Should Investors Be Nervous?

The House Ways and Means Committee proposed a slimmed down tax plan.

Under the Democratic proposal, the top corporate tax rate would rise from 21% to 26.5% – less than the 28% rate that the Biden Administration had sought, but slightly more than 25% rate that Citi Research was expecting. The top tax rate on capital gains would rise from 20% to 25%, instead of the 39.6% President Biden proposed. When the 3.8% Medicare surtax is included, the top capital gains rate would be 28.8%. The House Ways and Means Committee will debate the tax portion of the agenda this Tuesday. With thin majorities in both chambers of Congress, Democrats can afford just three defections in the House and none in the Senate with every Democrat vote needed to pass the agenda through the budget reconciliation process. While West Virginia Democrat Joe Manchin has expressed that he does not support $3.5 trillion in spending and is worried about inflation, history suggests that the bills have high odds of passage with 21 of 25 (or 85%) of past budget reconciliation bills having went on to be signed by the President. The self-imposed date for a vote is September 27, but it is not a binding date and can be missed without any serious ramification.

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Should Investors Be Nervous?

With the S&P 500 having rallied 36.8% without a 5%+ pullback over the last 318 calendar days, it makes sense that investors are becoming nervous about a potential correction. However, the length of the rally tells us very little with the S&P 500 having once gone nearly 7 years between 1990-1997 without a single double-digit correction. Since 1950, the S&P 500 has experienced 37 double-digit drawdowns over a span of about 70 years – implying that a double-digit drawdown occurs on average a little more than every other year (see figure 1). Thus, there is no real reason that we have to have a correction, but September is often viewed as a difficult month for the U.S. stock market with the S&P 500 averaging a loss of about 0.2% since 1990 (see figure 2). It may also be worth noting that the S&P 500 fell 9.6% in September 2020, but we don’t think that seasonality alone should be driving the market narrative.

Peak Date	Trough Date	Peak Price	Trough Price	Percent Loss	Number of Days
6/12/1950	7/17/1950	19.4	16.68	-14.0	35
1/5/1953	9/14/1953	26.66	22.71	-14.8	252
9/23/1955	10/11/1955	45.63	40.8	-10.6	18
8/2/1956	2/12/1957	49.74	42.39	-14.8	194
7/15/1957	10/22/1957	49.13	38.98	-20.7	99
8/3/1959	9/28/1960	60.71	52.48	-13.6	422
12/12/1961	6/26/1962	72.64	52.32	-28.0	196
8/22/1962	10/23/1962	59.78	53.49	-10.5	62
2/9/1966	10/7/1966	94.06	73.2	-22.2	240
9/25/1967	3/5/1968	97.59	87.72	-10.1	162
11/29/1968	5/26/1970	108.37	69.29	-36.1	543
4/28/1971	11/23/1971	104.77	90.16	-13.9	209
1/11/1973	10/3/1974	120.24	62.28	-48.2	630
11/7/1974	12/6/1974	75.21	65.01	-13.6	29
7/15/1975	9/16/1975	95.61	82.09	-14.1	63
9/21/1976	3/6/1978	107.83	86.9	-19.4	531
9/12/1978	11/14/1978	106.99	92.49	-13.6	63
10/5/1979	11/7/1979	111.27	99.87	-10.2	33
2/13/1980	3/27/1980	118.44	98.22	-17.1	43
11/28/1980	8/12/1982	140.52	102.42	-27.1	622
10/10/1983	7/24/1984	172.65	147.82	-14.4	288
8/25/1987	12/4/1987	336.77	223.92	-33.5	101
1/2/1990	1/30/1990	359.69	322.98	-10.2	28
7/16/1990	10/11/1990	368.95	295.46	-19.9	87
10/7/1997	10/27/1997	983.12	876.99	-10.8	20
7/17/1998	8/31/1998	1186.75	957.28	-19.3	45
7/16/1999	10/15/1999	1418.78	1247.41	-12.1	91
3/24/2000	10/9/2002	1527.46	776.76	-49.1	929
11/27/2002	3/11/2003	938.87	800.73	-14.7	104
10/9/2007	3/9/2009	1565.15	676.53	-56.8	517
4/23/2010	7/2/2010	1217.28	1022.58	-16.0	70
4/29/2011	10/3/2011	1363.61	1099.23	-19.4	157
5/21/2015	8/25/2015	2130.82	1867.61	-12.4	96
11/3/2015	2/11/2016	2109.79	1829.08	-13.3	100
1/26/2018	2/8/2018	2872.87	2581	-10.2	13
9/20/2018	12/24/2018	2930.75	2351.1	-19.8	95
2/19/2020	3/23/2020	3386.15	2237.4	-33.9	33

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This table shows S&P 500 Corrections & Bear Markets Since 1950. A double-digit correction occurs just about every other year with the longest span without a double-digit correction being almost 7 years.

