Following the latest round of talks hosted by the OECD, the U.S. won backing for a global minimum tax from a group of 130 nations that represent 90% of global GDP. It’s part of a wider corporate tax overhaul for multinationals and the Biden administration’s plan for raising revenue for “generational investments.” Heavy federal spending will push the budget deficit to $3T for the 2021 fiscal year, according to the Congressional Budget Office, which would be the second-largest since 1945 in nominal terms and as a share of the economy. The forecast doesn’t even include the impact of two “trillion-dollar” infrastructure proposals, though the budget office does forecast the economy to grow 6.7% this year after adjusting for inflation.

“It’s a historic day for economic diplomacy,” Treasury Secretary Janet Yellen declared, adding that the “race to the bottom is one step closer to coming to an end.” While the deal aims to prevent companies from relocating their headquarters to low-tax countries, others feel the plan could be hard to enforce internationally due to accounting rules, subsidies and exemptions for R&D and capital investment. The international drive is closely tied to the White House’s domestic agenda, which calls for raising the U.S. corporate tax rate to 28% from 21%, as well as the minimum tax on American-based companies’ foreign profits to 21% from 10.5%.

Some obstacles: Several European countries continue to object to the minimum tax rate, saying it would remove a tool for encouraging foreign investment. Among them are Ireland, which is the European headquarters for U.S. Big Tech companies like Google (GOOG, GOOGL) and Facebook (NASDAQ:FB), as well as Hungary and Estonia. Resistance from any EU nation could prevent the 27-member bloc from going ahead with the plan or at least force the bloc to resort to novel legal maneuvers that have yet to be tested.

The new tax approach could also run into opposition in the U.S., where Yellen needs to sell the deal to Congress. The changes could require the U.S. Senate to alter existing tax treaties, which would take a two-thirds vote and at least some GOP support. Republicans have already expressed opposition to any rise in taxes, while some lawmakers have condemned the idea of ceding taxing authority to other governments. Business groups have additionally complained that higher taxes could threaten the economic recovery as American companies navigate their way out of the coronavirus pandemic.

 

Jobs

 

The June jobs data came out unexpectedly strong, but maybe not strong enough.

Key Points:

  • June payrolls grew by 850,000, but the unemployment rate rose to 5.9% as more workers entered the labor force.
  • More positively, the “U6” rate which includes involuntary part-time workers fell to 9.8%, its lowest point since March 2020.
  • Hours worked fell due to manufacturing. Supply chain problems are causing parts shortages, reducing production and thus work hours.
  • Average hourly wages rose and are up 3.9% in the last year, led by the leisure/hospitality sector.
  • The US economy has now recovered 15.6 million of the 22.3 million jobs lost in March/April 2020.

We see unemployment as a supply issue: supply of willing workers still not growing fast enough, and inadequate supply of parts and materials without which companies have less need for workers. The Federal Reserve’s programs aren’t helping solve those. The recovery is unfolding but more slowly than hoped.

 

Ray Dalio

 

“I’ve watched a lot of bubbles over my something like 50 years of investing and I basically thought there was six things that make a bubble.”

Ray applies six bubble conditions to individual securities to gauge the aggregate percentage of stocks in a bubble. He then compares today’s “total stock market” and “emerging tech” stocks to the roaring 1920s, the dot-com bubble, and 2007.

Ray concludes that emerging tech stocks have checked three of the six “bubble” conditions and the other three are “frothy”––the condition one notch below “bubble.” The total market in general is not yet in a bubble.

 

 

This last chart is one of my favorites from his presentation. It goes back to 1900. The top section shows debt to GDP and the blue line in the bottom section plots interest rates. The red line shows the printing of money and the surge in the supply of money after the last two periods in history when interest rates hit 0 percent.

  • What you see is that when we have a lot of debt and debt is increasing, combined with interest rates hitting 0, what follows is the printing of money and that is a key element of bubbles. Why? It provides a lot of liquidity that enters the market and bids up all sorts of assets.

