ECONOMIC COMMENTARY

CIO Update: Mid-year outlook Washington policy, cyclical stocks and the battle for economic growth

A part of the Q3 2021 Market & Economic Insights series

Will the current economic rebound last? SVB Private Chef Investment Officer Shannon Saccocia shares her take on U.S.-China relations, domestic infrastructure spend and the other critical issues impacting the global economy. Listen now.


Audio transcription

Hello, and welcome to "Boston Private Perspectives." I'm Shannon Saccocia, chief investment officer of Boston Private. And I want to thank you for joining me today. As I was preparing my mid-year outlook, I was struck by the fact that we spend much less time today than we did even six months ago talking about Washington policy, when, in fact, it's as important as ever, particularly as it relates to CEO sentiment in the U.S. stock market.

At the beginning of the year in our 2021 outlook, I discussed the potential for changes in foreign policy to be a catalyst for growth this year in the global economy. One of the things that I was most interested in at the time, was how President Biden's approach to China would change compared with President Trump and his administration. And interestingly, we found it to be very similar, if not in some ways, slightly tougher on China over the course of the last six months.

A collaborative trade policy

One of the things to note is that the challenge with the Trump administration's dealings with China were that they were done in a way that was much different from his predecessors. Not only did the Trump administration focus on an America-first policy, which was quite different than the hands-off policy that the Obama administration had pursued. The fight for trade supremacy between China and the U.S. was played out amongst Twitter followers. And one of the things that was also challenging with the way that President Trump tried to tackle the inequality between the U.S. and China from a trade perspective, because it certainly exists, is that he didn't choose the route of working collaboratively with traditional American allies in order to bolster his case. And that's where we see the biggest change between the Trump administration and the Biden administration, as it relates to the treatment of China.

President Biden has made a very tactical decision, in our view, to attempt to strengthen the ties with other members of the G7. And focus instead of on specific trade issues, which obviously vary from country to country, from region to region, but instead focus his emphasis on human rights in order to create a unified front against China, which hopefully will result in more equality from a trade perspective. It's very early on in the process for President Biden, and we can't speak to the success or failure of this particular approach, but what is clear is that all of the tariffs that were in place at the end of the Trump administration are still in place today. And the rhetoric from President Biden has really not changed all that much in terms of thinking about protecting American workers, and the competitiveness of American companies that are operating within China.

And so, you know, our view is that the approach to China has not changed from an overall stance perspective. But the way that we're approaching improving the trade relationship with China over the long term has certainly changed a bit. We do expect this to start to accelerate over the course of the next couple of months. Clearly, the administration has been focused on the pandemic, and the economic recovery coming out of the pandemic, and really getting, you know, things like cabinet seats and whatnot situated over the course of the last six months or so. So we are hearing from Washington that some of the discussions, it'd be probably a bit too early to call them negotiations, with China have started once again, and that the focus right now is on where we sit with the original phase 1 trade deal signed in January of 2020. Is that agreement being upheld at this point? And how will we move forward from that trade deal? Which was expected to be, frankly, a start for more in depth and sweeping negotiations between the U.S. and China.

So with that as the backdrop, President Biden is also talking with the UK, and the European Union, and Japan about re-strengthening ties that were fairly strong prior to the Trump administration. And again, this is, you know, not only going to yield greater cooperation from a trade perspective, but also provide that support, if you will, for the conversations with China. What was even more clear at the beginning of the year, to us anyway, apart from the importance of trade policy over the course of the first couple of years of the Biden term, was that a democratic sweep in Washington would yield more spending. And much of the emphasis was on this idea of a sweeping infrastructure package.

Redefining infrastructure expenses

And so while we have been surprised at the Biden approach to China, we've also been surprised at where this path of infrastructure spending has led over the course of the last couple of months. So if you had asked me at the beginning of the year what was the likelihood of higher taxes and this large-scale infrastructure spending kind of moving through Washington and coming out the other side, I would have felt fairly confident that we would have both a fairly significant infrastructure spending package with infrastructure in quotes, and I'll talk a little bit about why I say that in a second, but also that we would see higher taxes both for individuals and for corporations coming out of that package in order to fund this significant increase in spending.

What's happened over the last couple of months is that we've seen a meaningful amount of pushback, clearly from the Republicans who had always stated that they would be opposed to a very significant spending package, you know, upwards of $3 trillion or so, but also several Democrats who are concerned on the back of what was a, you know, an unprecedented spend last year in combat in the pandemic. And, you know, I think one would argue that certainly was justified in many ways as far as from a fiscal response. But given that large amount of spending that is still going on, there's a trail of spending that's going to persist, likely through the end of this year, related to pandemic rescue plans, that they feel uncomfortable with the size of the infrastructure spend, and perhaps, from both the Republicans and some Democrats with the scope of that plan.

So we knew that there would be a difference between what the Republicans would support as true infrastructure, and that is the more traditional form of infrastructure: roads, bridges, airports. Both parties seem fairly aligned on the facts that infrastructure needs to include both that traditional infrastructure but also digital infrastructure in terms of developing better connectivity for rural areas, the expansion of the cell phone tower network, etc. But I think that where we're seeing the pushback is in grouping what feel like larger sweeping social programs into infrastructure spend. So childcare, education, those are...you know, have some roots in infrastructure, if you think about the ability to create facilities, the ability to allow for faster licensing and per missioning at the federal, state, and municipal level, to create those facilities. There is an infrastructure component to it, but certainly, you know, there is a bit of pushback. But that's not really infrastructure spend, and perhaps we don't have the capacity from a budget perspective to take on those types of programs this year.

