Monday Digest
Posted 26 April 2021
Overview: ‘risk on’ pauses while the real world keeps accelerating
Equity markets finally paused in their upward trend last week, with the most speculative assets like Bitcoin experiencing their first serious setback since February. Most likely it was a more general dampening of investor sentiment in the face of increasingly cautionary reports from investment bank analysts about overheating markets, alongside a powerful and tragic resurgence of COVID in India.
In the US, news emerged that the Biden administration is proposing to tax the capital gains of US citizens whose annual incomes already exceed $1 million at the top ordinary income tax rate of 39.6%. The tax will not affect UK tax-domiciled investors directly, but will particularly impact the US private equity sector, and could have some impact on ordinary US stockholders of the major listed companies. Historical observations from previous capital gains tax (CGT) rises show that stock markets have usually risen following an increase, but traded more sideways than up in the run-up, as investors crystalised gains under the lower tax rate and then reinvested.
For UK investors, much more important will be whether our own government takes the opportunity to follow suit – which given the noises ahead of the last Budget seems relatively likely. More decisive for US stock prices, however, will be the efforts to increase the tax take from companies directly. One might think that the Biden Administration is using CGT as a means of keeping up the pressure to get the corporate tax rise through. As a result, we continue to be somewhat wary of the largest stocks that would be most greatly affected by the increase in effective tax rates, given they have been most effective in utilising the existing loopholes.
Has COVID prompted governments to be more interventionist?
Last week gave us a few astounding days in the sporting world, after a renegade bunch of Europe’s biggest football clubs announced plans to break away to build their own league, only for the whole enterprise to fall apart as quickly as it appeared. Two parts of the story stick out. First, it was incredible to see so many disparate groups – fans and political parties of all stripes, together with sports professionals and major media executives – agree so strongly. Second, and perhaps more astounding, was the speed and force of the British government’s response, effectively pledging to use legal and legislative tools to prevent anything like this happening again.
From an investment perspective, that spirit of interventionism appears significant. The European Super League drama is certainly a special case – a hugely popular national institution being threatened by what many see as simple greed – and one that gives politicians ample opportunity to score points. But it is part of a trend reversal in politics both here and across the world. Since the 1980s, laissez-faire ‘neoliberalism’ has been the default mode of Western government, and successive politicians have been reluctant to step into free market affairs. But such interventions are increasingly being seen as a standard part of the government toolbox. From big-tech busting to vaccine rollouts and even sport, political deference to the private sector is drying up fast.
Climate action is back on the political agenda.
Nowhere is this re-emergence of political determination more apparent than in environmental policy. Joe Biden stole the headlines at last week’s virtual summit on tackling climate change, promising to half America’s CO2 emissions by the end of the decade. Grand statements on climate change have been a common theme from world leaders for several decades, but the intent from the current generation seems more wholehearted. What is interesting in the proposals is not just the big targets, but how they plan on reaching them. Both here and across the Atlantic, policymakers have drawn up measures to invest heavily in green infrastructure, including detailed plans on insulating homes, alternative energy sources and much more.
To make the promised changes, we will need to see a structural shift from global companies beyond what any one government is capable of doing. And ultimately, that will only happen if it becomes more profitable to invest in green energy than in polluting industries. That is precisely what global leaders’ current plans are aimed at. Carbon taxes and subsidies for green projects are nothing new, but by drawing up detailed governance systems for emissions, governments are clearly trying to disincentivise fossil fuel activities as much as possible, while pushing the incentives into greener energy. The plans are far from perfect, and there are a host of teething issues – from coordinating international ‘taxonomies’ to the widespread ‘greenwashing’ attempts to conceal emission statistics. But from a purely investment perspective, what it tells us is that the trend toward environmental or ethical investment is going full steam ahead.
In recent years, we have seen a huge uptick in demand for ESG (environmental, social and governance) investments. Part of this is down to growing ethical concerns from investors, but another part is simply that markets think ESG investments will be profitable down the line. If the green revolution really is upon us, they could well be right. And now that we are seeing governments intervene on an unprecedented scale to help the shift, their relative attractiveness should grow. Against this positive backdrop – and with interventionist politicians eager to support them – environmental companies have a real sporting chance.
Housing market: still hot property
The combination of incredibly supportive monetary and fiscal policy (and accelerating vaccination programmes) has led to widespread expectations of growth in activity and price inflation, and – thanks to ultra-low interest rates and favourable policies (in the UK, namely the government’s stamp duty suspension) – a notable rise in property prices. This is true virtually everywhere across the developed world, with some countries seeing increases to levels higher than ever before. In Australia, for example, property prices have shot up so much that the government is concerned about how a runaway market could impact consumers.
On the one hand, a booming property market is good news for the recovery, pushing up consumer balance sheets and therefore encouraging consumption. But on the other, if property prices spike too high and too soon, it will stretch affordability – particularly for those with low incomes that have been hit hardest by the recession – and potentially cause the market to get ‘toppy’.
Housing activity does have a direct effect on construction, which creates jobs and growth, as construction activity gets counted straight into GDP numbers. From a pragmatic point of view, politicians and policymakers are likely to be intensely focused on GDP figures, and so the building angle might be all that is needed to get them keen on house price rises. Certainly, we already see politicians promoting infrastructure spending – particularly green infrastructure – on the basis of the jobs it will bring. In the UK particularly, there is a great deal of ‘green upgrades’, from insulation to energy, that could be carried out across the nation for a relatively low cost.
Looking forward, there are reasons to be positive, including a continuation of the supportive policy environment. House prices can only rise if incomes are sustained. Eventually, this will come from the overall recovery and the growth it will bring. But in the meantime, the substantial monetary and fiscal stimulus of the pandemic will be needed. On the fiscal side, the worry is that governments could withdraw support too soon – an idea already being floated by some politicians concerned about ballooning national debts. Should that happen, the recovery could be set back, to the detriment of property prices.