Last week unveiled a dynamic interplay between the Federal Reserve's policy decision, market sentiment, and sectoral performances. Major averages responded favorably to the Fed's latest policy decision as the S&P 500 gained +2.31% during the week, resulting in a YTD return of 10.12%. Bond markets also gained +0.73%, cutting YTD losses to -1.00%. While the Federal Reserve kept the interest rates unchanged at 5.25%, Fed Chair Powell and its policymakers still affirm its projections for interest rates at the end of 2024 to be 4.50% "if the economy evolves as projected." Market sentiment rallied on the implication that the Fed's path forward still expects a 0.75 percentage points of cuts by the end of the year if there are no surprises to a "slowing economy."
Communication, Industrial, Technology, and Consumer Discretionary stocks had above-average gains on the Fed's decision with help from Alphabet (+6.79%), GE (+3.71%), Broadcom (+9.97%), and Tesla (+4.44%). Conversely, Apple fell flat from the market momentum as headline news surfaced that the Dept. of Justice issued an antitrust suit accusing Apple of anti-competitive practices in its smartphone hardware and software platforms. Apple's antitrust suit is a fresh reminder of Microsoft's many antitrust suits that cost the firm billions in fines, legal fees, and stagnant stock for years in the 2000s.
Complementary to last week's stock market reaction, long-term bond yields fell as the 10 yr., 20 yr., and 30 yr. landed at 4.22%, 4.47%, and 4.39%. With an inverted yield curve and current Fed median interest rate projections, please note that it appears the yield curve will remain inverted even with the planned cuts by the end of the year unless the long-term rates rise.
With the completion of March's FOMC, the next anticipated meeting is scheduled for April 30. With fourth-quarter earnings coming to a close, the week ahead will focus on major indicators guiding the Fed's interest rate policy for the remainder of the year: GDP, Durable Goods, and PCE.
"Inflation has eased substantially while the labor market has remained strong, and that is very good news. But inflation is still too high, ongoing progress in bringing it down is not assured, and the path forward is uncertain."
— Chair Powell's FOMC Press Conference, March 20, 2024.
Déjà vu – Dead on Arrival
President Biden has announced his proposed budget for the 2025 fiscal year. The budget includes large increases in spending, large and persistent deficits, and large increases in tax rates.
The budget for the next fiscal year includes $7.3 trillion in spending, significant increases in tax rates, and a deficit of $1.5 trillion. The Congressional Budget Office, CBO, has scored the budget over the required ten-year time horizon incorporating the President's proposed tax increases. The CBO predicts deficits will total $16.3 trillion over the period, and outstanding debt will grow to $45.1 trillion or 106% of GDP. The budget will raise government spending to 24.4% of GDP from 22.7% of GDP. Interest payments on the outstanding debt will grow to 3.4% of GDP annually, nearly the same as the percentage spent on national defense, 3.5% of GDP.
The President's budget proposal includes the assumption that tax receipts will increase as tax rates are increased. The proposed tax rate increases include:
Raising the corporate tax rate from the current 21% to 28%.
A 33% increase.
Requiring those with wealth of over $100 million to pay at least 25% of their income in taxes.
In addition, an increase in the tax rate for high-income individuals is among the assumptions underlying the President's budget.
Arthur Okun, advisor to President Kennedy, observed that the relationship between changes in tax rates and changes in tax receipts may not be as straightforward as the President assumes.
"High tax rates, are followed by attempts of ingenious men to beat them as surely as snow is followed by little boys on sleds."
Okun and President Kennedy understood that increasing tax rates does not ensure an increase in tax receipts.
"It is a paradoxical truth that tax rates are too high and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now. Cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring a budget surplus." John F. Kennedy
"A tax cut means higher family income and higher business profits and a balanced federal budget.... As the national income grows, the federal government will ultimately end up with more revenues. Prosperity is the real way to balance our budget. By lowering tax rates, by increasing jobs and income, we can expand tax revenues and finally bring our budget into balance." John F. Kennedy
The President's budget assumes unrealistic increases in tax receipts. Economic activity will decline because of the proposed increase in tax rates. Deficits will be much larger than anticipated. The Fed will be pressured to finance the more than $16.3 trillion in deficits that will materialize over the next ten years. Given the Fed's response to this type of pressure over the last 50 years, it will likely succumb, and inflation will increase again.
From January 1968 through January 1981, the stock market, as represented by the S&P 500 Index, generated an annual return after inflation of -0.7%. From January 1981 through January 2021, the Index produced a yearly after-inflation return of 8.5%. During the earlier period, on average, tax rates increased, regulations increased, inflation increased, and economic activity declined. In the second period, tax rates were reduced, regulations were reduced, inflation was subdued, and actual economic activity increased. The President's budget will likely produce economic conditions like those in 1968 to 1981.
Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.
