Week of September 2nd, 2024

Key Points for the Week

• Stocks eventually gained in a very volatile August, but be aware of September and October
• Various other groups did well, another sign this bull market is broadening out
• The Dow hit highs, something that tends to suggest a strong economy
• Be cautious about all the promises that are being made now – many are unrealistic
• Congressional majorities will be narrow, which will limit what a Republican or Democratic Congress can do, and a mixed Congress will face ever greater limits
• No matter who wins we’re likely to see some Trump era individual tax cuts extended, but that also means more deficits

Current Trends & News is a weekly financial recap curated by SPC Financial®’s team of wealth management and tax-integrated advisors.* We monitor and explore the intricacies of the financial world and share insights into market developments.

Economic Update

After gyrating wildly throughout the month, major U.S. stock indexes finished August higher.

“Despite a lot of uncertainty and some dramatic ups and downs, the Standard & Poor’s (S&P) 500 Index rose 2.3 percent in August, while the Dow Jones Industrial Average gained 1.8 percent to close at a record high. It was the fourth consecutive month of gains for both indexes. The month’s most remarkable comeback belonged to the Nasdaq Composite Index which eked out a 0.6 percent gain for the month. That's a shocking turnaround, given the Nasdaq entered correction territory early in the month…,” (A correction is a decline of at least 10 percent.)

↳Connor Smith of Barron’s

“As sentiment calmed, the CBOE Volatility Index (VIX), which gauges how volatile investors expect the market to be over the next 30 days, moved lower. Wall Street’s ‘fear gauge’—the VIX—dropped to 15. That’s after an unprecedented spike that took the index above 65 during the Aug. 5 market selloff”.

↳Rita Nazareth of Bloomberg

Why did investors regain their confidence?

There was some good economic news last week that proved to be just what markets were hoping to see. The data were strong enough to allay fears the economy might weaken too fast, but not so strong they might cause the U.S. Federal Reserve (Fed) to change its mind about lowering the federal funds rate in September. Here’s what happened:

• The economy remains steady. Investors have been worried U.S. economic growth might be slowing more quickly than previously thought. Those concerns were soothed when the Bureau of Economic Analysis revised its estimate for gross domestic product (GDP)—which is the value of all goods and services produced in the U.S. —from April through June. “The U.S. economy grew faster than initially thought in the second quarter amid strong consumer spending, while corporate profits rebounded, which should help to sustain the expansion,” reported Lucia Mutikani of Reuters.
• Inflation continues to soften. On Friday, one of the Fed’s favored inflation gauges—the personal consumption expenditures (PCE) price index showed headline inflation was 2.5 percent year over year. Core inflation, which excludes volatile food and energy prices, was up 2.6 percent year over year. “The soft price growth continues a recent stretch of cooler inflation readings and falls in line with what Fed officials were hoping to see before easing their restrictive monetary-policy stance,” reported Megan Leonhardt of Barron’s.

Last week, major U.S. stock indices moved higher. Yields for U.S Treasuries with shorter maturities moved lower over the week, while yields for longer maturities moved higher.

This Week in the Markets

What a month it was for investors. We started off the month with some huge down days over worries centered around the yen carry trade unraveling and a slowing U.S. economy, only to get past those worries almost as quickly and see stocks move right back to new highs (or near new highs). Election years tend to see summer rallies and that has played out nicely once again in 2024.

Next week we will discuss September in more detail, but it is worth noting that September is indeed the worst month of the year for the S&P 500 since 1950, over the past 20 years, and over the past 10 years. Oh, it is also the third worst month in an election year, with October the worst month. The bottom line, after one of the best starts to an election year ever for stocks, some type of seasonal weakness or pre-election jitters would be perfectly normal over the coming two months. Again, we’ll discuss this more in detail over the coming weeks, but just get ready for some potential volatility.

The Rally Broadens Out

Last week might have been flattish if you looked at the major index returns, but what stood out to us was that a recently popular AI stock was down nearly 8% and we saw many groups do just fine. It reported strong earnings, but the reality was expectations got a tad too high and the stock was pulled back to earth after huge year-to-date gains. If it was down like this last year at this time, we’d have fully expected to see a sea of red for investors, but that wasn’t the case last week, a great sign of improving market breadth.

