Taxing times for US equities
This week we tackle three key topics: President Biden’s tax plans, the prospects for US earnings and why the UK economy is set to outperform consensus expectations.
At first sight these seem like good news. US equities are attracting record inflows, share buybacks have picked up, and the earnings season is showing great results, with 67% of companies having beaten estimates by some margin. The US economy is strong, with the impressive vaccine rollout plan unleashing a surge in consumer spending.
The problem is that all this good news appears to be fully priced in. Economic momentum has probably peaked in the US, so there’s a good chance that upcoming data could disappoint as economic momentum begins to peak.
There’s another reason for caution. President Biden’s infrastructure Bill is making its way through Congress. The initiative involves $2.3tn of extra spending and $1.6tn of tax rises with the latter coming first. This means that fiscal policy will become a net drag on the economy initially. There are also some aspects of higher taxation which appear to have been overlooked in earnings estimates from here.
We don’t expect that either of the two issues above will cause any significant downturn, but there is scope for a period of relatively weak performance from US equities.
I don’t think emerging market equities will do much better. China is tightening policy to rein in explosive credit growth. India is suffering a disastrous second wave that is overwhelming their medical system and Brazil has similar problems.
Developed market countries are generally in much better shape, courtesy of their vaccination programmes. The UK and US are certainly leading the way but Europe is catching up.
The UK vaccine programme is a real model of success. Our consumer boom is just getting going and will be concentrated in the next few months, and the clear roadmap of easing restrictions has allowed people to plan, which in turn supports demand. Appointments for haircuts, meals out and holiday homes are in short supply!
Despite all of this, and the string of stronger-than-expected data released in the UK, forecasters have kept their projections at a relatively dismal level. Based on the consensus estimate, we would remain well below pre-COVID levels of economic activity well in to 2022. I believe that the UK will strongly outperform these expectations. This in turn would help sterling and reverse the recent rally in gilts.
So, in summary, the S&P 500, which reached yet another record high this month, may struggle over the summer, while emerging markets could find life tough. But the UK, which has been a serial underperformer ever since Brexit, may have its moment in the sun. We shall see.
Goldman Sachs as of 22 April 2021