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Friday Thoughts

I hope that you’ve had a great week. While the daytime temperatures have stayed warm for this time of the year in South Carolina, you can still feel that hint of cooler weather with our night time temps. Football is now in full swing, with all of our Homecomings in the Zimpleman house complete. The kids are in full Halloween prep mode. 

Last week, I wrote about the big issues that I felt were most concerning to the stock markets. The first one I mentioned was the legislative issues facing Congress. By the time my e-mail was published, the debt ceiling limit had been agreed upon and was in the midst of getting passed and sent to the Presidents desk. 

So, at least one crisis was adverted, right? The Dow had a big rally on Thursday because of the news, so that should be a positive, right? I’m not convinced. By definition, they did pass a debt ceiling limit increase of $480 billion. But, that is only enough to delay the “deadline” of default from October 18th to December 3rd - just 6 weeks! This was the proverbial kicking the can down the road. Not really kicking as much as very softly bumping. 

There’s no indication that either side will be anymore willing to back down from their positions in six weeks. The Democrats feel that this should be a bipartisan issue. Think of it as mutually agreed upon destruction.

But, there is the other giant elephant in the room - the two massive spending bills proposed by the Democrats - often referred to as the Build Back Better plan proposed by the Biden administration. Because of the size of the spending bills, they knew it would never pass a 50-50 Senate and would need to be broken into two spending bills. Usually, the Senate needs 60 votes to move key pieces of legislation through. But by using a unique process called  reconciliation, they can get certain bills through with a vote of 50, if the legislation and congressional leaders meet certain rules.

The first and smaller spending bill largely focuses on physical infrastructure across the country such as roads, bridges, and fiberoptic networking. It is supported by both parties and has already passed the Senate. The price tag for that bill is around $1.1 Trillion. But, there are a group of Democratic house members who refuse to vote for that bill until the Senate takes up and passes a larger spending bill. 

The larger bill is reported to be $3.5 trillion and funds a grab bag of Democratic wish list items such as lowering Medicare eligibility to 60 from 65, making the temporary child tax credit increase permanent, providing resident status to some illegal immigrants, increases in affordable housing, money to fight global warming, universal 3k and 4k for all children, and two years of community college for all, among other things. 

Several moderate Democrats senators have said that it’s too large of a spending bill and they won’t support it. Bernie Sanders says that he won’t agree to lowering the spending and that we need everything in there. Since the Senate is evenly divided, the Democrats can’t afford to lose one voter. Hence the stalemate. If they can’t get the larger bill through the Senate, will they be able to at least get a compromise on the smaller bill in the House? It’s not looking too good. 

Back to the debt limit increase - the Republicans are saying that if the Democrats are willing to even try to get the $3.5 trillion spending bill through the process of reconciliation, they should be able to do the same with the debt limit bill. They say that they don’t support the massive spending, so they think it should all be on the Democrats to do it. 

The reality is that the Republicans are as much to blame for our national debt as are Democrats. Spending continued to go up under President Trump, when the Republicans had control of Congress. Both parties have been unwilling to back away from the punch bowl at the party, whoever was throwing the party. 

I’m still not sure how any of this will get resolved. That’s what worries me, and why I consider it one of the key issues to watch over the next few months. By and large, the broader stock market indexes have reacted favorably when spending bills get passed. That means more money to be flowing out into the economy. But, at what point does the debt become more of a concern than the spending? 

There are also massive tax increases and new taxes in the spending bills. No one seems to be covering these in the popular media, but it is all the buzz in the financial trade papers. There are proposals to lower the threshold for estate taxes, new efforts to squash the use of trusts to shelter funds, limits on retirement account usage for some, and tax to be charged on retirement accounts over a certain level (the latest proposal was for IRA’s over $10 million), and, of course, an increase in income tax rates. 

What is not in the proposal are taxes on carried interest. That tax would be a major hit to many money managers and Wall Street firms. So, at this point, they seem to largely be indifferent to the new taxes. However, we’ve never seen tax and spend plans this massive. If it passes, somehow, the unintended consequences could be as massive as the legislation.

My gut tells me that the larger spending bill and corresponding taxes goes nowhere. The President’s tumble in the polls hasn’t helped get this over the finish line.They may be able to coerce enough house members to vote for the smaller bill. But, I’m not even sure of that. This is divided time, and it’s hard to jamb big legislation through our system in such a divided time. Perhaps that’s for the best. 

It still leaves the debt ceiling increase hanging out in early December. The can is just a few weeks down the road. 

So, what will the impact be to the markets, or your investment portfolio? I am anticipating an increase in volatility in the stock markets, that will probably overreact to the news headlines. Interestingly, I also suspect that we may see some volatility in the bond market, as the spending bills will be paid for more debt. But, volatility, in and of itself, isn’t a bad thing. Our reaction to it is where things can go wrong. The key is to not sell out of a high quality diversified portfolio just because we’re concerned. 

If you’re concerned and would like a review of the risk in your portfolio, please give me a call. I use a great piece of software that can analyze any portfolio and show you what it did during the great recession and use an algorithm to give you a 95% probability of what to expect over the next six months. I’m more than happy to run that risk analysis for you.

Meanwhile, keep the news turned off and get out end enjoy this fall weather. There are lots of events getting started back. I’ve seen advertisements for a food truck rally coming up, the fair is in Columbia this weekend and will be win Sumter in a few weeks. We’re finally getting back to our next normal. 

Next week, I’m planning on writing about inflation and the supply chain, as I’ve had a number of replies about last week’s e-mail.