This chart shows the average Monthly S&P 500 returns since 1990. Equities are often weak in the third quarter, but tend to rally in the fourth quarter.

There are a number of reasons that investors have been fretting about a potential sell-off, including the following:

1. The pace of U.S. economic growth and earnings-per-share (EPS) growth may have peaked as the initial reopening surge starts to normalize
2. Supply-side constraints remain relevant and the lack of qualified workers could lead to a jump in wages, which could pressure margins
3. The Fed could act faster-than-anticipated in response to rising inflation (investors will receive the August Consumer Price Index (CPI) print this Tuesday) or the pace of tapering could surprise investors
4. Interest rates could head higher once again and challenge technology shares as they did in mid-February
5. Washington, D.C. could surprise investors if infrastructure talks completely collapse, the debate to raise the debt ceiling heats up, or if the federal government is forced to shut down due to a disagreement on fiscal year 2022 funding. Importantly, raising the debt ceiling requires 60 votes in the Senate.
6. Chinese policymakers continue to make waves as they crackdown on the private sector, which is making investors nervous about the world’s second largest economy.

Most of these worries seem overblown, but when taken together, it is certainly possible that we see a correction. So how should investors think about this? Should they be nervous or not? We think the short answer is no, but let us give a long answer because that’s what former economists do.

First, we should acknowledge that the economy is slowing some with the Atlanta Fed GDPNow forecast now tracking at about 3.6%. The Fed also acknowledged this in their Beige Book, which said that the U.S. economy downshifted slightly in August and that “The deceleration in economic activity was largely attributable to a pullback in dining out, travel, and tourism in most Districts, reflecting safety concerns due to the rise of the Delta variant, and, in a few cases, international travel restrictions.” That said, we find it encouraging that timely business surveys like the ISM composite index, which is monthly gauge on economic activity in the manufacturing and services sectors, still points towards quarter-on-quarter annualized growth that is between 5% to 6% (see figure 3). While below the 6.6% 2Q real gross domestic product (GDP) print, recent data are far from signaling a stalling of the economy. To the contrary, the data seem to suggest an economy that is being held back by supply constraints – both labor constraints and product constraints (semi-conductors, etc.).

This line chart shows the ISM Composite Index vs. Real U.S. GDP (QoQ, SAAR%) from 2004 to 2021. Economic growth appears to be moderating some due to Delta, but a stalling in activity seems very unlikely.

The August employment report is an excellent example of such constraint. While the report disappointed with the economy adding just 235,000 jobs during the month (the economy added over 1 million jobs the month prior), it needs to be put into context. The first thing to note is that the Bureau of Labor Statistics said that about 5.4 million people said they were still not able to work due to COVID in August, which was up 400,000 from the month prior. That seems to imply that a broadening of vaccinations or fading of Delta cases could lead to a continued recovery in employment in the hospitality sector. We should also remember that the economy added 785,000 jobs in March 2021, then dropped to 269,000 jobs in April, and then rebounded back in May – adding 614,000 jobs. This is not the first weak (or even the worst) employment report we have seen during this economic recovery. In fact, during the fourth quarter of 2020, the U.S. economy averaged just 64,000 jobs a month. We have seen these ups and downs before and financial markets reacted very little.

This chart shows the Average Monthly Employment Gains, in thousands, between 1990 and 2019. August payrolls often surprise to the downside.

We would also point out that the U.S. economy has a record number of job openings right now with 10.9 million job openings available. That seems to imply that the labor market is suffering from a supply issue…not a demand issue with employers still seeing enough demand that that want to hire more people, but can’t find enough qualified workers. Perhaps this is because some people still wish to care for unvaccinated children or maybe they are drawing down savings while they look for a better job than they previously held. Either way, the problem does not seem to be the strength of the economy…it seems to be constraints caused by the global pandemic.

In terms of how the employment report impacts the Fed, it seems safe to say that an announcement that the Fed intends to begin tapering the pace of its bond purchases is unlikely to occur before November. However, odds still seem to favor an announcement before year-end. Depending on the details, financial markets could experience increased volatility around this event, but we think that the U.S. stock market will be able to handle a well-telegraphed announcement as the Fed has been signaling a desire to remain accommodative for as long as needed. Rising inflation could of course change this trajectory, but we think that peak inflation may be increasingly near.