Financials and industrials closed at their highest levels ever on a weekly close, while small caps and midcaps continue to show strength as well.

We’ve long said that the next stage to this bull market will be a broadening out of the rally, and not just the high-flying tech and communication services names doing well. Well, that is happening right before our eyes. A great way to see this is that the S&P 500 equal weight index closed at a new all-time high on Friday. This index weights all 500 names the same, so a few large names don’t dominate the overall action. It is another sign that many stocks are participating in this rally, which is a sign of a healthy market overall.

A Bullish Signal for the Economy

Two things to think about today.

• Since the Great Financial Crisis (GFC) ended 15 years ago our economy has been in a recession only 1.1% of the time.
• The Dow Jones Industrial Average started trading on May 26, 1896, and last Friday it closed at the highest level EVER.

Think about how many endless discussions have focused on the ‘soon to come recession’ only for stocks to continue to soar.

Just the past year we’ve been hit with worries over the yield curve, leading indicator indexes (LEI), small sample-sized purchasing manager surveys, wars, inflation, and the Bank of Japan (BoJ) hiking rates by just over 25 basis points (as silly as that last one sounds, it happened three weeks ago). None of these things have slowed down the bull market.

Since 1900 the US economy has been in a recession 22.4% of the time. But did you know six months after a new all-time high in the Dow, it has been in a recession only 8.9% of the time? And the last time it hit a new high during a recession was in late 1982, which also kicked off a huge bull market.

One of the better indicators regarding the economy historically has been the stock market. Yes, stocks hit new highs right before COVID and in early 2007, but the great majority of the other times over the past generation new highs have meant an economy that was growing, not an economy in a recession. New highs are another clue that our economy will likely avoid a recession over the next six months (but probably longer).

Promises vs Reality: Presidential Election Edition

With both the Republican and Democratic party conventions over, it’s safe to say we’re in the home stretch of the presidential election. In fact, early voting starts in 10 days in North Carolina, a key swing state. That also means campaign rhetoric is heating up, and promises are being made—some wild ones, too, but this is politics in the homestretch of an election and it’s not too surprising.

Campaign Promises Go Wild

Let’s look at some of the “policy” proposals that have hit headlines recently, from both candidates. I put policy in quotes because some of these seem rather off the cuff, without a lot of heft and practical implementation details behind them.

Here’s something former President Trump first proposed, and then Vice President Harris copied: making tips tax-free. As simple as it may sound, it becomes complicated after a little bit of thought. For one thing, tipped workers don’t earn much and so their incomes aren’t taxed a lot anyway. Then the question is whether tips will be exempt from Social Security and Medicare taxes—if so, that will actually reduce lifetime average earnings for tipped workers, which means they’ll receive fewer Social Security benefits. More practically, if someone earns $30,000 with half of that from tips, the question is why they should pay lower taxes than someone who earns $30,000 in straight-up income. Then of course, you could also have a situation in which a lawyer who bills $200/hour receives an additional $200/hour in “tips.”

Another proposal from Harris is that she’ll ban price gouging in the food and grocery industry. This has received a lot of attention, but it’s very unclear what exactly this entails. A lot of commentary has focused on it being implemented via price controls, but I think we can safely conclude that will never happen. You just have to go back and look at how former Defense Secretary Don Rumsfeld, and his then assistant, Dick Cheney, struggled to implement price controls under the Nixon administration in the early 1970s—an experiment that will likely never be tried again, with good reason. In this case, it looks like the Harris “ban” will take the form of already existing bans against price gouging in 37 states, and similar to the one President Trump signed in March 2020 to prevent hoarding of health and medical resources. In any case, it’s unlikely to do much for food price inflation, and is a case where the “promise” runs far ahead of reality. For Trump’s part, he’s said he’ll direct all agency heads and Cabinet secretaries to “use every tool and authority at their disposal to defeat inflation”—not too many specifics there.

