message: cool it.
The push-back from central bank governors and finance ministers gathering for the International Monetary Fund-World Bank spring meetings highlight how the sting from a surging US economy — manifested through high interest rates and a strong dollar — is ricocheting around the world by forcing other currencies lower and complicating plans to bring down borrowing costs.
Economy
Opinion: Higher capital gains taxes won't work as claimed, but will harm the economy – The Globe and Mail
Alex Whalen and Jake Fuss are analysts at the Fraser Institute.
Amid a federal budget riddled with red ink and tax hikes, the Trudeau government has increased capital gains taxes. The move will be disastrous for Canada’s growth prospects and its already-lagging investment climate, and to make matters worse, research suggests it won’t work as planned.
Currently, individuals and businesses who sell a capital asset in Canada incur capital gains taxes at a 50-per-cent inclusion rate, which means that 50 per cent of the gain in the asset’s value is subject to taxation at the individual or business’s marginal tax rate. The Trudeau government is raising this inclusion rate to 66.6 per cent for all businesses, trusts and individuals with capital gains over $250,000.
The problems with hiking capital gains taxes are numerous.
First, capital gains are taxed on a “realization” basis, which means the investor does not incur capital gains taxes until the asset is sold. According to empirical evidence, this creates a “lock-in” effect where investors have an incentive to keep their capital invested in a particular asset when they might otherwise sell.
For example, investors may delay selling capital assets because they anticipate a change in government and a reversal back to the previous inclusion rate. This means the Trudeau government is likely overestimating the potential revenue gains from its capital gains tax hike, given that individual investors will adjust the timing of their asset sales in response to the tax hike.
Second, the lock-in effect creates a drag on economic growth as it incentivizes investors to hold off selling their assets when they otherwise might, preventing capital from being deployed to its most productive use and therefore reducing growth.
Budget’s capital gains tax changes divide the small business community
And Canada’s growth prospects and investment climate have both been in decline. Canada currently faces the lowest growth prospects among all OECD countries in terms of GDP per person. Further, between 2014 and 2021, business investment (adjusted for inflation) in Canada declined by $43.7-billion. Hiking taxes on capital will make both pressing issues worse.
Contrary to the government’s framing – that this move only affects the wealthy – lagging business investment and slow growth affect all Canadians through lower incomes and living standards. Capital taxes are among the most economically damaging forms of taxation precisely because they reduce the incentive to innovate and invest. And while taxes on capital gains do raise revenue, the economic costs exceed the amount of tax collected.
Previous governments in Canada understood these facts. In the 2000 federal budget, then-finance minister Paul Martin said a “key factor contributing to the difficulty of raising capital by new startups is the fact that individuals who sell existing investments and reinvest in others must pay tax on any realized capital gains,” an explicit acknowledgment of the lock-in effect and costs of capital gains taxes. Further, that Liberal government reduced the capital gains inclusion rate, acknowledging the importance of a strong investment climate.
At a time when Canada badly needs to improve the incentives to invest, the Trudeau government’s 2024 budget has introduced a damaging tax hike. In delivering the budget, Finance Minister Chrystia Freeland said “Canada, a growing country, needs to make investments in our country and in Canadians right now.” Individuals and businesses across the country likely agree on the importance of investment. Hiking capital gains taxes will achieve the exact opposite effect.
Economy
Nigeria's Economy, Once Africa's Biggest, Slips to Fourth Place – Bloomberg
Nigeria’s economy, which ranked as Africa’s largest in 2022, is set to slip to fourth place this year and Egypt, which held the top position in 2023, is projected to fall to second behind South Africa after a series of currency devaluations, International Monetary Fund forecasts show.
The IMF’s World Economic Outlook estimates Nigeria’s gross domestic product at $253 billion based on current prices this year, lagging energy-rich Algeria at $267 billion, Egypt at $348 billion and South Africa at $373 billion.
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