The argument against that is that, you know, there are some grayer areas, health care, for instance, similar to the point that I made about, you know, cellular infrastructure and the ability to, you know, reach across what has been a fairly wide digital divide between urban and rural inhabitants here in the United States. You know, there are some...many actually who feel that the pandemic really highlighted and spotlighted the need for more health care access in rural areas, in underdeveloped areas. And so, you know, there is that aspect of it that may actually make it to a final bill.

And so what's happened is over the last six weeks or so, is we've started to see some Democrats and some Republicans come together with a compromise. And the compromise versions of these plans really do focus on what has been kind of traditional infrastructure. And the President has said that, you know, he would like to see these plans in tandem, a more traditional infrastructure package that would support what, I think, most Americans would feel as a necessary spend by the federal government at this point, given the state of our infrastructure, the idea being to continue to improve and repair our existing infrastructure, but enhance it with, you know, high-speed rail, public transportation improvements, and the cellular infrastructure spend.

And then follow that up with a broader sweeping plan that includes health care, and childcare, education, and probably most importantly to certain members of the Democratic Party, climate change. And so the challenge with that is that this compromise deal is coming across without any new taxes. So no increase in the corporate tax rate, which was widely expected to go back up to 28% from the 21% it was moved down to in the 2017 tax cuts and JOBS Act. But also no increases or changes in individual tax rates, including the capital gains tax rate, the estate tax exclusion, excuse me, and, you know, the highest income rate, as well as the step up in basis for securities held within an estate. So that in and of itself presents a problem because it limits the size and scope of the package with no tax increases being included.

And so, one of the things that we've seen is that, number one, this blue wave in Washington hasn't exactly translated to swift and mighty changes in spending. But it perhaps has shifted the agenda, at least, towards some of the social programs that the President ran on from a platform perspective. And I think that from a legacy perspective, President Biden understands that this is really kind of a two-year opportunity, the midterm elections are still very much unknown. And so, you know, over the course of this next six months or so, it's going to be critical for him to at least move the ball down the field on several of these key issues.

The other question that I get is, you know, given that, given the size of this infrastructure package, we talked about could be 3 trillion and is now 950 million...or billion, excuse me, or whatever it's being discussed as, what's the impact on some of these more cyclical parts of the market? We certainly have seen, in the course of the last six months, that the strong run up in prices in the most cyclical parts of the market. And so I've been asked if that is because of these infrastructure packages. Admittedly, there are some pockets, areas like solar, for instance, that have experienced maybe a bit of a stronger lift from infrastructure expectation. But it's worth noting that overall, cyclical names have been boosted by expectations for accelerating economic growth.

COVID variant impacts

And so if you're still in the camp, as we are, despite some meaningful concerns around the Delta variant, the slowing pace of vaccinations and the now increasing number of cases here in the United States and globally as the Delta variant and likely the next more infectious variant take hold, the overall view that the economy globally is going to continue to accelerate, we believe strongly in. And so, if you take that as the backdrop and you expect there to continue to be economic growth that's as robust as could be expected coming out of a pandemic, and even if we see some near-term softness or concern this fall with the Delta variant, there does need to be just this overall push higher in cyclicals.

Cyclical stock behavior

Now, whether that has run its course or not, you know, that's an entirely different question. And there is certainly some evidence that in areas like energy, for instance, with OPEC+ determining that they're going to increase supply, and some of these supply chain constraints that have been creating some artificially high prices for inputs such as lumber easing, we could go back to a more normalized expectation for cyclical stocks. But in my mind, it would not be because the infrastructure package is going to be smaller. Again, there are some pockets that have perhaps experienced stronger gains due to that infrastructure package that could be more vulnerable, if it turns out to be much smaller than anticipated. But overall, the trend in cyclicals, in areas like materials, and energy, and industrials has been driven more by these expectations for stronger growth than from anything from Washington.

What comes next

So where does that leave us? You know, with or without tweets, Washington remains and a very important variable as we look out over the next year. And we're going to continue to provide content and context on what's happening inside the beltway, both from a trade perspective, as well as from an infrastructure spending perspective, and honestly, from a COVID-19 response perspective, because right now, you know, there's a lot of conflicting information. Government agencies aren't exactly all on the same page. And it's going to be very important for the administration to handle this next surge, and the concerns around the Delta variant with care in order to create comfort that this economic rebound can be sustained.

Thanks again for listening to this week's podcast. I want to encourage all of you to reach out to our team here at Boston Private with any questions or concerns you may have. If you have any questions on my points today, you can find me on Twitter @ShannonSaccocia. You can also read our latest perspectives on the market, the economy, financial planning, and what's happening in Washington by visiting www.svb.com/private-bank. If you want all of this information delivered right to your inbox, I encourage you to sign up for our newsletters while you're there. And be sure to subscribe to the "Boston Private Perspectives" on Apple Podcasts, or Spotify, or wherever you prefer to listen, and I look forward to coming to you again very soon.

Shannon Saccocia serves as Chief Investment Officer at SVB Private, and is responsible for setting the overall investment strategy for the firm. She oversees the asset allocation, research, portfolio management, external manager search and selection, portfolio implementation, trading, and investment risk management functions.

The views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of SVB Private or other members of Silicon Valley Bank and SVB Financial Group. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein