President Biden and the Market
By Paul Meeks
Here are things to consider about the market as President Biden takes office:
Who’s the boss?
It doesn’t matter who’s in office, or least it doesn’t make as much of an impact as you may think. Historically, there hasn’t been a meaningful difference in annual stock market returns (in percentage terms) given different combinations of control of the United States House of Representatives, the U.S. Senate and the White House. The tilt between conservatives and liberals on the U.S. Supreme Court hasn’t mattered much either. Even a red or blue wave (in this case) hasn’t been much of a tell.
We may avoid a tsunami
The blue wave may be more like a ripple. Given how tenuous the Democrats’ hold is on the U.S. Senate, President Biden should find it difficult to pass his most “progressive” fiscal measures. He’s also likely to be focused on COVID-19 for the foreseeable future. Our corporate tax rate was 35 percent before President Trump. He pushed it to 21 percent. President Biden has promised 28 percent. Is this a fair compromise? What does Sen. Joe Manchin think? (You will be hearing that a lot.) When will Congress get to work on this? It may not be for a year or more.
The Fed rules
The president isn’t even in my top ten most important Americans in finance and investing. The person to keep an eye on is Jay Powell. He’s the chair of the Federal Reserve Board (Fed), America’s central bank. He leads the gang that sets U.S. monetary policy, and it has spoken. The Fed funds (interest) rate that it controls has been pinned to the floor since last spring thanks to COVID-19 business shutdowns. Officially, the rate is in a 0-0.25 percent range, and the Fed has promised that it won’t be increased until at least 2024. Frankly, that’s all you need to know.
Stocks soar in this rate environment, and bonds are uninvestible because they yield essentially nothing, which, of course, is even less than inflation. Although Powell was nominated by President Trump and took the Fed’s reins in 2018, I expect that President Biden will reappoint him when the chair’s term expires in 2022. It’s not unusual for a president to reappoint a Fed chair from another party if the economy is solid. Also, incoming treasury secretary Janet Yellen was Powell’s boss when she was Fed chair (2014-2018). I bet she puts in a good word for Powell with the president.
“It’s the economy, stupid.” (James Carville, 1992)
Our economy is in good shape. The consensus forecast for real (i.e., inflation adjusted) gross domestic product for 2021 is 4+ percent. We’re recovering from a deep but brief recession caused by COVID-19, so we may not replace 2019’s output for another year or two, but we’re back on track. Before COVID-19, our economy had grown at about 2 percent per year ever since our last catastrophe, the financial crisis (2007-2009). Relatively speaking for a big, mature economy that typically plods like an ocean liner, we’ll be zipping around like a speedboat this year.
COVID-19 is a key financial factor, and it’s still our greatest risk. If we see a further spike in U.S. cases and deaths that forces American business to shutter like they did in March and April 2020, then all bets are off. In that two-month span, our economy contracted by a third on an annual basis. Simply, we can’t absorb another blow like that. Luckily, Moderna and Pfizer, and soon Johnson & Johnson, are to our rescue with vaccines. Let’s hope we get better at inoculating Americans. So far, we’ve distributed approximately 27 million doses, but only about a third have been stuck in someone’s arm. To be realistic, I’d be prepared for little progress reversing COVID-19 until this fall. In the meantime, if we stop the acceleration of cases and deaths, I’m still bullish on stocks because the market discounts the future and doesn’t trade on the present.
Probably the greatest risk to my rosy market outlook is that inflation jumps quickly and sharply. If and when inflation perks up, the Fed will move from loose monetary policy featuring ultralow interest rates to a tighter stance, including raising rates. Rising rates kill stock valuations. However, I think that the Fed won’t change its tune on rates unless the yield on our 10-year Treasury note eclipses 2 percent. Now the rate is 1.1 percent, although it was 0.50 percent in March when we were in COVID-19 panic.
Who wins and who loses in the Biden administration?
