Tax Strategies

Financial Markets Start to Worry About Increased Treasury Supply

This commentary was issued recently by money managers, research firms, and market newsletter writers and has been edited by Barron’s.

Oct. 30: It is important to pay attention to the changing conversation. Normally, long interest rates go up or down because of the economic outlook and changing inflation expectations. But markets are now beginning to worry about increasing Treasury supply, and Treasury-auction metrics are getting more attention.

How much more Treasury supply might be coming? Third-quarter U.S. GDP came out yesterday, and it shows that the economy is currently $1.3 trillion below its trend line. To completely “fill up the hole” after Covid, we would need $4.4 trillion. In other words, a fiscal package of $1.3 trillion to $4.4 trillion would bring the economy back closer to where it was pre-Covid, and thereby push the unemployment rate down from its current level at 7.9% toward its February level at 3.5%. If the U.S. economy has to enter a second lockdown to get the virus under control, the fiscal need will be bigger. If we get a vaccine faster than expected, the fiscal need will be smaller.

Adding another few trillion in Treasury supply will put upward pressure on long rates and steepen the yield curve. The question is to what degree the Federal Reserve is prepared to step in and buy longer-dated U.S. government debt and thereby have monetary policy play an important role as underwriter for fiscal policy. How the Fed talks about this topic and how markets interpret the Fed’s statements and actions are very important parts of the new conversation in markets.

Why GDP News Doesn’t Matter

Macro Note

Avalon Investment and Advisory

Oct. 29: GDP grew at a 33.1% [annualized] pace in the third quarter, but the news was greeted by a resounding “meh”.

  • Why? Because old news is good news, and it is all about the outlook—not the “backlook.” With Covid-renewed restrictions beginning in Europe, the growth outlook has become far more muddied there. The fear is that resurgent cases in the U.S. portend a similar retrenchment of activity.

  • With U.S. fiscal policy stalled, monetary policy going full-throttle can only do so much.

  • The interaction of an uncertain, but surging, virus and stalled fiscal policy creates a thick fog around the path of the U.S. recovery. That is why GDP—and other old news—might be great, but doesn’t matter.

Goodbye, Supply-Side Economics

Market Commentary


Oct. 28: A corporate-tax reset [under a Biden administration] would be unwelcome news for sectors like technology and health care, which together make up more than 40% of the S&P 500. Profitable companies within these sectors sported effective tax rates of 15% and 20%, respectively, last year. Biden’s proposed 25% corporate tax rate would boost their tax liabilities. Additionally, both sectors are heavily invested in intellectual property, much of which is held offshore. Technology companies derived more than half of their revenue offshore last year, while 37% of health-care revenue was generated outside the U.S. Other sectors with a tax bulls-eye on their backs are financials, materials, and consumer staples.

A doubling of the capital-gains tax rate would also inflict pain on sectors with the highest unrealized gains, prompting an acceleration of gain realization. Technology, a sector that has gained more than 180% over the past five years, would be most exposed. Consumer discretionary, which nearly doubled in the interim, would be next. Media reports indicate that Donald Trump megadonor Sheldon Adelson, sensing a Joe Biden victory, is considering selling his Venetian and Palazzo casinos on the Las Vegas Strip to accelerate a capital gain into 2020.

Whether a “blue wave” or a Biden White House are in store, 2021 would likely mark a secular reversal in economic policy. Ushered in by President Ronald Reagan and Federal Reserve Chairman Paul Volcker in the 1980s, monetary policy and supply-side economics held sway in Washington over the past 40 years through a combination of lower interest rates, smaller tax burdens, and lighter regulations. The federal-funds rate has cascaded from 20% to zero. Corporate taxes as a share of GDP have slid from 2.6% to 1.1%, while the value of the stock market has grown nearly four times faster than the economy….A Biden victory would likely initiate a shift toward fiscal, demand-side stimulus. Over time, such a result could mean a reversal in inflation, interest rates, and the relationship between wages and profits.

Strength in Storage REITs

Momentum Strategies Report

Clif Droke Market Analysis

Oct. 27: One of the areas of potential strength I’m keeping an eye on is the storage REIT stock group. Storage REITs have shown a conspicuous amount of relative strength lately, and for good reason. With real estate as strong as it is and so many Americans migrating from big cities, storage units are in very high demand right now. Consequently, we may soon be getting another confirmed entry point in the leading storage stocks once the October swoon has ended. [Note the] recent progression in one such stock,

Public Storage

[ticker: PSA].

Jolly Holiday Sales

Special Reports

Wells Fargo Securities

Oct. 26: In what undoubtedly will be remembered as one of the most challenging and transformative years for most retailers, we are forecasting that holiday sales will increase 9% in 2020, which would be the largest increase on record. That is not to say that things are fine for all retailers, (they are not), nor is it to say that consumers are in excellent financial shape (they are not, particularly those toward the lower end of the income spectrum). However, a forced thrift that has curtailed spending in the service sector and canceled travel plans frees up income for more spending on gifts. After the anxiety and stress of a year defined by the virus, natural disasters and a divisive election, we suspect that holiday sales will also benefit from a yearning for comfort and normalcy, which many consumers may associate with having a few more gifts under the tree.

Traditions of the shopping season, like the throngs of Black Friday shoppers the day after Thanksgiving, will be largely replaced this year with rolling special sales and “buy-online, pick-up in store” deals, while online retailers pile on gains after last year’s first-time finish as top overall category of holiday sales. In fact, since


Prime Day moved to October, many of its competitors began offering opposing special offers during the month. Some holiday shopping has already been pulled forward, so we wouldn’t be surprised to see the pace of sales taper off in the traditional holiday spending months of November and December. Even if that is the case, our measure of holiday sales sits comfortably at an all-time high as of September after disruption from the virus earlier this year. The 2020 holiday sales season is on track to be a blowout. But keep it in perspective: This boom in goods spending is coming at the expense of spending on services, which remains depressed. In short, we do not look for overall consumer spending to return to its pre-crisis peak until the second quarter of 2021.

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