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April 23, 2021

by JM Hanley

After two months on a nearly uninterrupted upward trajectory, equity markets experienced a modest decline this week. Value stocks outperformed growth, reversing another recent trend. The news was relatively quiet, and the market spent the week digesting first quarter earnings and plans for a potential increase in the capital gains tax.

Thus far, 9% of the S&P 500 has reported, and earnings have grown over 30% – much better than the expected 25%. Winners from the pandemic, like major builders and home appliance makers, have done particularly well. No portfolio companies reported this week. Johnson and Johnson did better than expected, and increased its outlook for full-year profit. So did Verizon, Coca Cola, and AT&T. The latter, which owns HBO, got a boost from strong streaming subscriptions. Intel, which finds itself in the middle of a computer chip shortage that has halted assembly lines worldwide, put up good numbers but otherwise failed to inspire confidence. Netflix also proved a disappointment. Subscriber growth seems likely to tail off as other entertainment options return.

Given the scale of the outperformance, share price reaction was generally lackluster. This has fed concerns that the price-to-earnings ratio of the market as a whole may be too high.  The “multiple” is correlated to bond yields and future earnings growth. Both are currently in an optimal range, perhaps unsustainably so. Consumer demand looks set to surge as reopening get underway. Those expectations inform estimates of rapid earnings growth. But with supply chains constrained, a surge in demand could accelerate inflation. That would drive up bond yields, which would pressure the multiple.

An increase in the corporate tax rate, meanwhile, would directly impact future earnings. The Administration’s current proposal would produce about a 5% headwind to SP 500 earnings, while a watered-down version would be about 3%. The proposed increase in the capital gains rate would affect individual investors; specifically, those with incomes over $1 million would see a combined rate of 43.6%. A current loophole that enables those who inherit securities to skirt capital gains taxes might also be closed. This could be a short-term headwind for the market as holders rush to sell before higher rates come into effect. In the longer term, lower after-tax returns could result in lower overall investment (liquidity) in equity markets. In both cases, the tax headwind would be somewhat offset by higher earnings from the economic stimulus of the infrastructure spending.

The Administration seems to be struggling to find consensus on a plan in Congress, where its majorities are narrow. Democrats may seem more eager to increase taxes, but history shows that both parties find it difficult to do so in practice. We are happy to discuss clients’ tax situation if desired.

Next week is “tech week” for corporate earnings. Visa, Google, Facebook, Apple, Boston Scientific, and Amazon, among others, are scheduled to report.

The information contained in this commentary is not investment advice for any person. It is presented only for informational purposes to assist in explaining factors that may have had an impact in the past or may have an impact in the future on client portfolios or composites. All expressions of opinion reflect the judgment of the firm on this date and are subject to change. Included information has been obtained from sources considered reliable, but we do not guarantee that the foregoing materials are accurate or complete. Investors should contact Ulland Investment Advisors for individualized information prior to deciding to participate in any portfolio or making any investment decision. Ulland Investment Advisors does not provide tax advice. All investors are strongly urged to consult with their tax advisors regarding any potential investment.

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Ulland Investment Advisors

4550 IDS Center · Eighty South Eighth Street · Minneapolis MN 55402 · Telephone: 612-312-1400 · Facsimile: 612-204-3464