Trump has also said he’ll offer senior citizens massive relief by ending taxes on Social Security benefits (currently it’s not taxed on up to $25,000 for individuals, and 50% of benefits above that are not taxed). Technically, this will be lost revenue for the Social Security trust fund, but overall, it amounts to something like a $1.6-$1.8 trillion increase in the federal deficit over the next 10 years.

Both Harris and Trump have suggested enhancing child tax credits (CTC). Harris’s proposal would permanently increase it from $2,000 to $3,600—it was briefly at this level in 2021 but wasn’t extended due to its massive cost. In addition, she would also add a new CTC of up to $6,000 for middle- and lower-income families with children in their first year of life. Not to be outdone in the promises sweepstakes, Trump’s Vice Presidential nominee, J.D. Vance, floated the idea to increase the CTC to $5,000 for everyone. Think of what all of these, or any of these, would do to the deficit.

Let’s Get Real: Control of Congress Matters

Lost amid a lot of analysis of the above proposals is that they aren’t likely to move far in Congress. In addition to the presidential election, we also have the House up for re-election, alongside a third of Senate seats. Gauging real-time aggregated views from the prediction market site Polymarket, the Presidential election looks to be a toss-up, but things go in opposite directions for control of Congress. (Note that prediction markets aren’t necessarily all that predictive, but they provide a useful view of current collective sentiment around likely outcomes.) As of Sunday night, according to Polymarket:

• Democrats have a 63% chance of winning the House
• Republicans have a 72% chance of taking the Senate
• Republicans have a 32% chance of a full sweep (Presidency, House, Senate) while Democrats have a 22% chance

There’s a reasonable chance we’re looking at split party control of Washington D.C. post-election, but even if not a lot of policies will require a two-third majority in the Senate to prevent a filibuster and a closely divided Senate or House gives the centrists of the majority party a lot of power. (Remember the influence Senators Manchen, Sinema, and Tester have had the last four years, and that Senators Collins, Murkowski, Romney, and McCain had during the Trump administration.) However, it’s really tax policy that is going to be the single-biggest issue next year, and that can potentially pass through the Senate under a process called “reconciliation,” which needs only a simple majority of 51 votes.

2025: A Big Year for Tax Policy

The Tax Cut and Jobs Act of 2017, which former President Trump signed into law, contained both corporate and individual tax cuts. The corporate tax cuts (including dropping the corporate tax rate from 35% to 21%) were permanent, but the individual tax cuts were all set to “sunset” at the end of 2025. Unless these tax cuts are pro-actively renewed, Americans will see their taxes go up starting in 2026. At the same time, renewing them will increase the deficit by $4.6 trillion over ten years, according to congressional scoring. Keep in mind that 2026 is a mid-term election year, and that’s going to crystallize Congress’s focus on getting something done.

The contours of tax policy are going to matter for investors as well, and so it’s worth walking through the broad areas.

Starting with a potential Harris administration, the biggest risk for markets is an increase in the corporate tax rate. However, given how close the House and Senate will be, an increase is unlikely, with a probability near zero if Republicans control even one chamber. Even if Democrats sweep, moderate senators are unlikely to agree to an increase in the corporate tax rate. At the same time, tax cuts for more wealthy households will probably not be renewed, though any deficit reduction from that side will likely be eaten up by expansion of the child tax credit.

With a potential Trump administration, the biggest risk is not tax policy he’s said his administration would renew all the tax cuts, and perhaps even drop the corporate tax rate to 15% (music to investors’ ears). Instead, the big risk will be an expansion of the tariff regime, which a President can impose without Congress. We may see renewed trade wars, which could adversely impact capital expenditures and the production side of the economy (as it did in 2018).

The table below illustrates the various major policy changes and their likelihood under different scenarios of congressional control. The big takeaway is really at the bottom of the table, which shows the deficit increasing under all scenarios—it’s just a question of how much.

Populism and Deficits Are Here to Stay

The one through-line across all the proposals floating out there now, and what’s actually likely to be passed, is larger deficit spending, a sign that both candidates are leaning into populism. Campaigns always make a lot of promises during election season, but the populist rhetoric from both candidates is actually quite unusual, especially given where we are in the economic cycle.

