Year-end selling pressure? While changes to tax policy will be subject to the legislative process in the event of a Biden victory, speculation is emerging around tax treatment of long-held investment assets. These include an elimination of “stepped-up basis” and rate increases on capital gains, with a potential increase from 23.8% (including the 3.8% NIIT) to the current top marginal federal rate of 39.6%. If Biden wins with Democratic majorities in Congress, “you’re going to have a lot of people scrambling,” according to Marcum Partner Ed Reitmeyer, as quoted in Bloomberg this week. This scenario could temper an otherwise bullish environment into year-end, the economy supported by expectations of large fiscal spending, resulting from a November “blue wave.”
Investment-led Recovery. The current US recovery is being driven by investment spending, not consumption; that’s the view of Cornerstone Macro’s Nancy Lazar as expressed this week on Wealthtrack. While the speed and scale of the initial policy support helped stabilize the economy, it is the underlying strength from Capex, housing, manufacturing/onshoring and a more astute consumer that will power the economy for years to come. This is a refreshing and positive view of a private sector that can power forward on its own, without constant government support. “It really is different this time. Don’t be distracted by negative leisure/travel news, watch the rails and steel [for confirmation].”
.png?width=421&name=capex%20(2).png)
Q3 Earnings-Positive Surprises, Stretched Valuations. According to FactSet, with 10% of the S&P 500 companies reporting results, 86% have reported a positive EPS surprise, exceeding the 5-year average of 73%. The forward 12-month P/E ratio for the S&P 500 is 22.0, above both the 5-year (17.3) and 10-year (15.5) averages. A 22.0 P/E translates into an earnings yield of 4.55%. The 10-year US Treasury yield closed Friday at 0.74%, thus the current Earnings Yield on the S&P 500 is 3.8%.
Peak Complacency? This week, the extra yield demanded on the riskiest junk bonds fell to pre-pandemic lows. Data from Bank America ML (below) showed retail investors reducing cash levels, while recent Nasdaq call activity reflects a lack of fear in the market. Meanwhile, Liz Ann Sonders from Schwab made the observation that net short futures in the VIX and long futures positions in the S&P 500 are exceeding levels preceding the start of the 2020 bear market.
