The economy during the first quarter of 2021 has been filled with stimulus, growth, recovery, and change. The world is dealing with the new normal, which also continues to shift. The markets have seen highs and lows over the past year, and now we are seeing the possibility of inflation. During our first 2021 economic update webinar, we dove into the current economic conditions and made predictions about where our economy is headed. We also made some suggestions about what you should be doing with your money now.
What’s happening in the U.S. economy?
The capital markets have seen tremendous growth so far this year, with both the S&P 500 and Dow Jones Industrial Average seeing gains north of 11%. The NASDAQ has lagged a bit after seeing incredible growth last year. The year-over-year growth rate of earnings is the highest that it’s been since 2010, but many analysts still seem to be pessimistic about earnings estimates. COVID vaccine distribution and case count, corporate earnings, interest rates, inflation, stimulus, and tax policy will continue to be the main factors driving the markets in 2021.
Unemployment continues to trend downward; it’s currently the lowest we’ve seen since the onset of the pandemic. The decline is expected to continue with the help of herd immunity and the easing of pandemic restrictions in public places. The unemployment rate is not homogenous across the states. Florida is among the states with the lowest unemployment rates, while New York, California, and Pennsylvania have some of the highest unemployment rates.
Many people continue to be concerned that the Federal Reserve is inflating a bubble. The data seems to show that that is not the case. The Federal Reserve did provide the capital markets the liquidity needed to survive the crisis last spring. However, since last spring, the government has done a lot more talking than taking action, allowing the markets to recover through other means.
Interest rates and inflation are on everyone’s mind. As opposed to prior recessions that left people jobless and created spikes in personal bankruptcies, we are currently seeing an unusually high personal savings rate in America. While certain commodities and economic sectors are experiencing inflation (such as housing markets, lumber, and oil), it’s driven by an increase in demand from Americans who have cash in their pockets. Keep in mind that the price spikes in these areas are being compared to a period when there was little-to-no demand and prices were far below normal. Interest rates also remain low, which is giving homebuyers even more incentive and room in their budgets for larger homes.
The dollar also remains strong. When we look at the trade-weighted U.S. dollar index, we see that the dollar is essentially in the same range that it’s been for most of the past decade. And the dollar is significantly stronger than it was before, during, and immediately after the great financial crisis. From that standpoint, the indicators are telling us that despite inflation fears, the dollar remains strong and is not in any danger of collapse, despite what you may read on the internet.
Consumer confidence continues to gain strength—it’s already back in the 120 range. We expect that by July, consumer confidence will be back to what we were seeing before the start of the pandemic in March 2020: on track to outpace December of 2019 when no one had even heard of COVID. When consumers are confident, they spend, which can currently be seen in home sales. We’re seeing that especially in the South, where home sales have skyrocketed both in units sold and selling price.
In the long run, the economic growth trend is still intact, even with the levels of public debt accrued due to the pandemic. Economic growth in the first quarter was a very positive number and was a bit above the trendline. Looking at the last 20 years of economic history, despite a lot of events happening in the world, the economy, several recessions and economic crises, the long-term trend of economic growth is still on track, confirming our strategies of investing for the long-term.
We have received many inquiries lately regarding international investments and selling stocks to sit on cash. We recommend continuing to invest in US companies rather than international companies as many investors have considered lately. The US is the biggest vaccine distributor on the planet, which has been one reason why we have seen one of the fastest economic recoveries. Despite current market fluctuations and proposed tax changes, we continue to believe that it is best to stay in the markets, focusing on the long-term economic trends.
Potential legislative changes
The prospect of higher taxes continues to be a concern, especially for investors, and will continue to be a source of uncertainty until President Biden’s tax reform comes up for a vote. The President proposes to raise the U.S. corporate tax rate from 21% to 28%, which would mark the first increase since 1993 and the sixth tax hike since 1945. During the five prior corporate tax rate increases, the S&P 500 index posted an average calendar year gain of 12.9%, with positive price returns in each instance.
President Biden has proposed to move the capital gains tax rate from a maximum of 23.8% today to 43.4% for those making over $1 million. He has also proposed reducing estate tax exemptions from $11.7 million to $3 or $5 million and eliminating the step-up in basis. These proposed changes could mean big changes for investors and taxpayers, but nothing is certain at this time. We encourage you to avoid being swept up in speculation and prepared to make any necessary changes in consultation with your advisor if these proposals become law.
When we look at the infrastructure proposal, we see there are several areas that could benefit from changes in tax policy. From an investor standpoint, look at companies that will benefit from the spending. Transportation and building plans, basic materials, and equipment will be needed if the infrastructure proposal passes, and those types of companies will benefit from the proposed infrastructure plan.
As many Americans have experienced, the IRS is experiencing a dire backlog. The IRS is under tremendous strain this tax season, dealing with pandemic-related tax codes, programs, staff shortage, the challenges of remote work, and the extra burden associated with delivering three rounds of stimulus checks to millions of Americans. The Executive branch is paying attention to this need and is pushing for additional funding to help the IRS step up its audit rate, as well as cover other areas of need.
If you have any questions not covered in the Q1 2021 economic update webinar, please contact us for further clarification or to schedule a consultation with a financial advisor.