The 3 biggest threats to the Biden bull market
Earlier this week, the United States opened a new chapter. After the November election, Joe Biden was sworn in as the 46th President of the United States.
Although Biden comes to power with the U.S. economy still reeling from the 2019 coronavirus disease pandemic (COVID-19), he has a number of winds in his back. The Federal Reserve has pledged to keep lending rates at or near historic lows, and Democratic control from both houses of Congress makes it more likely that additional fiscal stimulus will be passed. With monetary and fiscal policy igniting a match in the US economy, it is quite possible that we could see a a raging bull market emerges.
But as investors, we are also keenly aware of the frequency of stock market crashes and corrections. For example, the benchmark S&P 500 (SNPINDEX: ^ GSPC) possesses underwent 38 corrections of at least 10% over the past 71 years. That’s an average of one sizable movement less every 1.87 years.
What we often don’t know in advance is what will cause a crash or a fix. As we contemplate what a new administration in Washington might mean for the U.S. economy and stock market, the following three threats are the most significant for Biden’s bull market.
Historically low credit rates spoil businesses and consumers
For more than 12 years, businesses and consumers have benefited from historically low credit rates.
On the business side of the equation, low borrowing costs have allowed growth stocks to expand their workforce, spend aggressively on innovation, acquire other businesses, and even gain money. accelerate return on capital programs. For example, the backbone of technology Apple (NASDAQ: AAPL), which generally corresponds to operating cash flow, was borrow money at exceptionally low rates buy back its own shares.
Meanwhile, consumers have used historically low credit rates to get into debt. This includes mortgage debt, which is booming now as mortgage and refinance rates are at an all-time low. According to the Federal Reserve Bank of New York, mortgage debt in the United States reached $ 9.86 trillion at the end of September 2020.
The problem is, loan rates can’t stay that low forever. When they start to rise, the recency bias will come back and bite the US economy and stock market quite hard.
Lending rates could increase by 100 basis points (1 percentage point) and remain well below norms. But recent history has shown just how spoiled businesses and consumers have become with low loan rates.
As you can see in the graph above, the 30-year mortgage rate has seen two instances in the past decade where rates have risen by 100 basis points relatively quickly (2013 and late 2016). In these two cases, the creation of mortgage loans and the refinancing activities fell off a cliff and decreased by more than 50%.
This is just one example. If the Fed starts raising its target federal funds rate in 2024 to ensure the US economy does not overheat, the reaction to the lending rate hike could be severe. Businesses and consumers have been spoiled for so long with favorable lending rates that they will find it difficult to take advantage of historically low rates, but not “low” from what they might have seen a few months or so ago. maybe a year or two since.
Suffice it to say that the recency bias when it comes to lending rates is a big threat to the Biden bull market.
A deluge of auto crime floods the financial sector
Another potential concern is the steadily rising default rates on auto loans.
I will freely admit that I have been sound the horn on auto loan default rates for years. Until now, these cries were unwarranted. However, car loan delinquencies are heading in the wrong direction. They have been increasing steadily for nine years, long before the COVID-19 pandemic.
Back in August, TransUnion auto loan delinquencies stood at 3.1%. But that figure doesn’t tell the whole story, as it doesn’t represent the 6.2% of auto loans withheld in July and 4.3% in August. By comparison, the auto loan forbearance rate was only 0.5% during the same period of 2019. Lenders have been accommodating in the face of job losses and income issues related to COVID- 19 for much of 2020, but those waivers aren’t going to last forever.
The good news here is that auto loans are pale compared to the mortgage market. With $ 1.2 trillion in loans outstanding, there will be no stories of economic collapse like in 2008-2009. But a delinquency rate of, say, 5% to 6% is more than enough to put a financial stocks who are already facing higher delinquencies on mortgages and personal loans.
Although the country’s central banks appear well capitalized, investors should not overlook the possibility of the auto loan bubble bursting and the financial sector being forced to remain on the defensive. This would put a serious crush on Biden’s bull market.
Politics weighs on growth
Don’t overlook the possibility that Biden’s tax plan will trip Wall Street.
The Biden administration has a long list of tasks ahead of it. Tackling the coronavirus pandemic and vaccinating as many Americans as possible tops this list. Since this won’t happen overnight, it’s also imperative that Biden and Congress help American families and businesses. All of this will be expensive (trillions of dollars), which means additional federal revenue is needed.
During his campaign, Biden exposed at least a dozen major tax changes he would like to see implemented. Among these changes was an increase in the top marginal corporate tax rate from 21% to 28%. In 2018, the Tax Cuts and Jobs Act (TCJA) lowered the corporate tax rate to an eight-decade low of 21%, from 35%. Biden’s plan only recovers half of the rate cut adopted by the TCJA.
While there is no doubt that this additional income will be needed, higher corporate tax rates could reduce operating income by about 10%. The most notable difference is that we could see a Sustained decline in share buybacks.
Companies like Apple that have repurchased their shares are reducing their outstanding shares and, in many cases, increasing their earnings per share. This makes publicly traded stocks more attractive to investors. With fewer share buybacks, earnings growth could slow significantly, especially for S&P 500 companies.
In other words, the policy could be the loss of Biden’s bull market.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.