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WEEK AHEAD
March 25-29, 2024
The equity rally and, notably, technical momentum continued to strengthen the foundation of our tactical indicators and bullish position (100%).
Last week unveiled a dynamic interplay between the Federal Reserve's policy decision, market sentiment, and sectoral performances. Major averages responded favorably to the Fed's latest policy decision as the S&P 500 gained +2.31% during the week, resulting in a YTD return of 10.12%. Bond markets also gained +0.73%, cutting YTD losses to -1.00%. While the Federal Reserve kept the interest rates unchanged at 5.25%, Fed Chair Powell and its policymakers still affirm its projections for interest rates at the end of 2024 to be 4.50% "if the economy evolves as projected." Market sentiment rallied on the implication that the Fed's path forward still expects a 0.75 percentage points of cuts by the end of the year if there are no surprises to a "slowing economy."
Communication, Industrial, Technology, and Consumer Discretionary stocks had above-average gains on the Fed's decision with help from Alphabet (+6.79%), GE (+3.71%), Broadcom (+9.97%), and Tesla (+4.44%). Conversely, Apple fell flat from the market momentum as headline news surfaced that the Dept. of Justice issued an antitrust suit accusing Apple of anti-competitive practices in its smartphone hardware and software platforms. Apple's antitrust suit is a fresh reminder of Microsoft's many antitrust suits that cost the firm billions in fines, legal fees, and stagnant stock for years in the 2000s.
Complementary to last week's stock market reaction, long-term bond yields fell as the 10 yr., 20 yr., and 30 yr. landed at 4.22%, 4.47%, and 4.39%. With an inverted yield curve and current Fed median interest rate projections, please note that it appears the yield curve will remain inverted even with the planned cuts by the end of the year unless the long-term rates rise.
With the completion of March's FOMC, the next anticipated meeting is scheduled for April 30. With fourth-quarter earnings coming to a close, the week ahead will focus on major indicators guiding the Fed's interest rate policy for the remainder of the year: GDP, Durable Goods, and PCE.
"Inflation has eased substantially while the labor market has remained strong, and that is very good news. But inflation is still too high, ongoing progress in bringing it down is not assured, and the path forward is uncertain."
— Chair Powell's FOMC Press Conference, March 20, 2024.
Déjà vu – Dead on Arrival
President Biden has announced his proposed budget for the 2025 fiscal year. The budget includes large increases in spending, large and persistent deficits, and large increases in tax rates.
The budget for the next fiscal year includes $7.3 trillion in spending, significant increases in tax rates, and a deficit of $1.5 trillion. The Congressional Budget Office, CBO, has scored the budget over the required ten-year time horizon incorporating the President's proposed tax increases. The CBO predicts deficits will total $16.3 trillion over the period, and outstanding debt will grow to $45.1 trillion or 106% of GDP. The budget will raise government spending to 24.4% of GDP from 22.7% of GDP. Interest payments on the outstanding debt will grow to 3.4% of GDP annually, nearly the same as the percentage spent on national defense, 3.5% of GDP.
The President's budget proposal includes the assumption that tax receipts will increase as tax rates are increased. The proposed tax rate increases include:
In addition, an increase in the tax rate for high-income individuals is among the assumptions underlying the President's budget.
Arthur Okun, advisor to President Kennedy, observed that the relationship between changes in tax rates and changes in tax receipts may not be as straightforward as the President assumes.
"High tax rates, are followed by attempts of ingenious men to beat them as surely as snow is followed by little boys on sleds."
Okun and President Kennedy understood that increasing tax rates does not ensure an increase in tax receipts.
"It is a paradoxical truth that tax rates are too high and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now. Cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring a budget surplus." John F. Kennedy
"A tax cut means higher family income and higher business profits and a balanced federal budget.... As the national income grows, the federal government will ultimately end up with more revenues. Prosperity is the real way to balance our budget. By lowering tax rates, by increasing jobs and income, we can expand tax revenues and finally bring our budget into balance." John F. Kennedy
The President's budget assumes unrealistic increases in tax receipts. Economic activity will decline because of the proposed increase in tax rates. Deficits will be much larger than anticipated. The Fed will be pressured to finance the more than $16.3 trillion in deficits that will materialize over the next ten years. Given the Fed's response to this type of pressure over the last 50 years, it will likely succumb, and inflation will increase again.
From January 1968 through January 1981, the stock market, as represented by the S&P 500 Index, generated an annual return after inflation of -0.7%. From January 1981 through January 2021, the Index produced a yearly after-inflation return of 8.5%. During the earlier period, on average, tax rates increased, regulations increased, inflation increased, and economic activity declined. In the second period, tax rates were reduced, regulations were reduced, inflation was subdued, and actual economic activity increased. The President's budget will likely produce economic conditions like those in 1968 to 1981.
Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.