FAS Monthly Market Update October 2020

FAS Monthly Market Update October 2020

Posted By FAS Team

 

Economic Conditions

U.S. GDP grew at an annual rate of 33.1% in the third quarter of 2020, according to the advance estimate released by the U.S. Department of Commerce.  This was a stark difference from the 31.4% decline we experienced in Q2.  While the 33.1% reading topped economists’ expectations of 32% annualized growth, this kind of reading was not entirely surprising given the unprecedented circumstances the world has experienced this year.  The economy’s steepest quarterly decline in history came when the entire global economy was quite literally brought to a halt in Q1.  Fiscal and monetary stimulus, along with debt and rent deferments from lenders and landlords, allowed many businesses and individuals to slow the bleeding.  This helped tee up the surge in consumption, the largest contributor to GDP, which increased over 40% in Q3 and lead to the record breaking increase that more than doubled the previous post-WWII record increase.

Despite the strong growth, the economy still has a ways to go as the economy is still roughly 3.5% below its level at the end of 2019.  To put that into perspective, the peak to trough drop in GDP during the Great Recession was roughly 4%.  Unemployment still remains at 7%, albeit trending downward.  However, that trend has started to slow and could continue to slow as more job losses due to Covid-19 become permanent.  The number of permanent job losses increased throughout Q3 and only recently began falling in October to 3.6M where it currently sits, although that number is still less than half the number of permanent job losses during the Great Recession.

Market Conditions

Following the month of September when the markets pulled back from near-all-time-highs then began to rally into the end of the quarter, major indexes again pulled back another 7.5% from recent highs into the end of October as investors began to take profits/get nervous leading up to the election.  Markets began last month with a 5% gain before selling off leaving all major indexes negative for the month.

What occurred leading up to and through the election was something most investors probably didn’t predict.  Markets began their rallies at the start of November and the S&P 500 was already up 5% from its October bottom by election day.  Despite the initial uncertainty around election results, markets continued to climb.  We’ve always said the market hates uncertainty, however the one thing most of the election previews we had been reading had in common was that the election would not be decided on election night due to the number of mail in ballots and different states’ procedures for counting ballots.  It was almost as if the market was certain there would be uncertainty around the election and therefore rallied when expectations were met.  The market has since neared all-time highs once again following the news of successful vaccine trials as it is assumed the end is now somewhat in sight, even if that end may be several months, if not a year, away.

The Biden Tax Plan

Political differences, tweets and lawsuits aside, it has become clear that Joe Biden will be the next President of the United States.  One of the most widely discussed topics in this election cycle has been Joe Biden’s tax plan.  Like most other political issues in recent years, it has been hotly debated with no real explanation of the finer details and how it would truly impact taxpayers – only “job destruction” and “war on the middle class” from the right and demands of the rich “paying their fair share” from the left.  In order for the President Elect to get his tax plan passed he will need a simple majority in the Senate.  Legislation requires a 3/5 majority in the Senate in order to become law, however tax changes can be made through budget reconciliation which only requires a simple majority.

The Democrats lost nine seats in the House to the Republicans but still retain the majority, albeit by the thinnest margin in decades.  The Republicans lost one seat to the Democrats in the Senate and now hold 50 seats to the Democrats’ 48 seats with two Senate races yet to be decided, coincidentally both in the state of Georgia.  There are currently two seats held by Independents who typically vote with the Democrats.  If the Democrats are able to flip both seats, the Senate will be effectively split 50/50 with Vice President Kamala Harris being the tie breaker.  If the Republicans are able to keep a simple majority, the Democrats will have to wait at least two years until midterm elections to flip more seats and gain a majority.  Since there is a chance the Democrats could win both seats in the Georgia runoff, we feel it is a good idea to lay out exactly what Joe Biden’s tax plan entails.

The first key feature of the Biden tax plan would be to raise the corporate tax rate from 21% to 28%, still lower than the 35% corporate rate pre-2018.  Additionally, the plan would create a minimum tax on corporations with book profits of $100M or higher – essentially an alternative minimum tax for corporations.

On the individual side there are several more changes that would be made beginning with repealing the Trump tax cuts which are not set to expire until 2025.  This piece most likely only refers to those whose incomes surpass $400,000.  Prior to the Tax Cuts and Jobs Act the top marginal tax bracket was taxed at 39.6% and applied to income over $418,400.  The TCJA raised the threshold for the top marginal tax bracket to $600k and lowered the tax rate of the top marginal bracket to 37%.  Mr. Biden has stated that the tax increases would only affect those earning $400k or more, which we assume means the tax rates for each of the lower marginal tax brackets would not revert back to 2017 levels.

In addition to increasing the tax rate for the highest marginal bracket, the plan would impose a 12.4% Social Security payroll tax on all earned income over $400k.  The 12.4% would be split 50/50 between the employer and employee with each paying 6.2% just like the current Social Security payroll tax.  Social Security tax is phased out on income above $137,700.  This would phase the payroll tax back in above $400k, creating a gap between $137,700 and $400,000 in which no additional Social Security taxes would be assessed.

