“May” the force be with you: Should I stay or should I go? What are Biden’s plans?

Details of Biden’s US infrastructure and tax plan

US President Biden unveiled his American Jobs Plan some time in April. It comprises $2.3 trillion over 8-years with increased corporate taxes over 15 years

• 1.3 trillion to construct, repair, and upgrade transportation and community infrastructure, affordable housing, and new schools
• $600 billion for research and development, manufacturing, and workforce investment
• $400 billion for elderly care

There will also be a focus on green infrastructure goals:

• Biden pledged at the climate summit that US will double its emissions cut targets by 2030
• 10-year extension to tax credits for solar, wind, and other renewables
• $174 billion for Electric vehicle incentives

This includes:

1. Up to $7,500 for EV auto purchases. One idea being debated is for the existing 200,000 annual vehicle limit to be raised.
2. Installing 500,000 EV chargers by 2030.
3. Replacing 50,000 diesel transit vehicles with electric.
4. Electrifying up to 20% of the school buses.

What will likely be passed and how much will taxes need to increase by to fund Biden’s plan?

The Democrats’ slim 50 plus one majority in the Senate means these measures will not all likely go through unchallenged. The crucial component will be the input of the more moderate members of the Democrat party, who may in turn lower the size of the program, should these programs pass with just a 50-seat requirement or under the “reconciliation rules”.

Furthermore, the Republicans have countered with a lower  $500 - $900 billion plan. If legislation requires 60 seats to pass, a compromise amount is the more likely scenario as both parties will look to negotiate.

What is ultimately passed will be crucially linked to the level of taxation required to finance it. If the plan is brought down in size, the proposed tax changes will also correspondingly reduce in magnitude. This is our base case as we believe it is a more politically acceptable result.

Also, keep in mind the capital gains tax at this point only affects 0.3% of the US population.

Importantly, monies could also be raised via raising global minimum corporate tax rate from multi-nationals, in particular, big technology companies (with large profits and low tax rates). In the long-run, such measures will be manageable for these technology companies, albeit sentiment could be impacted in the short term. There is also expectation for many other countries, including France and Germany, to follow suit. Such proposal could gain in popularity. 

With a growing focus on income inequality, in the US as well as globally, we can also expect larger focus on the redistribution of income in the following years. This is especially so given that current income and capital gains tax are at or near all-time lows in the US.

In short, we expect moderately higher taxes and some reduction in the size of the two proposed fiscal programs. The process will likely be back and forth, and should continue over the next four months.

Sell in May and go away?

This is the main topic on everyone’s mind as we are in the month of May. Historically speaking, the S&P 500 index is on average seasonally weaker from May to the end of October. However, it is important to note that returns are on average positive, just lower when compared to the November to the end of April period. 

In fact, in the last 10 years, the S&P 500 index delivered positive returns in 7 out of 10 years during the May to October period, with the last 5 years (2016 – 2020) all registering positive returns.  Hence, selling in May for the sake of it may not always be the right strategy.

On the other hand, portfolio strategy will prove crucial. In that regard, we were early in our call on reflation trade. Hence, we are now selectively taking profit on two sectors, industrials and materials. We move from overweight to neutral for these two sectors, after they gained more than 25% from end of September till date.

At the same time, we are upgrading two defensive sectors. Healthcare has been a notable laggard year-to-date, and we upgrade it from neutral to overweight.  

We also upgrade consumer staples from underweight to neutral. On average, defensive sectors tend to outperform over the summer months ahead. As equities have performed well in the past six months, we believe dividend yield and quality will become more important for portfolio allocation. These lower volatility stocks will also complement exposures in gold-mining, financials, and selected technology in terms of portfolio allocation.

Key Driver / Risk:

Key drivers of global markets going forward will be earnings (which has been very strong so far in the 2nd quarter), easy financial conditions and more fiscal stimulus. At the same time, watch out for inflation and taper talk. These are events that could cause a pick up in short-term volatility later in the year.

Conclusion / Strategy:

We expect moderately higher taxes and some reduction in the size of the two proposed fiscal programs. We are overweight the long-term theme of decarbonisation. This theme will increase in momentum given the progressive policies of the three largest economic blocs: EU, US, and China.

As for “Sell in May and go away”, we recommend to stay the course as we still remain overweight on global equities. However, sector rotation within your portfolio allocation is key given the performance over the past six months.

Overview of our CIO Asset Allocation for May 2021

GDP & CPI Forecasts

GROWTH

• We expect an overshoot of the pre-pandemic GDP levels amid the additional stimulus plan in the US including the “Build Back Better” infrastructure plan.
• We can expect a gradual recovery in the Eurozone from May with the removal of the sanitary restrictions and faster recovery from H2.

INFLATION

• In the US, a surge in inflation in Q2/Q3 is likely to fade before reheating in H2 2022.
• There are still a lot of excess capacities and the potential for people to come back to the job market. This limits the inflation risk especially in Europe.

Equity

Equity markets still in a clear uptrend: the key US, Europe, Japan and Emerging Markets stock indices remain well above their 200-day moving averages, pointing to clear uptrends. But beware, we are entering less favourable seasonality, which favours low volatility and defensive equity strategies over May-September, with cyclical stock indices typical underperformers.

After the great outperformance of cyclical stocks over the last 6 months, we have decided, also due to less favourable seasonality, to downgrade Industrials & Materials to neutral, and upgraded some defensive sectors that have underperformed - Consumer Staples to neutral & Health Care to positive.

Fixed Income

• We expect tapering to be decided at the December FOMC meeting, but there is a growing risk that it could be in September.
• Some Fed members want to link tapering to a certain level of vaccination (75% was cited by Fed’s Bullard). That level could be reached during the summer.
• After a short-term pause, long-term US bond yields could take a leg higher as actual data confirms recovery in economic activity. Our 12-month target for US 10-year Treasury yield is 2%.
• Downgrade China to neutral: With the recent development of China Huarong bonds, which fell sharply on rumours of restructuring, we are turning more cautious on high beta China SOEs which count on government’s implicit supports. We are also more defensive on longer duration high yield bonds which are subject to mark-to-mark volatility given the upward trend of US Treasury yields coupled with heighted caution on onshore funding access. Having said that, market liquidity continues to support China credits, including some high beta private companies such as selective single B developers. 

Forex & Commodities

Most of the positive factors supporting the GBP are priced in but there are still reasons to believe that the currency could appreciate further. Value stocks tend to do best in a weak dollar environment. Given their high weighing in UK equity indices, this should drive inflows. Moreover, the GBP is quite sensitive to the global equity sectors that the pandemic hit the most. The process and outlook for reopening is thus positive for the GBP. We have revised up our 12-month forecast for GBPUSD to 1.49 (from 1.45). 

GOLD: Gold prices rebounded in April, helped by slightly weaker real bond yields and lower USD.  We remain positive on gold as central banks do their best to keep financial conditions as easy as possible. Inflation fears and worries of excessive money printing should help gold prices back to $1800-2000.

OIL: World oil consumption will rebound by 6 million barrel a day in 2021. Most of the fuel inventory accumulated during the pandemic will have dissipated by the end of this quarter. As the OPEC+ lifts progressively its production quotas, we expect Brent to trade around $65 in the coming months and higher after. 

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