Despite last week’s significant political developments and the turmoil at the nation’s Capitol building on Wednesday, U.S. equity markets continued to gain ground and closed the week at new all-time highs. For the week, the S&P 500 gained 1.9%, while the Nasdaq Composite and Dow Jones rose by 2.5% and 1.7%, respectively. Cyclical sectors, including energy, materials, and financials, notched the biggest gains on the week as the shift in control of the Senate with Democrats winning the two seats in Georgia increased the probability for additional stimulus and fed higher expectations for government debt issuance and inflation. As inflation expectations rose, bonds sold off and pushed long-term interest rates higher with the 10-year U.S. Treasury yield ending the week at 1.11% compared to 0.92% one week ago. It is the first time that the 10-year yield has exceeded 1% since March.
With the Senate now split 50/50 between Democrats and Republicans following the Georgia run-off elections and the tie-breaking vote going to VP Kamala Harris, Democrats have a narrow majority in Congress that increases their ability to introduce new legislation. However, such a narrow majority, particularly with Republicans gaining seats in the House in the recent election cycle (now split 222 vs. 211 in favor of Democrats), is likely to have a moderating impact on future policy and reduce the likelihood for more extreme changes in government spending or tax rates. As a result, the initial equity market reaction last week was somewhat muted in terms of the overall direction, though under the surface there was a rotation from more defensive sectors like consumer staples toward more economically sensitive stocks as market participants assessed potential impacts of regulation across industries and the path of inflation and economic growth.
On the economic front, Friday’s December jobs report demonstrated continued disruption from the coronavirus pandemic in parts of the service sector. Overall, employers cut 140k jobs in December, marking the first month of net job losses since April, while the unemployment rate held steady at 6.7%. The pain was particularly acute among restaurants and bars and other leisure and hospitality businesses, which collectively lost 498k jobs during the month. It wasn’t all bad news, however, as most other industries posted job gains, including the retail sector, which added 121k payrolls to handle higher holiday season consumer spending. Additionally, the number of permanent job losses declined by 348k in December to 3.4 million, which was a healthy indication of the economy’s ability to reabsorb displaced workers from hard hit industries.
In the week ahead, President-elect Joe Biden is expected to unveil his economic and vaccine roll-out plan to deal with the fallout of the pandemic on Thursday. The proposed plan, which is anticipated to have a price tag in the trillions of dollars, will likely include additional direct stimulus checks, extended unemployment benefits, further funding for vaccine distribution, and aid to state and local governments. Biden has pledged to deliver 100 million doses of coronavirus vaccinations within his first 100 days in office. As government spending grows under Democrat leadership, market participants will also be listening for more color around planned tax increases, though the continued economic strain from the pandemic may delay implementation of any planned hikes. Currently, it is anticipated that the Trump administration tax cuts will eventually be partially unwound with the top tax rate on personal regular income heading back to 39.6% and the corporate tax rate increasing to 28% after being cut from 35% to 21% in 2017.
Overall, the implications for the economy and financial markets from the shift in the balance of power are not cut and dry. Democrat leadership is supportive of market and economic tailwinds from continued stimulus, consumer support, infrastructure spending, and potentially easing trade tensions on some fronts, which are offset to some degree by greater probability of tax hikes, more stringent regulation, and greater government debt burdens. We will continue to keep clients apprised of developments on policy and regulation and the implications for investment and financial planning strategy in the months ahead.
