Monday Morning Quarterback (01/11/2021)

January 11, 2021

Biden’s Tax Proposals and 1031 Exchange in Jeopardy

With Democrats taking control of the executive and legislative branches, there is an increased likelihood that Biden’s tax proposals will become law. According to the Committee for a Responsible Federal Budget, his tax plan could collect $3.35-$3.67 trillion in the next ten years, equal to ~1.3% of GDP. Unfortunately, this plan could include the elimination of several real estate tax breaks, including: (1) the $25,000 exemption from passive, rental real estate losses realized by middle-income Americans, (2) expedited depreciation of write-offs for certain asset classes, and (3) qualified business income deductions for rental real estate activities turning a profit. Additionally, the 1031 exchange could be eliminated for investors with annual incomes above $400,000. The popular tax benefit has been around for 100 years, and cutting the program could impede deal flow and negatively impact real estate prices. Finally, Biden has pledged to overhaul the Opportunity Zone program. The change could include reforming the law to prevent projects such as self-storage and luxury residential developments.

Expansion in Manufacturing & Services:

On Tuesday, the Institute for Supply Management (ISM) reported that their national factory activity index expanded last month to 60.7, the highest level since August 2018. With the pandemic’s continued influence, demand for goods increased and pulled away from the demand for services. Despite a 57.2 reading on the ISM’s index of activity in the service sector, the improvement reflected COVID-related supply shortages, as the survey’s measure of supplier deliveries increased to 62.8. However, most indicative of economic health was the employment index, which dropped to 48.2 from 51.5 in November. A reading below 50 indicates contraction, which was reflected in last month’s jobs’ report.

December Job Losses Surprise Economists

For the first time since April 2020, the U.S. lost jobs, reflecting the effect of growing coronavirus infections. With some states instituting business restrictions and curfews, employment at restaurants and bars plunged. Consensus estimates projected an addition of 50,000 to 100,000 jobs; however, nonfarm payrolls dropped by 140,000, keeping the unemployment rate at 6.7% (0% m/m). While hospitality jobs declined by nearly half a million, there was promising growth in retail trade (+120,500) and business services (+161,000), illustrating the economy’s resiliency outside of the leisure and hospitality industry. Furthermore, the amount of unemployed Americans reporting permanent job loss fell to 3.37 million, a four-month low. Last year, a total of 9.37 million jobs disappeared, making last year’s loss the largest recorded since 1939.

Chart of Job Losses

December 15-16 FOMC Minutes:

Perhaps the least surprising news last week was the minutes from the December 15-16 FOMC meetings. The transcript showed that officials determined to maintain asset purchases at the current pace of $120 billion a month. Many participants said that once substantial economic progress is realized, the Fed could gradually taper.

Pandemic Update

Both coronavirus related casualties and cases again set daily and weekly records last week. On Thursday, over 4,000 COVID-infected Americans died, resulting in a weekly high of 21,900 deaths. On Friday, U.S. pandemic cases skyrocketed above 300,000 for the first time, pushing the number of new weekly cases to 1.7 million. As of January 10, the pandemic has claimed more than 373,000 American lives and infected nearly 7% of the U.S. population at least once.

Chart of New Coronavirus Cases Reported per Day

Chart of New Reported Coronavirus Deaths per Day

Democrats Take the Senate

Last week, Georgia Democrats Raphael Warnock and Jon Ossof won their Senate races, shifting the U.S. Senate’s control to Democrats, enabling President-elect Joe Biden’s legislative agenda to pass through Congress with little opposition. This agenda could include another $1 trillion in fiscal stimulus, $2,000 in direct payments to citizens, and a $1.5 trillion infrastructure investment. According to the Army Corp of Engineers, the U.S. needs to invest over $4.5 trillion to update infrastructure. Following the Senate victories, Goldman Sachs economists raised their 2021 growth forecast for the U.S. to 6.4% from 5.9%. Consensus has stood at 3.9%, making Goldman the most bullish bank on Wall Street.

What To Expect This Week

This week, the Bureau of Labor Statistics will release December’s Consumer Price Index (CPI) and retail sales. The CPI should reflect last month’s elevated gasoline prices. However, core inflation should stay relatively low. According to Raymond James’ Chief Economist Scott Brown, retail sales are likely to show weakness in holiday spending.