Taxes, Tesla, and Tapering? Will investors prove to have been tricked after yet another record finish to the month of October for the major indexes? Or will they be treated to more of the same – mostly strong earnings and even stronger returns as we desperately try to move on from the pandemic’s economic devastation. Much of that depends on policy coming out of Washington D.C. over the next month. The focus will be on any shifts in expectation to the level of fiscal spending, monetary accommodation, and taxation. Despite the major supply headwinds and labor costs evidenced on many income statements, including those of Big Tech, markets remain resilient.

The tapering of asset purchases by Fed Chairman Jerome Powell & Co. is widely expected to be announced at the FOMC meeting this week, given persistent inflation and more restrictive policy from the central banks of England, Australia, and New Zealand. Two quarter-point increases in the federal funds rate have already been priced in as the yield curve flattened between the 2 and 10-year Treasury yield marks. The spread declined from around 130 basis points earlier in the month to 105, briefly spooking markets.

Are overall market valuations justified?

Throw in the inflation worries and a sharp decline in GDP growth from the prior quarter to just around 2% annualized – investors may wonder if overall market valuations are justified. Yes, potentially, if the broader market continues to fill out and supply pressures begin to ease. Worry signals from the bond market may be overblown as the flattening curve was mostly technical. A yield curve inversion (longer dated debt yields fall below short-term yields with similar credit characteristics) is much more indicative of recession, and we are not there yet. There are pockets of froth, but no structural issues. Internationally, China’s real estate developers and slowing GDP, along with high inflation in developed and emerging markets such as the UK and Brazil, is something to keep an eye on.

Ongoing COVID impact

The recovery from Covid has had a risk-on and -off again relationship with the reflation trade globally. The latest headline figures and statistics portend a recession and slowdown at first glance. Take a closer look at what’s driving those figures though. We have a supply issue, which is more annoying than anything. Lack of demand causes recessions. Demand for goods is currently insatiable, and we have not even opened the lid on demand for services, post Covid. The world is awash in liquidity and never has there ever been looser fiscal and monetary policy. When accounting for the estimated neutral policy interest rate for an economy that is not too hot and not too cold, we are easily 3-4 times below that threshold.

That is hardly restrictive monetary policy factoring in tapering with a few rate hikes. Enormous amounts of cash, household savings, and institutional money continues to search for a home in everything from crypto to meme stocks to generate returns. With entrenched inflation and the potential for rising rates amid this staunch demand, we remain overweight high-quality equities in inflation sensitive sectors incorporating an ESG lens. We continue to utilize a barbell approach to growth and value while maintaining a strong international allocation as well for diversification. Dividends overseas are double the rate of domestic stocks, boosting income in a low yield environment. Prices globally remain quite low relative to the US markets. Our bond allocation includes short duration investment grade exposure and TIPS for inflation protection.

The tax situation, which has quietly returned to the forefront after original plans were mostly scrapped, might be viewed as a huge victory of sorts for investors, all things considered. Raising corporate, capital gains, and individual tax rates were thought to be a certainty. Now, the targets for generating revenues have become narrower – surcharges for very high earners ($10 mill. or more) and a 15% minimum corporate tax for firms generating billion-dollar profits. There is still a decent chance that even the revised legislation falls through with the divided Democrats in congress. Higher taxes in some fashion are likely in order to pay for President Biden’s compromise bill on soft infrastructure.

The fiscal spending proposal was cut in half to around $1.85 trillion and includes funding for child and health care, early education, and green energy.

Speaking of green energy and infrastructure – we believe this investing theme, among other ESG focused sectors will continue to be a valuable and strategic component to a diversified portfolio for decades to come. Markets may exhibit choppiness and volatility after the sharp rebound in asset prices and the potential for rising rates, but the bull case for ESG remains strong for the long term. When businesses are competing for the greater good ethically, it’s not just good policy, it’s good business. Shareholders and stakeholders both benefit.

From Wall Street to Main Street, investors’ and society’s values are becoming more aligned. No doubt that is one of the reasons Tesla is now part of the trillion-dollar market capitalization club amid news of rental car company Hertz’s partnership. Even traditional investment, energy, and value-oriented companies are changing their entire business models to support EVs, cleaner energy, better corporate governance, and a more socially equitable society. Juxtaposed against Tesla, you may look at Facebook, another tech focused mega-cap. They changed their name to Meta, a potential diversion from the constant bad press. They have fallen out of the trillion club – maybe due to inadequate corporate governance – despite its planned omnipresence in future society. There may still be a bullish case for Meta, but the point being, it may be easier to sleep at night and produce less volatile returns in the long run when you invest with your values.

In the spirit of Fall and the holiday season, I will end by mentioning that it is a real “treat” to be working with KLR Wealth. I am quite thankful for the opportunity to provide you guidance on your journey to a successful financial future. Wishing you all the best in your health and wealth.

Michael Trotter is the Chief Investment Officer at The Patriot Financial Group, LLC. Michael is a proven investment professional with over 10 years of experience in the fund and wealth management space.