The path ahead for Fed policy may also be somewhat dependent on fiscal policy with a grand fiscal finale from Congress likely near month-end. Not only is Congress debating the Biden Administration’s proposed infrastructure agenda (please see the Week Ahead section for details about the tax proposals), but it must also vote to raise the debt ceiling and fund the federal government for fiscal year 2022. While the September 27 vote on infrastructure is self-imposed and non-binding, meaning it can be missed, the deadline to fund the government by September 30 is binding and an agreement is needed to avert a federal government shutdown.

We are expecting financial markets to be gripped by Washington headlines in coming weeks, but we think it’s important to not overreact. Since 1976, the federal government has shutdown 21 times with the average shutdown lasting about 8 days. During those shutdowns, the S&P 500 averaged a return of +0.1%, which is essentially unchanged (see figure 5). The worst performance was in 1979 under Jimmy Carter when the S&P 500 fell 4.4%.

Year	President	Dates of Federal Government Shutdown	Number of Days	S&P 500 Performance During the Shutdown (%)
1976	Gerald Ford	September 30 to October 11	10	-3.4
1977	Jimmy Carter	September 30 to October 13	12	-3.2
1977	Jimmy Carter	October 31 to November 9	8	0.7
1977	Jimmy Carter	November 30 to December 9	8	-1.2
1978	Jimmy Carter	September 30 to October 18	18	-2.0
1979	Jimmy Carter	September 30 to October 12	11	-4.4
1981	Ronald Reagan	November 20 to November 23	2	-0.1
1982	Ronald Reagan	September 30 to October 2	1	1.3
1982	Ronald Reagan	December 17 to December 21	3	0.8
1983	Ronald Reagan	November 10 to November 14	3	1.3
1984	Ronald Reagan	September 30 to October 3	2	-2.2
1984	Ronald Reagan	October 3 to October 5	1	0.1
1986	Ronald Reagan	October 16 to October 18	1	-0.3
1987	Ronald Reagan	December 18 to December 20	1	0.2
1990	George H.W.Bush	October 5 to October 9	3	-2.1
1995	Bill Clinton	November 14 to November 19	5	1.3
1995-1996	Bill Clinton	December 16, 1995 to January 6, 1996	21	0.1
2013	Barack Obama	October 1 to October 17	16	2.3
2018	Donald Trump	January 20 to January 23	3	1.0
2018	Donald Trump	February 9	1	1.5
2018-2019	Donald Trump	December 22, 2018 to January 25, 2019	34	10.3
Average			average number of days shut down is 7.8 Days	average percent change for S&P 500 Performance During Past Federal shutdowns is +0.1%

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This table shows S&P 500 Performance During Past Federal Government Shutdowns. Past federal government shutdowns have not materially impacted the stock market.

Likewise, there has been only one year when the S&P 500 posted a negative annual return in the year that either the top income, corporate, or capital gains tax rate was changed (see figure 6). That occurred in 1969 when the US economy experienced a recession as President Johnson tried to close a budget deficit caused by the Vietnam War while the Federal Reserve tightened its monetary policy. That is far from the situation investors face today.

This table shows the old and new Marginal Income Tax Rate Increasein 1968, 1969, 1991, 1993 and 2013

Year	Old Tax Rate	New Tax Rate	President	Legislative Act	S&P 500 Total Return	Real U.S. GDP YoY (%)year of year change in percent
1968	70.0%	75.3%	LBJ	Revenue and Expenditure Control Act of 1968	11.04%	4.91%
1969	75.3%	77.0%	LBJ	Revenue and Expenditure Control Act of 1968	-8.40%	3.13%
1991	28.0%	31.0%	Bush Jr.	Revenue Reconciliation Act of 1990	30.47%	-0.11%
1993	31.0%	39.6%	Clinton	Omnibus Budget Reconciliation Act	10.08%	2.75%
2013	35.0%	39.6%	Obama	American Taxpayer Relief Act of 2012	32.39%	1.84%
Average					Real U.S. GDP YoY (%)year of year change in percent is15.11%	average percent change for S&P 500 total return is 2.51%

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This table shows the old and new Marginal Income Tax Rate Decreasein 1964, 1965, 1970, 1971, 1981, 1982, 1987, 1988, 2001, 2002, 2003 and 2018

