Fiscal glad tidings from Congress - Wells Fargo Investment Institute

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Fiscal glad tidings from Congress

Wells Fargo Investment Institute - December 21, 2020

by Gary Schlossberg, Global Strategist

Key takeaways

  • Congress reached agreement Sunday night on a $900 billion pandemic relief bill aimed at containing slowing economic growth this winter and supporting a solid, vaccine-related growth recovery by spring of 2021.
  • Households are set to receive the lion’s share of fresh government aid in the form of direct income payments and enhanced unemployment insurance, and indirectly, through another paycheck protection program for small businesses.

What it may mean for investors

  • We continue to favor the high-quality equity themes for 2021 that we preferred through much of 2020. However, we expect stronger economic growth by spring and, if that scenario develops, we could begin to see opportunities to favor high-quality but more growth-oriented international and U.S. equity sectors. In addition, we expect the Federal Reserve’s cautious stance on the economy to continue, keeping yields low by historical standards and favoring high-yield and preferred securities.

A $900 billion pandemic-relief bill set for congressional approval Monday will deliver much-needed support to hard-pressed individuals along with frontline small businesses, the health care sector, and the transportation industry. Negotiations on final details pushed through the weekend, forcing a short-term funding extension to keep the government operating. In tandem with the relief bill, Congress will vote on $1.4 trillion legislation to fund the government through next September.

The last hurdle to reaching an agreement was cleared with a compromise on the Federal Reserve’s (Fed’s) emergency lending facilities. The agreement reportedly prevents resurrection of credit windows established earlier in 2020 but leaves the door open to establish new facilities in the future — effectively leaving the Fed’s operating leeway intact. 

Stocks, moving with the ebb and flow of talks on pandemic relief last week, opened down Monday with news of new COVID strains in the U.K. and fear of more lockdowns in Europe.

In reaching a compromise, both sides recognized the political risks of a breakdown in talks just ahead of crucial Georgia runoff elections to determine party control of the Senate. More importantly, many feared that a new round of lockdowns and business restrictions, and the looming year-end expiration of income and rental support programs, could intensify what economists expect to be a first-quarter 2021 growth slowdown. The Georgia runoffs determining party control of the Senate also will go a long way toward determining whether a follow-up relief bill from the government will further lessen that threat.

Major provisions of the agreement

Months of negotiations have altered the size and composition of this bill’s latest round of fiscal support. A $908 billion bipartisan proposal successfully closed the gap between the Democrats’ original $2.4 trillion package and the Republicans’ $500 billion counter offer. The target was lowered to $748 billion by the decision to defer debate on contentious issues of business liability for COVID-related lawsuits and $160 billion in direct financial assistance to state and local governments, and it climbed to $900 billion on the last-minute entry of $150 billion in fresh refund checks to individuals.

The heart of the $900 billion package includes the following, all set to expire at the end of the first quarter of 2021:

1. Direct income payments of $600 per individual, costing $166 billion. 

2. A $130 billion tab for an added $300 in weekly supplemental unemployment insurance payments, in addition to extension of the standard 13 weeks of benefits and expiring programs for contractors and for the long-term unemployed. 

3. Another $284 billion in funding for the small-business Paycheck Protection Program (or PPP). 

4. A $45 billion transportation funding package including a reported $16 billion in airline assistance. 

5. About $63 billion in funding for health-care providers, including $32 billion for vaccine development and distribution, and another $22 billion for testing and tracing.

Other key features of the relief bill include a further extension of the Centers for Disease Control eviction moratorium until January 31, 2021 and $25 billion in rental assistance to state and local governments and Native American tribes. Also included is $82 billion in funding for colleges and schools, according to news reports. 

Consumer spending support

The relief bill is consumer-oriented, directly and through the payroll protection feature of small-business assistance. Extended and enhanced jobless benefits mean that initial claims likely won’t run off as quickly as they would otherwise. However, that and other direct financial support in the bill will support consumer spending. Overall, we view government support in a broader context, as mitigating a growth slowdown that economists warned would have deepened in the early months of 2021 absent that relief. 

Underscoring that economic slowdown has been accumulating evidence heading into the critical holiday shopping season. October-November retail sales posted their first back-to-back decline since early in the pandemic during March and April. And weekly initial weekly jobless claims were up a second straight week in the period to December 12, signaling further slowing of the labor market recovery this month. 

Fortunately, housing and manufacturing activity remain solid, and our base case is that the economy will reaccelerate after the period of slow winter consumer spending. Our outlook calls for 3.8% gross domestic product (GDP) growth in 2021, the fastest since the 1990s. 

We view the economy as unlikely to tip into a new recession, and the bill now in Congress should add support during a difficult winter season. The bill is targeted to just that relief in setting a March 31 end to most provisions. The main risk to our view is that a much worse slowdown than we expect could delay the reacceleration of the economy, but we believe that strength in housing and manufacturing are sufficient to carry the economy through the rough patch.

Implications for investors

For 2021, we continue to favor the higher-quality theme that we maintained for most of 2020. The tilt toward high quality — as represented by companies with stable profitability and low financial leverage — is expressed by our preference for U.S. equities over international equities and U.S. large and mid-cap stocks over U.S. small-cap stocks. We also see high-quality characteristics in the Communication Services, Consumer Discretionary, Health Care, and Information Technology sectors, which we favor.

First-quarter economic growth is likely to be slow, even if the president signs into law the support measures mentioned above. Looking beyond the near-term weakness, the economic and earnings recovery should strengthen in 2021. As the year develops, opportunities may arise in some traditional cyclical sectors, especially those with higher-quality characteristics. We remain favorable on the Consumer Discretionary sector, which is full of industries that likely will benefit from an improving economy. We also upgraded Materials to favorable and Industrials to neutral, reflecting a weaker U.S. dollar, improving fundamentals, and the possibility of increased infrastructure spending.

As the economy improves, we expect modest gains in interest rates: Our 2021 targets for 10- and 30-year U.S. Treasuries are roughly a quarter of a percentage point higher than current yields. Fed policy makers at their final 2020 meeting agreed to maintain a proactive level of economic support. We expect that long-term rate increases above our targets will trigger additional Fed measures to lower rates again. Consequently, we favor yield-seeking strategies, such as preferred securities and corporate and municipal high-yield bonds – and prefer to use credit managers to navigate credit risks among these choices.

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