The Federal government’s “primary balance,” which is revenue minus spending excluding interest payments on Treasury debt, is one way to measure how much net spending is happening at the Federal level. The chart below shows the primary balance as a percent of GDP. As you can see, prior to the 2010s, the primary balance was always in positive territory as economic expansions wore on. It fell into deficit only during recessions, which isn’t surprising because that’s when economic stabilizers (like unemployment benefits) kick in, and revenue collection drops (as there’s less income). In short, US fiscal policy has historically been counter-cyclical, which is generally what it should be.

But the late 2010s was markedly different, as the primary balance remained in deficit territory, hitting -2% of GDP by the end of 2019. We’re well removed from the pandemic right now, but the primary balance is still historically low, at -1.8% of GDP (something we’ve seen only in recessions prior to 2010). Given what the candidates are proposing, it’s fairly certain that the primary balance remains in deficit territory well into the second half of the 2020s.

As we wrote in our Midyear Outlook, deficit-financed spending can boost corporate profits if it doesn’t crowd out consumer spending or private sector investment. That’s positive for markets as well, since profits are what matter. In fact, this is something we saw as recently as 2016-2019, when profit growth surged on the back of higher fiscal deficits (due to the 2017 tax cuts). Even more recently, we’re seeing federal spending “crowd in” private investments on the manufacturing construction side—construction of computer, electrical, and electronic manufacturing facilities has jumped more than 1,100% since the end of 2020 in real terms. Over the last two years, profit growth was boosted by rising fiscal deficits, which more than offset rising household savings. At the same time, we saw a rise in productivity growth.

The main concern with deficit-fueled spending is whether it leads to inflation. It’s quite likely that a US economy that is near its productive capacity sees bouts of higher inflation as well, leading to higher interest rates. The good news is that inflation has been falling recently, and the Fed is poised to cut rates. Combine that with profit growth driven by more fiscal spending, and we have two positive tailwinds for equities over the next year.

We Just Want to Have Fun!

When you live a busy and sometimes stressful life, play can be important for your health. Adam Piore of Newsweek reported, “A weighty and growing body of evidence—spanning evolutionary biology, neuroscience and developmental psychology—has in recent years confirmed the centrality of play to human life. Not only is it a crucial part of childhood development and learning but it is also a means for young and old alike to connect with others and a potent way of supercharging creativity and engagement.”

The idea dovetails with a cultural trend known as “kidulting.” The Economist reported on the rise of kidulting, “…where adults engage in lighthearted activities traditionally designed for children…a giant ball pit for adults in three British cities, welcomes 25,000 visitors each month. Even museums and immersive exhibitions typically aimed at actual children now host adult only evenings…Enthusiasts say that such spaces heighten creativity, human connection and joy, triggering the pleasure-seeking chemical [dopamine].”

New museums have popped up to help adults unleash their inner child. For example, the Museum of Ice Cream offers a fun-dae out for adults (children are welcome, too). They can frolic in pools of artificial ice cream sprinkles, engage with themed playscapes, and eat ice cream.

The WNDR Museum offers a completely different kind of fun. It engages visitors through interactive experiences with installations like The Wisdom Project that asks visitors to answer the question, “What do you know for sure?” and requests that they consider what information is important enough to put out into the world. Museum visitors also can use imagination to create AI-generated artwork or visit the Quantum Mirror, “an infinity room with over 150 mirrors that touches on our interaction with technology. Our obsession with screens, the way that our self-perception has changed as social media has become more popular in our society.”

The National Institute for Play cautions that, while play is important for adults, what one person embraces as play may be an annoyance to another. Instead of interactive museums, your jam may be a fantasy football league, a book club or a hike in the woods. What do you do just for the fun of it?

A Reminder About Scams

Scams usually start with a phone call, email, text, or another form of communication. The person typically claims to be from an agency or organization you know – or one that sounds like it might benefit you, such as the National Sweepstakes Bureau or a lottery.