Year	Old Tax Rate	New Tax Rate	President	Legislative Act	S&P 500 Total Return	Real U.S. GDP YoY (%)year of year change in percent
1964	91.0%	77.0%	LBJ	Revenue Act of 1964	16.43%	5.76%
1965	77.0%	70.0%	LBJ	Revenue Act of 1964	12.46%	6.50%
1970	77.0%	71.8%	Nixon	Tax Reform Act of 1969	3.89%	0.19%
1971	71.8%	70.0%	Nixon	Tax Reform Act of 1969	14.22%	3.29%
1981	70.0%	69.1%	Reagan	Economic Recovery Tax Act of 1981	-4.88%	2.54%
1982	69.1%	50.0%	Reagan	Economic Recovery Tax Act of 1981	21.50%	-1.80%
1987	50.0%	38.5%	Reagan	Tax Reform Act of 1986	5.18%	3.46%
1988	38.5%	28.0%	Reagan	Tax Reform Act of 1986	16.61%	4.18%
2001	39.6%	39.1%	Bush Jr.	Economic Growth and Tax Relief Reconciliation Act of 2001	-11.89%	1.00%
2002	39.1%	38.6%	Bush Jr.	Economic Growth and Tax Relief Reconciliation Act of 2001	-22.10%	1.74%
2003	38.6%	35.0%	Bush Jr.	Jobs and Growth Tax Relief Reconciliation Act of 2003	28.68%	2.86%
2018	39.6%	37.0%	Trump	Tax Cut and Jobs Act of 2017	-4.38%	3.00%
Average					Real U.S. GDP YoY (%)year of year change in percent is6.31%	average percent change for S&P 500 total return is 2.73%

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This table shows the old and new Corporate Tax Rate Increasein 1950, 1951, 1952, 1968, 1993

Year	Old Tax Rate	New Tax Rate	President	Legislative Act	S&P 500 Total Return	Real U.S. GDP YoY (%)year of year change in percent
1950	38.0	42.0	Truman	Revenue Act of 1950	31.45%	8.68%
1951	42.0	50.8	Truman	Revenue Act of 1951	23.97%	8.05%
1952	50.8	52.0	Eisenhower	Revenue Act of 1951	18.16%	4.09%
1968	48.0	52.8	LBJ	Revenue and Expenditure Act of 1968	11.04%	4.91%
1993	34.0	35.0	Clinton	Omnibus Budget Reconciliation Act	10.08%	2.75%
Average					Real U.S. GDP YoY (%)year of year change in percent is18.94%	average percent change for S&P 500 total return is 5.70%

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This table shows the old and new Corporate Tax Rate Decreasein 1964, 1965, 1970, 1971, 1979, 1987, 1988, 2018

Year	Old Tax Rate	New Tax Rate	President	Legislative Act	S&P 500 Total Return	Real U.S. GDP YoY (%)year of year change in percent
1964	52.0	50.0	LBJ	Revenue Act of 1964	16.43%	5.76%
1965	50.0	48.0	LBJ	Revenue Act of 1964	12.46%	6.50%
1970	52.8	49.2	Nixon	Tax Reform Act of 1969	3.89%	0.19%
1971	49.2	48.0	Nixon	Tax Reform Act of 1969	14.22%	3.29%
1979	48.0	46.0	Carter	Revenue Act of 1978	18.45%	3.17%
1987	46.0	40.0	Reagan	Tax Reform Act of 1986	5.18%	3.46%
1988	40.0	34.0	Reagan	Tax Reform Act of 1986	16.61%	4.18%
2018	35.0	21.0	Trump	Tax Cut and Jobs Act of 2017	-4.38%	3.00%
Average					Real U.S. GDP YoY (%)year of year change in percent is10.36%	average percent change for S&P 500 total return is 3.69%

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This table shows the old and new Capital Gains Tax Rate Increasefrom 1970, 1976, 1987 and 2013

Year	Old Tax Rate	New Tax Rate	President	Legislative Act	S&P 500 Total Return	Real U.S. GDP YoY (%)year of year change in percent
1970	27.5%	36.5%	Nixon	Tax Reform Act of 1969	3.89%	0.19%
1976	36.5%	39.9%	Ford	Tax Reform Act of 1976	23.81%	5.39%
1987	20.0%	28.0%	Reagan	Tax Reform Act of 1986	5.18%	3.46%
2013	15.0%	23.8%	Obama	American Taxpayer Relief Act of 2012 / Patient Protection and Affordable Care Act of 2013	32.39%	1.84%
Average					Real U.S. GDP YoY (%)year of year change in percent is16.32%	average percent change for S&P 500 total return is 2.72%

