Markets sing a familiar tune: U.S. stocks rally, Treasury yields fall.

Brian Nick

The last week’s market highlights:

Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s Q2 2021 Outlook:
  • U.S. economy: Poised for its best year of GDP growth in decades.
  • Global economy: Should also surge as large developed countries sprint into the post-pandemic world.
  • Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
  • Fixed income: Take more risk in credit-sensitive parts of the market.
  • Equities: Bullish on cyclicals but looking for opportunities again in growth.
  • Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.

Quote of the week:

“There are years that ask questions and years that answer.” – Zora Neale Hurston 

Investors don’t need to worry (yet) about higher U.S. taxes

The American Rescue Plan Act (ARPA) passed last month totaled approximately $1.9 trillion in spending with no offsets from higher revenues (i.e., taxes). President Biden’s newest proposal, the infrastructure-centric American Jobs Plan (AJP) is not being pitched as a similarly free lunch. Rather, the $2 trillion spending would be paid for in part by corporate tax increases, the closing of certain tax loopholes and higher levies on the wealthy.
The AJP is undoubtedly a complex and ambitious plan designed to upgrade U.S. infrastructure, revitalize manufacturing, shore up supply chains and much more. But until the proposal becomes an actual bill on the floor of one or both houses of Congress, the details remain highly susceptible to change. When the time comes, all of the plan’s details will be worth delving into, but, for now, let’s focus on the market implications of potential tax increases, especially to the corporate rate.
  • Taxes matter, but other factors may matter more for equity investors. The AJP as proposed would reverse much of the 2017 Tax Cuts and Jobs Act. Business profits soared in 2018 after the new law trimmed the top corporate tax rate from 35% to 21%. (Individual and estate tax rates were also lowered.) But despite booming bottom lines, U.S. equities struggled for the 12 months following the bill’s passage in December 2017, due in part to a disruptive federal government shutdown in late 2018 and to trade policy uncertainty that likely dented firms’ desire to make new investments.
    The Russell 3000 Index, which tracks stocks of all capitalization sizes, actually lost 9.1% during that stretch. Over the next two 12-month periods, however, the index surged 35.7% and 20%, respectively, as the economy picked up steam and policy risks abated.5 The lesson for equity investors when assessing any potential tax-law changes that might accompany the AJA, were it to pass? Be sure to consider other factors beyond tax policy that could affect stock prices over the short and long term.

  • We don’t yet know what tax increases – if any – are going to pass. Some economists are pointing out that corporations and individuals may not need to shoulder the burden of higher taxes to pay for the AJP. Instead, the government might borrow to fund the plan, as it did with the ARPA last month. It could do so at attractive financing rates, as long-term Treasury yields remain well below their long-term average. And thus far in April, the bellwether 10-year note has stayed range-bound, closing at 1.67% on April 9. Similarly, the 30-year bond has been relatively stable, ending the week at 2.34%.6
    Since Biden announced the AJP on March 31, Treasury investors seem unfazed by the possibility of the U.S. accumulating yet another round of massive debt on top of the $5 trillion in fiscal stimulus already enacted. The market’s apparent nonchalance in the face of such higher spending may be because the AJP hews closely to the program Biden discussed during his campaign — i.e., there haven’t been any unpleasant surprises for markets to digest.

  • The U.S. economy, in our view, should be able to more-than-adequately absorb the magnitude of higher proposed taxes on both individuals and corporations. The percentage of taxpayers who make enough money to be affected by the rumored increases in individual rates is small, and balance sheets for higher earnings households have never been stronger.
    While corporations won’t like paying more in taxes, especially after the 2017 cuts, they’re not currently encountering difficulties raising capital through either the bond or equity market. Moreover, earnings appear set to increase by as much as 30% in 2021, not least because of the $5 trillion in U.S. fiscal stimulus, much of which has found its way into the pockets of individuals and should eventually bolster corporate bottom lines, if it hasn’t done so already.

Another financial first for China—even if it’s taken about 900 years 

Sometime during the 7th through 9th centuries, Chinese merchants found the weight of coins cumbersome and decided that printed money would be far more efficient. Later, in the 12th century, China’s rulers issued the world’s first government-produced paper currency.
Now, China has become the first major economy to establish its own digital currency, the “e-yuan,” designed to eventually replace coins and bills. 
The e-yuan is still being tested. In recent months, China has given away millions of dollars’ worth of the digital currency via lottery in several cities, enabling the 100,000 or so winners to download the handouts (worth about $30 apiece) onto their phones and spend them. And although no official launch date has been announced, China may be eyeing the 2022 Winter Olympics in Beijing as a way to showcase its position as the global leader in payments technology.
Comparisons that liken the e-yuan to bitcoin or other cryptocurrencies may be inevitable, but they’re wrong.
  • Bitcoin and its ilk exist outside the financial system and aren’t issued or backed by any government. In contrast, the Chinese central bank, the People’s Bank of China (PBoC), will issue and regulate the e-yuan, and China’s government will guarantee its status as legal tender.

  • Whereas Bitcoin offers a measure of anonymity, the e-yuan offers none. Chinese authorities will be able to monitor transactions in real time, significantly expanding the government’s survelliance capabilities, which worries civil libertarians. For their part, officials claim that the new e-currency will enable them to track money laundering, terrorist financing and any electronic criminal activities.

  • Bitcoin has been prone to extreme price swings, making it a prime target for speculative investors. In contrast, the PBoC will employ strict controls to ensure no valuation differences emerge between the digital currency and physical bills and coins. This should keep volatility, and thus speculation, to a minimum.

  • China is hopeful the e-yuan will advance the country’s long-term goal of challenging the U.S. dollar as the primary currency for settling international trade transactions. Any progress toward this objective will be complicated, as it’s always been, by China’s complex and opaque financial system. A more likely scenario, in our view, is that the e-yuan could loosen China’s managed peg to the greenback.
Meanwhile, the PBoC has another pressing matter on its agenda: reining in the country’s credit supply. China relied heavily on debt to fuel its economic recovery from COVID-19. But now that the Chinese economy appears to be humming again, the PBoC has instructed banks to reduce lending in a bid to prevent asset bubbles from forming. This downshift in Chinese policy accommodation stands in stark contrast to the fiscal expansion underway in the U.S. The gap in GDP growth for 2021 between the two economic superpowers will likely be the narrowest in decades.
  1. Marketwatch
  2. Russell
  3. Federal Reserve via FRED
  4. Bureau of Labor Statistics
  5. Russell
  6. U.S. Treasury
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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