The attempted insurrection in Washington last Wednesday was deeply disturbing. The television coverage of rioters storming into the Capitol building, breaking windows, and threatening lawmakers was high drama of a kind we never thought we would see in the United States.
The riot, which led tragically to five deaths, was all driven by Donald Trump’s obsession that the election was somehow stolen from him and his ability to convince millions of Americans of that absurdity, despite all evidence to the contrary.
Fortunately, law enforcement eventually prevailed (after a ludicrously slow response time) and Congress was back at work within a few hours.
The news made headlines around the world. But in spite of its long-term political consequences and historic implications, it was not the only important U.S. political story of the week. The other was the Democratic sweep of the Georgia senatorial run-off election on Tuesday, which ended Republican control of the Senate and opened the way for many of president-elect Joe Biden’s sweeping reforms.
U.S. markets reacted surprisingly strongly to the Georgia upset, with the Dow gaining 438 points on Wednesday, the day the results were confirmed (and the same day as the Washington riot).
The Georgia outcome creates a 50-50 tie in the Senate. But incoming vice-president Kamala Harris will cast the deciding vote in any tie, effectively giving control to the Democrats.
Wall Street’s reaction is a little puzzling. After last fall’s election, stocks rose when it looked like the Republicans would maintain control of the Senate by a razor-thin margin. The theory was that gridlock in Washington would be positive for stocks because the Republicans in the Senate would block many of Joe Biden’s policies that were seen as unfriendly to business.
Primary among them is Mr. Biden’s pledge to partially roll back Donald Trump’s tax cuts, which gave the markets a huge boost at the time they were enacted in 2017 (for the 2018 tax year). There has been much talk about Mr. Biden’s proposal to increase the corporate tax rate to 28 per cent (from 21 per cent now). But his plan goes well beyond that. If it is fully implemented, marginal rates on high-income earners will rise, deductions would be reduced, the long-term capital gains tax would be increased, and social security taxes would go up.
None of this will appeal to Wall Street, nor to many individuals. But the odds of it happening have been greatly increased by the Georgia vote.
So, with tax hikes in the offing, what has the markets so excited that even an attempted insurrection couldn’t slow it down? It appears to be that along with the new taxes will come billions of dollars in new spending to stimulate the economy.
The centrepiece is the incoming president’s plan to spend US$2-trillion on infrastructure projects over the course of his first term. It’s a highly ambitious program that includes, according to his campaign site:
- Transforming crumbling transportation infrastructure, including roads and bridges, rail, aviation, ports and inland waterways.
- Develop the “second great railway revolution,” with a focus on enhancing rail safety and speed while reducing greenhouse gas emissions through electrification.
- Invest in “high-quality, reliable” public transit in urban areas.
- Develop a “100 per cent” clean energy economy.
- Replace aging water pipes and ensure every American has access to clean drinking water.
- Bring broadband to every household (21 million Americans don’t have it now).
Plus, there will be new credits for first-time homebuyers (great for the housing industry). His plan also involves restoring credits for buying electric vehicles (good news for Tesla and other EV manufacturers) and introducing tax breaks for emission-reducing investments in residential and commercial buildings.
Ambitious? You bet. Doable? Some of it, now that the Democrats have Senate control. But not all of it. This is an agenda for a generation, not for a single presidential term.
But if even a quarter of Mr. Biden’s plan is enacted, it will represent a huge stimulus for the economy. An easing of the coronavirus epidemic would further enhance economic gains. With bonds offering low yields and little upside potential, you can see why stocks are booming.
More analysts are starting to use the word “bubble” to describe what’s going on in the stock market. Jeremy Grantham, a widely respected British money manager, said last week the markets are in a “fully fledged epic bubble” that will eventually burst.
When? That’s anyone’s guess. But this irrational exuberance can’t go on forever.
So, what does this mean for your investments? If you own securities that have run up big gains in recent months, you might want to consider taking some profits by selling part of your holdings. If the money is in a non-registered account, consider the capital gains implications, keeping in mind that you won’t need to declare the profits until you file your 2021 return.
Low-risk equities such as utilities and telecoms will likely drop if there is a big market sell-off, but any loss should be temporary, and the dividends should keep flowing. Retain those positions.
Continue to hold gold and/or gold stocks for protection against inflation, which could see a resurgence given massive government stimulus programs.
Bonds and bond funds will likely provide little return and pose a risk if interest rates rise. But retain a small holding of fixed-income securities for stability and in the unlikely event we move to negative interest rates.
In short, don’t do anything drastic. But if appropriate, raise some cash and be prepared to take advantage of a pullback if it happens.
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Gordon Pape