You can see when the blue line hits zero interest rates (1930 and 2008 and since).

 

 

Bonds

 

We’re talking about boring old bonds, which once paid investors a meaningful return for giving money to someone else to use.

But nowadays, it’s also wise to think about bonds differently.

U.S. bonds used to be called risk-free returns. These days, we’re calling them return-free risk. With bond yields so low, plus taxes, plus looming inflation, you could be putting about half of your portfolio into an asset almost guaranteed to lose money.

Let me say that again, and please pay attention to this: with 20% to 40% of your portfolio in bonds, I can guarantee you will lose money over time. Yet this is still the narrow strategy most financial planners would recommend to you.

It doesn’t take much to see the problem here, though. A 10-year U.S. Treasury note pays a 1.5% yield today, while a 30-year U.S. Treasury bond will pay 2.1%.

If the Federal Reserve’s “official” inflation numbers are running higher than that (around 4% year over year, as of May) and many prices elsewhere are rising by greater rates on balance, you’re losing money by owning “safe” bonds.

If 40% of a portfolio is dedicated to a low-return asset class that won’t keep up with inflation, it’s the opposite of safe. They’re going to drain your retirement account and purchasing power before the government does anything about it, if at all.

The 60/40 stock/bond portfolio is dead.  That is why we use Equity Indexed accounts to get higher returns on our principal guaranteed sccounts.  Higher returns with less risk since there is zero interest rate risk.

 

Different Kind of Inflation

 

Prices for all of these goods and services, prices for stocks and houses and art are NOT going up the way you think they are. Instead, it’s the value of our money going down.

I get this a lot. People say, “We are experiencing inflation, so stocks should go down! Because that’s what happened in the 1970s.”

This isn’t the 1970s. This is a different sort of inflation.

What we are experiencing now is a monetary inflation, compounded by big government interventions in the labor market. This is not stagflation.

In fact, the period of stagflation that we experienced in the 1970s was an anomaly, as far as great inflations go, and isn’t likely to be repeated.

THIS kind of inflation benefits stocks. Stocks are inflation pass-thru vehicles, though most people realize that by now.

International trade is suffering because of, well, politics, but also, firms are taking measures to protect supply chains. In a world of low political tensions, it made sense to produce all the world’s semiconductors in Taiwan. That doesn’t make sense anymore. So, businesses are bringing manufacturing home to places where the cost of labor is higher.

Also, the countries with low-cost labor aren’t so low-cost anymore, shipping costs are rising, etc.

It’s too soon to say how this will play out. We currently have 5% inflation, which probably underestimates actual inflation by a lot.

 

Market Data

 

  • The correlation between Growth and Value stocks has plunged to the lowest since 1928. The closest comparison was the year 2000, but there were many more less dramatic precedents. Other correlations are breaking down, too. These have been a better sign for one factor versus another rather than the broader stock market.
  • As we near the end of June, both stocks and commodities have rallied strongly for the year. Going back nearly 90 years, 2021 stands out as having the best combined gains in the S&P 500 and Bloomberg Commodity Index. That kind of momentum mostly favored stocks going forward, but not commodities.
  • June was a tough month for gold due to the Fed’s hawkish shift.
  • China’s soft PMI readings don’t bode well for copper.
  • Earnings expectations continue to drive stock gains this year.
  • Pullbacks during the second year of bull markets can be severe.
  • Stocks most correlated with Treasuries are the most expensive.
  • Advancers-decliners are not confirming this week’s new all-time highs on the major averages. Only 56% of the S&P members are above their 50-day moving averages. And the equal-weighted S&P is underperforming the cap-weighted S&P.
  • Stocks jumped, with Nasdaq 100 outperforming (tech stocks have been more correlated with bonds).
  • And the dollar weakened.
  • The relatively “benign” US employment report sent bond yields lower, boosting Nasdaq 100 stocks.