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This table shows the old and new Capital Gains Tax Rate Decreasefrom 1979, 1981, 1997 and 2003

Year	Old Tax Rate	New Tax Rate	President	Legislative Act	S&P 500 Total Return	Real U.S. GDP YoY (%)year of year change in percent
1979	39.9%	28.0%	Carter	Revenue Act of 1978	18.45%	3.17%
1981	28.0%	20.0%	Reagan	Economic Recovery Tax Act of 1981	-4.88%	2.54%
1997	29.2%	20.0%	Clinton	Taxpayer Relief Act of 1997	33.36%	4.45%
2003	20.0%	15.0%	Bush Jr.	The Jobs and Growth Tax Relief Reconciliation Act of 2003	28.68%	2.86%
Average					Real U.S. GDP YoY (%)year of year change in percent is18.90%	average percent change for S&P 500 total return is 3.25%

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History suggests that the broad stock market responds more to the strength of the economy and the resulting earnings growth than it does to changes in the tax code. Will there be winners and losers? Sure, that seems likely, with the companies that benefitted the most from the 2017 tax cuts already underperforming a bit relative to companies that will not be impacted much, but it has not been dramatic.

With earnings growth likely to remain solid, but slowing, intra-year declines may become more common. However, intra-year declines often tell investors very little about annual returns. As figure 7 shows, since 2009 the S&P 500 has experienced 7 intra-year declines of over 10% and yet just two years (2015 and 2018) posted negative returns for the year. In the years that the S&P 500 experienced a double-digit decline, the average annual return come year-end was approximately 8.0%.

This chart shows the Intra-Year Declines vs. S&P 500 Annual Returns (%) from 1980 to 2020. Intra-year declines are common, but annual declines are less common and usually occur near periods of recession.

So getting back to our short answer…the economic expansion is likely to continue for the next several years and earnings will likely rise further as well. Given that backdrop, any pullback or correction will likely to be bought as investors are unlikely to view a sell-off as the start of a new bear market and more as a healthy consolidation after a lengthy, uninterrupted rally. That means staying focused on one’s long-term investing goals and staying invested is the approach for the average investor to take.

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Index	Weekly Chg (%)change in percent	YTD (%)year to date change in percent	12 Months (%)12 month change in percent	Div. Yield (%)division yield in percent
Dow Jones	-2.2	13.1	25.7	1.8
S&P 500	-1.7	18.7	33.5	1.3
NASDAQ	-1.6	17.3	38.4	0.6
Instrument	Weekly Chg (%)change in percent	YTD (%)year to date in percent	12 Months (%)12 month change in percent	Level
10-Year Treasury Yield (%)	1.8 bps	42.7 bps	66 bps	1.34%
Gold ($/Oz.)	-2.2%	-5.8	-8.1	$1,787.6
Oil ($/bbl)	0.6	43.7	86.9	$69.72

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This table shows returns for various USA equity markets and select assets, in weekly, year-to-date and 12 month changes. International stocks performed better last week.

Index	Weekly Chg (%)change in percent	YTD (%)year to date in percent	12 Months (%)	Div. Yield (%)division yield in percent
Global	-1.2	14.1	30.4	1.7
Europe	-1.5	12.7	26.0	2.7
Japan	3.5	9.0	25.7	1.9
Emerging Markets	-0.5	2.9	23.0	2.2

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This table shows the percent changes of stock market returns for Global, European, Japanese and Emerging Markets, over weekly, year-to-date and 12 month periods.

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Date	Time	Event	Period	Surv(M)	Prior
9/14	6:00	NFIB Small Business Optimism	Aug	99.0	99.7
9/14	8:30	CPI YoY	Aug	5.3%	5.4%
9/14		CPI Ex Food and Energy YoYyear over year	Aug	4.2%	4.3%
9/15	9:15	Industrial Production MoMmonth over month	Aug	0.5%	0.9%
9/16	8:30	Retail Sales Advance MoMmonth over month	Aug	-0.8%	-1.1%
9/16		Inital Jobless Claims	9/11/2021	323k	310k
9/17	10:00	U. of Mich. University of Michigan Sentiment	Sep P	72.0	70.3

This table lists a number of key economic events, analysis reports and forecasts from influential institutions. Inflation data will be watched closely.