There would also be changes made to the way long-term capital gains are taxed.  Currently the tax rate for long-term capital gains is 15% for most investors and 20% for those with incomes over $496k.  There is an additional 3.8% Medicare contribution tax on all investment income above $250k. Mr. Biden’s tax plan would increase the long-term capital gains rate from 23.8% to 39.6% (i.e. the ordinary income rate) on income above $1M.  Additionally, the plan would eliminate the step-up in basis rule.  Under current tax law, any investment holdings passed on to heirs upon death receive a “step-up” in basis meaning any unrealized gains are essentially wiped out for tax purposes with the basis of inherited assets being the fair market value on the date of death.  For example, if someone had purchased Apple years ago at $15/share and passed away today when the share price was about $115, their heirs would inherit those shares with a cost basis of $115, allowing them to avoid paying the taxes on that $100/share long-term gain.  This would eliminate that feature and cost basis would carry over to future generations.

Considering the current situation with the runoff and the relatively slim odds, according to polls, of the Democrats winning both seats, it does not look as though we will see any significant changes to the tax laws in at least the first two years of Mr. Biden’s presidency.  If that is the case the Democrats will need to win back control of the Senate in 2022 midterms in order to push through any kind of tax legislation.

Disclosures & Index Definitions

Under style performance boxes, indexes referenced in the equities section for large, mid and small reference the Russell 1000, Russell MidCap and Russell 2000 stock indices, respectively. The Barclays US Government, Barclays Credit and Barclays High Yield fixed income indices refer to Gov’t, Corp, and HY, respectively. Short, Intermediate and Long refer to the time frame of the investments and their positions on the yield curve.

The information and opinions stated in this presentation are not intended to be utilized as an overall guide to investing; nor should they be taken as recommendations to buy, sell or hold any particular investment. This presentation is not an offer to sell or a solicitation of any investment products or other financial product or service, an official confirmation of any transaction, or an official statement of presenter. The opinions and views conveyed are for informational purposes and make no recommendations in regards to how a client’s portfolio should be managed, as that involves inquiring, in depth, of a client’s or prospective client’s risk tolerance, investment objectives, time frame for investing and any other details pertinent to said client’s or prospective client’s financial situation. The presentation may not be suitable to be relied on for accounting, legal or tax advice.

Past performance is not indicative of future returns. Prices and values of investment vehicles will rise and fall as broad market conditions change. Investors’ portfolios may fluctuate, to varying degrees, in tandem with market conditions.  Diversification neither guarantees returns nor does it eliminate the risk of a portfolio decreasing in value. Equity securities tend to be more volatile than bond/fixed income products and carry greater risk factors than that of fixed income products. Smaller capitalization equities (i.e. mid and small caps) typically involve more risk than that of larger capitalization stocks. Political, economic, and currency risk are all risks subsumed under the additional risk factors of investments in international securities, to include  those in both developed and emerging markets. In addition, political conditions in emerging markets can tend to be more volatile than in those of developed markets.

Investments in bonds will be subject to credit risk, market risk and interest rate risk. Interest rates will have an inverse effect on prices of bonds. Bonds of lower credit ratings, also known as High Yield bonds which hold a rating of less than investment grade (BB+ and below), will have greater risks attached than will those of investment grade bonds and will experience greater volatility.

All dates are as of October 30, 2020, unless stated otherwise.

Presentation prepared by Financial Advisory Service, Inc., an SEC Registered Investment Adviser. Securities offered through FAS Corp., an affiliated insurance agency and broker/dealer.

Any dissemination, distribution, copying, or other use of this presentation or any of its content by any person other than the intended recipient is strictly prohibited. FAS only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses to this presentation that involve either the effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion.

Index Definitions

The S&P 500 Index is based on the market capitalizations of 500 large companies whose stocks are listed on the NYSE and NASDAQ. This is widely regarded as the single best gauge of large cap US Equities.

The Dow Jones Industrial Average  is a price-weighted average of 30 actively traded blue-chip stocks, primarily industrials. It is used as a barometer of how shares if the largest US companies are performing.

The NASDAQ is a market capitalization weighted index of the more than 3000 common equities listed on the NASDAQ Stock Exchange. These securities include American Depository Receipts, common stocks, real estate investment trusts, and tracking stocks.

The MSCI EAFE (Europe, Australasia, Far East) Net Index is recognized as the pre-eminent benchmark in the US to measure international equity performance. It comprises the MSCI country indices that represent developed markets outside of North America, Europe, Australia, and the Far East.

The MSCI Emerging Markets Index captures large and mid cap representation across 23 Emerging Markets (EM) countries. With 822 countries, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The Barclays US Aggregate Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS, ABS, and CMBS.

All index information has been gathered from public sources who are assumed to be reliable, although we cannot guarantee the accuracy or completeness of those public sources.