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by  Brad Willock Apr 30, 2021

What’s the outlook for U.S. equity markets? In less than 10 minutes, Brad Willock answers four key questions:

  • Which sectors are poised to benefit most as the U.S. economy starts to recover?
  • What are some of the expected impacts of Biden’s new infrastructure plan?
  • What will be the likely effect of higher corporate taxes on earnings?
  • After strong performance so far in 2021, is there still ‘room to run’?

Watch time: 9 minutes 49 seconds

View transcript

Considering the current economic recovery in the United States, what sectors are well positioned to benefit over next 12 months?

The U.S. economy is progressing nicely.

If you remember a year ago, the economies across the whole world were locked down. And as a result, of course, the business shut down and as a result of the virus, activity level slowed to zero in the case of, for example, international air travel that actually was zero. And same with the number of people in restaurants.

So if we look at the way the recoveries progressed from a COVID standpoint, the U.S. has done a really nice job, particularly since the Biden administration took over, with the rollout of the vaccine. They’ve inoculated almost 80% of people over 65 and about 46% of all adults have had at least one dose of vaccine. And so what you see is an improvement in business activity, everything from the number of people flying to the number of people in restaurants. The spending data from credit cards shows the same thing. In fact, in Florida, if you compare the number of people in restaurants, not just number but the amount that they’re spending, what you see is that amount is up 21% year over year when you include people from out of state, so they’ve travelled to Florida. And so you can see that data. Things are happening as I’ve even heard anecdotal evidence of hotels running out of staff, not having enough staff to deal with all the people. So this is quite a difference in a year. And so the recovery is well underway.

Now what does that mean in terms of the portfolio and sector performance? Well, what it means is cyclical sectors, things like financials and materials and [energy and industrials], they’ve done better as the economy has started to improve and as investors have started to look forward to the improvement that we’re likely to see. Last year was the year of the consumer goods part of the market, and this year we expect consumer services to have their comeback. So for that, you should think about things like restaurants and hotels, casinos, theme parks, and things like that, perhaps travel-related but more domestic travel. Those are the aspects of the economy that should do well in these parts of the market that we expect to do well as well.

But the other element is now given changes at the political level in terms of fiscal stimulus, we should also expect the industrial part of the market to have a pretty good go.

How will President Biden’s infrastructure plan affect U.S. equities?

Well, Biden’s infrastructure plan is all part of a bigger program called Build Back Better. Three Bs. And so the American Jobs Plan, which is the first part we’ve learned about most recently, has three big goals. One is to reduce greenhouse gas emissions, the second one is to address racial and social inequality, and the third is to generate many tens of thousands of well-paying jobs across a number of different industries. And the emphasis on all these three goals, at least from the Biden administration’s point of view, is they’re trying to make the competitiveness with China a major feature here, which I think is quite smart. And this is more than traditional infrastructure, which would normally be spending on highways and roads and bridges and airports and ports and things like that. They’ve also included spending, and quite a lot of it on elements like broadband internet connection across rural areas and places where it may be in some urban centres where it doesn’t get as high a download speed. Other things like electric vehicle charging is another place where there’s hundreds of billions of dedicated spending and grid infrastructure.

So because we’re going to need to produce an enormous amount of electricity to fund the electrification of our auto fleet over the next 30 years, a lot of money is being dedicated to improving the power grid. And so that’s some different notion of infrastructure which I think is very interesting.

And following on the bad weather in Texas that we saw which basically caused a power outage in that massive state for the better part of a week, we can see the spending is definitely needed and is likely to be quite transformative if we can get that done.

They’re also including a lot of spending in R&D, which hasn’t particularly been an area of focus over the last decade, but that could lead to better productivity for the economy as a whole, and should net be a significant positive for those who supply all the tools and parts in all of these spending targets.

How will the prospect of higher corporate tax impact U.S. equity markets?

Right, higher taxes. One of the main features of the American Jobs Plan is to pay for it. And to pay for it, what the Biden administration has proposed is to increase the tax rate, the top marginal corporate tax rate, from 21% to 28%. Most people that I speak to in Washington, D.C. on this topic suggest that 25% is more likely. There are a couple of senators, Democrat senators, whose vote is required to get this through, that have said that they won’t support a tax rate above 25%. So that sort of puts the ceiling at 25%, and that is fairly important. The main goal of this tax portion of the plan is to not only generate a significant amount of revenue over a period of time for the government, but the target is multinational companies, particularly very large ones that have a lot of intellectual property in other countries and are not paying a very large amount of tax. So when you think about companies like in the technology industry, there are lots of health care companies that fall into this bucket, as well as some companies like Facebook and Google in the communication sector. So they will be impacted.

When I take a look at the earnings impact potentially from this, it’s … If you imagine the S&P earning something around $200, maybe $205 in 2022, if this plan is enacted as proposed with a 28% corporate tax rate and all the other ones on international incomes, it could take the earnings down by $12 to $15 and cut the growth rate in half from about 15% to about 8%. So earnings would come out around $190 in that case. And so I think we’ll end up somewhere in the middle. We’re definitely going to see some taxes, but it’s unlikely to be the worst-case scenario.

Following the unprecedented rebound in equity markets in 2020, is there still room to run?

Right. The run-up in the last year has been amazing. It’s been the best recovery off of a major low in history. The S&P’s up over 80% and the risk reward isn’t nearly as good as it was, quite clearly. And that’s normal in the second year after a major low. Typically, returns are in the low double-digit range. But the stock market’s trading at around 20, 22 times forward earnings and a lot will depend on what happens to taxes in this infrastructure bill. And what we’re doing in our portfolios is improving the quality of what we own.

The companies that have rallied the most since the vaccine data from Pfizer came out in November, a lot of them were smaller, many companies in industries that are quite cyclical, and they’ve had a major move and discount a lot of improvement in the coming year. Stocks look forward. And so what we’re doing is we’re taking some money off of those areas of the market that have really had a big move in the last five months and spreading it into parts of the market that are a little more value-oriented and that have higher dividends and are trading at better free cash flow yields. In other words, they’re cheaper and of higher quality. And we think that allows us to bear the storm if there is one in the next few months, particularly if this infrastructure bill has a hard time getting through Congress.

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