Notes on the week aheadContributor Dr. David Kelly
Federal Credit Card Day
For most of the United States, April 15th is the day when annual tax returns are due and every year, at around this time, the Tax Foundation announces “Tax Freedom Day”. The idea behind Tax Freedom Day is to recognize that every year a sizable chunk of Americans’ income goes to pay federal, state and local taxes. In 2019, the Tax Foundation estimates that this comes to 29% of national income, so that metaphorically, all the income earned by Americans until April 16th goes to pay taxes while they only get to keep income earned from April 17th onwards.
In the year 1900, Tax Freedom Day occurred on January 22nd. Since then, the growth of government activities has pushed the date later and later. In 2000, the date hit its latest ever at May 1st but has since drifted earlier and, with the passage of the 2017 Tax Act has drifted further back from April 21st in 2017 to April 16th in 2019.
This calculation serves as a useful reminder about the importance of spending public money wisely. Every dollar taxed is a dollar that an individual or company could have spent themselves. Voters should constantly ask whether the country is better off when the government taxes and spends that dollar.
However, with all the focus on taxes this week, it is worth considering a different day which could perhaps be called, “Federal Credit Card Day”. Federal Credit Card Day is the day in the year beyond which all federal government spending is borrowed, that is to say, put on the “national credit card”.
Of course, economic conditions can shift the timing of Federal Credit Card Day. In 2000, at a peak in the business cycle, the federal government ran a budget surplus and there was no net federal borrowing. Conversely, in the height of the great recession, Federal Credit Card Day drifted back into August, with revenues covering only about 60% of federal spending.
In 2015, federal revenues funded just over 87% of federal spending, placing the date at November 14th. Since then, despite a strengthening economy, Federal Credit Card Day has drifted earlier in the year. Last year it was October 16th. This year, with federal revenues expected to cover just 77% of spending, it is estimated to fall on October 8th.
The most troubling aspects of this are timing and attitudes. In 2019, the U.S. economy is close to a 50-year low on unemployment. If this is not a cyclical peak, it is at least a cyclical plateau. If, even at the best of times, we are barely covering three-quarters of our spending, how will we fare in times of adversity? Equally seriously, the public seems not to care about deficits, allowing politicians of the right and left to promise lower taxes and higher spending, while barely paying lip service to the issue of how to cover the cost of their plans.
Something to think about in the week ahead, as investors consider how much higher stocks can go, given that the S&P500 has already risen 16% so far this year and is now trading at a forward P/E of 16.8 times.
Economic data due out this week should be relatively reassuring, with gains expected in both Regional Manufacturing Surveys for April and Industrial Production for March. In addition, steady International Trade data for February, along with gains in both Retail Sales and Housing Starts for March, should support other recent evidence that the economy maintained a roughly 2% growth pace in the first quarter.
Earnings data could also be soothing, with 49 S&P500 companies due to report. While analysts expected a decline in year-over-year operating earnings per share at the start of the quarter, companies reporting so far have exceeded expectations at a better pace that usual, holding out hope of a small gain in first-quarter earnings, followed by something slightly better later in the year.
Of course, the expectation of small single-digit gains in real output and earnings hardly seems to justify either the overall level of equity valuations or the pace of stock market gains so far in 2019. However, as has been the case for most of this long bull market, the counter-argument is “what else are you going to do with your money?”
As of Friday, the yield on a 3-month T-bill was 2.44% and the yield on a 10-year Treasury bond was 2.56%. With core CPI inflation running at 2.04% year-over-year in March, the real yield on Treasury securities is far below historical averages. In addition, the earnings yield on stocks remains well above the yield on Baa corporate bonds, making stocks look attractive relative to corporate debt.
Still for investors, this is a time for caution rather than euphoria.
Some worry that with rising government debt, a day of reckoning, in the biblical sense, is at hand. This is probably too alarmist, as there is little sign yet that the world’s lenders are getting tired of U.S. Treasuries. However, for investors, it is important to recognize that unconstrained deficits could eventually boost interest rates, inflation and taxes while undermining investor confidence.
This suggests a long-term need for greater awareness of the tax-efficiency of investment strategies as well as a focus on real assets, international investments and more defensive U.S. equities as the dangers of a credit-card fiscal policy continue to grow.