The person may know your name and address. They may give you their official title or an identification number. No matter how official they seem, you can be confident it is a scam if the person contacting you:

• Indicates there is a problem with your benefits.
• Asks you to pay to receive a prize.
• Suggests that paying will increase the chance of winning.
• Requests financial information, such as a bank account or credit card number.
• Pressures you to act immediately.
• Tells you to pay using a specific method, such as a gift card or cryptocurrency.

If this happens, remember that the Social Security Administration, the Internal Revenue Service, Medicare, and your bank do not call, email, or text to ask for money or personal information. They do not demand that you pay immediately, and they do not accept payment by gift card, prepaid debit card, cryptocurrency, or another untraceable form of money transfer.

When you suspect a scam:

• Hang up or close the message. Do not respond in any way.
• Remain calm.
• Think back over the call. Write down any personal information you may have inadvertently shared.
• Report the scam. Contact the Federal Trade Commission at ReportFraud.ftc.gov. You may also want to report the incident to your state’s attorney general or your local consumer protection agency.
• Share your knowledge. Talk with family, friends, and neighbors about your experience so they know what to look out for.

When you receive a digital message, no matter how official it seems, do not click on any links. Do not give or confirm any personal information, including your name, birth date, phone number, address, email address, place of birth, driver’s license, passport, or Social Security numbers, bank or other account numbers, and PIN numbers.

Being skeptical can keep you safe. Remove yourself from the situation. Do not share information. If you feel anxious and need to confirm that it was a scam, contact the organization using a method provided on their official website.

Corporate Transparency Act

The Corporate Transparency Act was enacted in 2021 and was passed to enhance transparency in entity structures to combat money laundering, tax fraud, and other illicit activities.

Beginning January 1, 2024, certain business entities created or registered to do business in the United States will be required to report identifying information about the beneficial owners to FinCen, the Financial Crimes Enforcement Network. Per FinCen rules, a beneficial owner is an individual or group of individuals who, directly or indirectly, owns or controls the company. Reporting companies typically include:

• Domestic reporting companies: Corporations, limited liability companies, and any other entities created by the filing of a document with a secretary of state or any similar office in the United States.
• Foreign reporting companies: Entities (including corporations and limited liability companies) formed under the law of a foreign country that have registered to do business in the United States by the filing of a document with the secretary of state or any similar office.

FinCen has updated their FAQs that includes new information about the reporting process, reporting companies, reporting requirements and much more, with the expectation that further guidance will be provided in the future. The updated FAQs can be found here.

Did you Know? This Week in History

September 3, 1777: The Stars and Stripes flies in battle for the first time

The American flag is said to have flown in battle for the first time, during a Revolutionary War skirmish at Cooch’s Bridge, Delaware. Patriot General William Maxwell ordered the stars and stripes banner raised as a detachment of his infantry and cavalry met an advance guard of British and Hessian troops. The rebels were defeated and forced to retreat to General George Washington’s main force near Brandywine Creek in Pennsylvania.

Three months earlier, on June 14, the Continental Congress adopted a resolution stating that “the flag of the United States be thirteen alternate stripes red and white” and that “the Union be thirteen stars, white in a blue field, representing a new Constellation.” The national flag, which became known as the “Stars and Stripes,” was based on the “Grand Union” flag, a banner carried by the Continental Army in 1776 that also consisted of 13 red and white stripes. According to legend, Philadelphia seamstress Betsy Ross designed the new canton for the Stars and Stripes, which consisted of a circle of 13 stars and a blue background, at the request of General George Washington. Historians have been unable to conclusively prove or disprove this legend.

With the entrance of new states into the United States after independence, new stripes and stars were added to represent new additions to the Union. In 1818, however, Congress enacted a law stipulating that the 13 original stripes be restored and that only stars be added to represent new states.

On June 14, 1877, the first Flag Day observance was held on the 100th anniversary of the adoption of the Stars and Stripes. As instructed by Congress, the U.S. flag was flown from all public buildings across the country. In the years after the first Flag Day, several states continued to observe the anniversary, and in 1949 Congress officially designated June 14 as Flag Day, a national day of observance.

Weekly Focus

To leave the world better than you found it, sometimes you have to pick up other people’s trash.

Bill Nye

There is only one thing in life worse than being talked about, and that is not being talked about.

Oscar Wilde