COVID-19 should be the top priority for the Biden administration during its first year in office. Most agree that this should be the focus. But, once the pandemic is contained, which economic sectors should investors highlight and which should they avoid given President Biden’s plans? However, remember, I’m skeptical that his major policies will skate through Congress. To set the stage, here are the 11 sectors that comprise the economy and their percentage weights in the market as defined by the S&P 500 stock index:
Information technology (27.6 percent). Technology rules the world and should continue to do so after a brief rotation out of this sector into reopen-the-economy cyclical stocks. Also, growth names, particularly technology stocks, outperform value securities when rates are this low. I “talk tech” on CNBC very week. If you don’t watch this cable network, connect with me on LinkedIn. All my video and written content (but not my Mercury articles) are posted there.
Health care (13.5 percent). This sector is front and center during COVID, but it may be threatened once the Biden administration starts to govern after the pandemic.
Consumer discretionary (12.7 percent). In this sector, I distinguish between traditional brick- and-mortar retailers and e-tailers. Many of the former have already gone bust. We’ve seen retail, bar and restaurant closures around Charleston. The keys to survival for restaurants are digital ordering, delivery and a drive-through window. Eat at FIG, but invest in Dominos (DPZ) or Chipotle (CMG). A full-service restaurant is a bad business even in good times.
Communications services (10.8 percent). Think of this sector as your telephone companies and your social media firms if you’re a kid. The former, particularly the carriers like AT&T (T), Verizon (VZ) and T-Mobile (TMUS), should benefit from the global ramp of 5G wireless, which should be a big deal during the next few years, particularly if the U.S. and China stop fighting. As to the social media titans like Facebook (FB), Alphabet (GOOGL) and Twitter (TWTR), they’re under regulatory assault here and abroad, so these stocks are no longer one-way tickets to riches. Also, what happens to these firms since they’ve blocked President Trump and after he’s out of office? Interesting fact: According to Socialbakers, he had 88.6 million Twitter followers on January 5, 2021, which was more than half of Twitter’s “daily active users.” Now President Trump has zero.
Financials (10.4 percent). Commercial banks make their money on their net interest margin, which is the percentage spread between the rates at which they borrow and lend. Although interest rates are low, which has dinged bank profits, they’ve recently lifted a bit, and bank spreads have widened somewhat. This bodes well for the sector. Also, banks are cyclical, so they should do well as we reopen our economy after COVID-19.
Industrials (8.4 percent). These are cyclical too.
Consumer staples (6.5 percent). These are the products that are on the shelves at Publix. They’re great companies in which to hide during tough times because we always need to eat. However, these stocks, many of which have rocketed during the pandemic to absurd valuations for typically slow-growth companies, could fall once we’re no longer living in the COVID-19 bunker.
Utilities (2.8 percent). These are dividend yield stocks. Period. Currently, the average utility yields 3.3 percent, which is what you should expect to earn on this investment this year if its price is unchanged. I search for companies that pay juicy yields, but they also have price appreciation potential. Therefore, I rarely touch these boring companies.
Materials (2.6 percent). The same thing goes as for materials. These stocks should have a reopen-the-economy bounce, but I’m not sure that it’ll be sustained.
Real estate (2.4 percent). In our remote work world, I think commercial real estate, particularly office space, is in trouble and that the threat remains after COVID-19. On the other hand, residential real estate should continue to prosper, particularly in cool (not the temperature) places like Charleston. It also helps that it’s so cheap to borrow money for a mortgage loan if you can qualify for one.
Energy (2.3 percent). This is particularly interesting. Fossil fuels are in secular decline, and President Biden wants to speed their demise with his aggressive spending on clean energy. Yes, over time investors should go green; but in the meantime, the world consumes 95 million barrels of oil per day, and these “dirty” companies will be lifted as economies come back to life. I like a few ugly oil companies with high, sustainable dividend yields. One such firm is Enbridge (ENB). It’s a Canadian pipeline company. Oh, its dividend yield is a whopping 7.4 percent.
Chew on this. I’ll be back with more ideas and updates, but first let’s give President Biden a chance to sit at the Resolute Desk and get to work before making further predictions.
Paul Meeks, CFA, manages the Wireless Fund (WIREX) and is a portfolio manager at Independent Solutions Wealth Management. He also teaches at The Citadel and at the College of Charleston. He is on Daniel Island.