Tax hikes and a significantly improving economy leading to higher interest rates are concerns that could become driving forces for markets later this year.
“Post-inauguration correction likely on peak policy, profits & positioning,” wrote Michael Harnett, chief investment strategist at Bank of America.
The S&P 500 grew at a 13.73% annualized rate, or 67.26%, over Trump’s term, the index’s third-biggest annualized gain under a president, as investors celebrated tax cuts and the rolling back of regulations. The benchmark index, which set 150 records under Trump, finished 0.6% below its all-time high on Tuesday, the final full trading day of his term.
The Nasdaq Composite index, meanwhile, posted a 24.17% annualized return, the largest under a president since the exchanges debut in 1971 during the Nixon administration. The tech-heavy index set 183 records during Trump’s four years in the White House.
“Markets are priced for perfection,” said Greg Valliere, chief U.S. policy strategist at Toronto-based AGF Investments, which has $38.8 billion in assets.
Biden has pledged to raise the top corporate tax rate to 28% from 21%. The rate was lowered as part of Trump’s Tax Cuts and Jobs Act, which also encouraged U.S. corporations to bring home $1 trillion of overseas cash.
Other tax changes being considered are hiking the top tax rate on capital gains and dividends to 43%, up from 24%, and also raising the income tax for the highest earners.
Aside from higher taxes, investors must grapple with the implications a red-hot U.S. economy will have on interest rates.
Economists at Goldman Sachs forecast U.S. gross domestic product will grow at a 5% annual rate in the first quarter of 2021 and a 5.8% rate for the year, boosted by the recently approved $900 billion COVID-19 relief package. The economy could grow at an even faster pace if Congress passes the $1.9 trillion package that Biden proposed last week.
A model from the Federal Reserve Bank of Atlanta that takes into account recent economic data shows the economy likely grew at a 7.4% annualized rate during the fourth quarter of last year after growing at a record 33.4% pace in the third quarter as businesses began to reopen following COVID-19 lockdowns.
Enthusiasm surrounding the economic recovery has caused skittishness in the bond market where selling of U.S. Treasurys has resulted in the 10-year yield climbing from 0.515% on Aug. 4 to X% on Tuesday. The rally has come despite the Federal Reserve reiterating its pledge to keep interest rates near zero through at least 2023.
Valliere said he “wouldn’t be shocked” to see the 10-year yield reach 1.5% by the summer and warns the yield approaching 2% would be a “concern for the stock market,” which has seen a relentless bid fueled by the Fed’s promise to keep rates low and talk of additional fiscal stimulus from Congress.
The S&P 500 price-to-earnings ratio is currently trading at 27.4 compared with its historic average of 17.6 going back to 2000, according to Dow Jones Market Data.
The options market is “pointing to even higher prices,” said Anthony Saliba, CEO of the Chicago-based Matrix Execution Group, an executing broker-dealer that specializes in options and equities. "There's more demand for the calls than there is supply."
The preference of owning calls versus puts indicates investors are choosing not to buy protection which is typically done to guard against a downside move.
Saliba, who has been betting against the market since the week after the election while trading into and out of the positions, concedes there is nothing pointing to an imminent reversal in the stock market, yet he is still looking for a sharp move lower.
“I think you get through inauguration, you see the infighting among the Democratic Party and then I think people say, ‘Maybe I better take some profits,’” Saliba said.