 

US Economy

 

  • Perceived labor market slack is part of the reason for the Fed’s reluctance to begin withdrawing stimulus.
  • While some workers will reenter the labor market, there is a chance that many will not. Yes, more Americans are returning to work as states end emergency unemployment benefits
  • But it is entirely possible that the labor market will remain tight, with full employmentreturning much faster than the Fed expected. Economic growth could surprise to the upside, pushing the output gap deep into positive territory.
  • And we could be looking at full employment as soon as Q1 of next year
  • If we see more fiscal stimulus labor shortages will become more acute.
  • CEO hiring plans have not been this high in two decades – perhaps longer.
  • The US central bank may well find itself behind the curve later this year as wage growth accelerates
  • Many companies continue to report growing unfilled orders.
  • Workers are busy.
  • Firms are reporting higher vendor delivery times.
  • Price pressures continue to grow.
  • Texas-area factories are extremely confident about future business activity.
  • Americans are increasingly optimistic about the COVID situation.
  • Here is how well some of the 50 states has done at recovering the jobs it lost during the pandemic. Leading the way is Utah, which has recovered 115.9% of the jobs it lost — meaning all of them and then some. Next is Idaho at 111.7%, then Montana at 87%, then South Dakota at 80.9%, then Arkansas at 77.8%, then Tennessee, Arizona, South Carolina, Mississippi, Indiana, New Hampshire, Texas, and Nebraska.
  • The Conference Board Consumer Confidence Index jumped this month, topping expectations.
  • The unemployment rate is rapidly heading lower.
  • Households’ inflation expectations remain elevated.
  • Many households are sitting on sizeable excess savings, which may support further spending.
  • Home prices continue to surge. The 14.6% year-over-year gain at the national level is a record high for this index.
  • Home prices are rapidly outpacing wages.
  • This month’s regional Fed manufacturing reports point to a peak in supply-chain bottlenecks. To be sure, the problem will plague US businesses for months to come, but this could be the beginning of the end.
  • The ADP report showed strong gains in private payrolls in June, topping forecasts.
  • The Chicago PMI pulled back from the May highs. The report indicated that input price gains sped up in June, and hiring slowed.
  • Regional surveys point to a strong ISM Manufacturing report at the national level
  • Pending home sales surprised to the upside. Despite sharp price increases, housing demand remains robust.
  • We are likely to see a jump in existing home sales in June.
  • However, mortgage applications are now running below 2019 levels.
  • The June jobs report showed continuing recovery in the labor market, but it wasn’t strong enough to quicken the Fed’s plans for reducing monetary accommodation.
  • The unemployment rate unexpectedly increased.
  • But underemploymnet (U-6) continues to move lower.
  • Long-term unemployment remains elevated:
  • Part-time work for “economic” reasons is almost back to pre-COVID levels.
  • Labor force participation has flatlined.
  • Prime-age participation is improving, but many older Americans are not getting back into the labor force.
  • Labor force participation among African Americans is rebounding rapidly and is now above that of white Americans.
  • The employment index dipped below 50 (which means contraction) amid widespread raw materials and labor shortages.
  • Indicators of supply-chain bottlenecks remain extreme but appear to be leveling off. Below we have the backlog of orders, supplier delivery times, and customers’ inventories.
  • June automobile sales declined sharply due to tight inventories.
  • Public non residential construction spending continues to deteriorate.
  • US goods imports remain near record highs.
  • Financial conditions are the easiest in years, according to Bloomberg’s indicator.
  • The Citi US inflation surprise index hit another record high.

 

Thought of the Week

 

“Technological advance has so accelerated the tempo and complicated the character of social change that present social ills can scarcely be properly diagnosed before they have been so far transformed that the proposed remedies are no longer adequate.” – John Mauldin

 

2 Pictures of the Week

 

 

 

 

All content is the opinion of Brian J. Decker