Equity Overview

Stock market optimism from continuing fiscal and monetary stimulus efforts in addition to vaccination progress, drove equites higher in the first quarter. Major equity indices moved higher with the energy, financial and industrial sectors leading in the first quarter.

International developed market indices were mostly positive for the first quarter, with emerging market indices primarily flat to negative amid growing debt concerns. Rising inflation is stoking some hesitation among debt heavy global companies as costs to operate and borrow increase.

LPL Financial’s year end S&P 500 estimate is currently 4,100, which was increased in February. We are fast approaching that target not even half way through the year, so it shouldn’t come as a surprise to see upward revisions as the economy reopens and more vaccines are distributed. Despite the potential for a strong 2021 and 2022, there are near term risks that can’t be ignored. As we have seen the past year, Covid-19 is not going away. The potential for virus variants that may be more resistant to vaccine efforts will be an ongoing battle and it still is not certain for how long an individual will have immunity after vaccination. In addition to virus concerns, Americans are also facing potential tax increases and tougher government regulations in the banking and technology sectors.

Fixed Income Overview

Bonds are going to be in a challenging environment for the foreseeable future. Yields are still historically low reducing the current income investors receive, and they have been moving up in 2021 hurting current bond prices. In the first quarter yields rose across all fixed income sectors, with the 10-year Treasury yield reaching 1.74% as of March 31st, the highest level since January 2020.

In Warren Buffets’ most recent Berkshire Hathaway shareholder letter, he comments “Bonds are not the place to be these days. The income recently available from a 10-year U.S. Treasury bond was .93% at yearend-fallen 94% from the 15.8% yield available in September 1981. Fixed-income investors worldwide-whether pension funds, insurance companies or retirees-face a bleak future”.

While fixed income investments may continue to provide diversification benefits and stability during stock market turmoil, investors hoping to generate meaningful rate of return through bonds will either need to reposition their portfolios or adjust their expectations.

How Government Inflation Gauges Differ 

The traditional gauge for inflation, known as the Consumer Price Index (CPI), is being challenged by yet another government produced measure known as Consumer Expectations. The most recent data released shows an inflation rate of 1.7%, as noted by the CPI compiled by the Bureau of Economic Analysis for February 2021. The Federal Reserve maintains its own inflation gauge, yet is based on consumer expectations of where inflation is headed. That inflation gauge ended February at 3.09%.

Many economists believe the Fed’s inflation gauge to be a more accurate indicator of actual inflation since it is directly based on consumer expectations. The traditional CPI extracts food and energy, ironically two of the most inflationary areas for consumers this past year.

Some of the items included in the CPI basket are housing, clothing, transportation, medical care, and education. The challenge of the CPI is that it takes a look-back approach rather than a look-forward approach which takes consumer expectations into account. Expectations also vary among age groups, where seniors are more concerned about medical care and transportation, while younger adults worry about apparel and housing.

Sources: BEA, Federal Reserve

Macro Overview

The prospect of resurgent inflation has developed into a growing concern for markets globally. Some believe that current inflationary pressures may be transitory and not lasting, while others contend that higher prices may become more permanent.

Rising fiscal deficits along with increasing levels of federal debt are prompting the administration to explore the most significant tax hikes since 1993. Tax increases are being considered for corporations, businesses structured as pass-through entities, estate taxes, and capital gains.

Optimism surrounding a third round of stimulus payments along with rising vaccination rates fueled equity markets in March as an economic revitalization began to take hold. Major equity indices ended the quarter positively as companies saw a resurgence in activity and sales.

The pandemic has brought about modifications and changes to business models throughout numerous industries, many of which are passing along higher costs to consumers. Many of the higher cost trends are not being recognized by some government inflation gauges and not accounted for in forecasts. The suggestion that inflationary pressures are only temporary are being contested as a growing number of businesses are expected to make pricing changes permanent.

The IRS announced that it is extending the tax filing deadline to May 17th, allowing tax payers more time to assess the effects of COVID related changes for individual and small business filers. With the IRS extending the deadline, nearly all states will follow suit and extend the tax deadline to May 17th as well, but most are maintaining the due date of April 15th for estimated tax payments. In addition, the IRS has extended the deadline for 2020 catch up contributions for Traditional and Roth IRAs as well as health savings accounts.

In addition to stimulus payments, the $1.9 trillion bill passed in March, known as the American Rescue Plan Act of 2021, will provide an exemption on taxes paid on unemployment benefits up to $10,200. The IRS communicated that automatic refunds would be issued to those who have already filed their 2020 taxes and have paid taxes on unemployment last year.

A $2.25 trillion infrastructure plan introduced by the administration is expected to focus on transportation, cleaner water, high-speed broadband and manufacturing. An increase in corporate taxes is the primary source of funding the proposed plan, although the proposed rate of 28% will likely fall short of bridging that gap completely.

The rapid rise in mortgage rates since the beginning of the year has led to a slowdown on refinances nationwide. The 30-year fixed rate mortgage reached the highest level in over nine months at 3.17% as of March 25th, yet still at historical lows relative to the 50-year average for a 30-year fixed mortgage rate of 7.88%.

Identified mutations of the COVID-19 virus have raised concerns about the spread of a variant known to be more transmissible than the initial virus, prompting the CDC to caution the public about relaxing preventive measures.

Sources: IRS, Federal Reserve, CDC, Congress.gov

Taxes Hikes are Coming

While the three stimulus programs amounting to over $4.5 trillion were mostly funded by government debt, the recently introduced $2.25 trillion infrastructure plan will be primarily funded by tax increases. Preliminary indications are that the anticipated tax hikes will target both corporations and high earning individuals. The tax increases may be the largest since 1993. The following are among the proposals currently being considered:

• Raising the corporate tax rate to 28% from 21%
• Eliminating the rule that allows U.S. companies to avoid certain taxes when they locate investments in foreign countries
• Imposing a 15% minimum tax on income corporations book income
• Reducing tax preferences for pass-through entities, such as LLCs, S-Corps & Partnerships
• Tax increases for individuals earning more than $400,000