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The ‘Engineered’ Recovery Will Crash This Part Of The Stock Market

Things are looking up.

History’s largest vaccination program is picking up steam. The economy is getting back on its feet. And it looks like the record stock market rally still has legs.

In his latest memo, one of my most admired investors and Warren Buffet’s “crush,” Howard Marks, wrote:

“Over the course of my career, there have been a handful of times when I felt the logic for calling a top (or bottom) was compelling and the probability of success was high. This isn’t one of them. There’s increasing mention of a possible bubble based on concerns about valuations, federal government spending, inflation and interest rates, but I see too many positives for the answer to be black-or-white.”

That’s a happy thought. But here’s the catch.

The economy didn’t come back to life on its own. The Fed printed trillions of dollars to defibrillate it. The stock market didn’t hit record highs all by itself either. The Fed used zero rates and “assurances” to make stocks more attractive at the expense of safer bonds (I wrote about it earlier here).

This “engineered” recovery will have a price to pay. And in a moment, I’ll tell you about the unlucky part of the stock market (which includes big names like Apple
AAPL
and Starbucks
SBUX
) that’s likely to pay the highest toll.

But first, let’s talk about where it all might begin.

Stashes of greenbacks on the sidelines

If Covid is reined in by the summer as expected, there’s a good chance a giant wave of greenbacks will wash through the economy this year.

During Covid, Uncle Sam has printed over $5 trillion. But as we discussed before, a lot of that money hasn’t yet made it into the economy. People stashed away a good chunk of their checks in savings accounts. Meanwhile, companies shored up their balance sheets with billions in cash.

The end result is that a record pile of money is now sitting on the sidelines, as you can see here:

Now, there’s an expectation that part of this cash pile will rain down on the economy once Covid is over.

In other words, people will get back on planes and go places. They’ll buy nice stuff and indulge in other normal life pleasures. Companies will rush to put their cash to use, too. They’ll reinvest it or pay it out to shareholders in the form of dividends and buybacks.

And it’s not just the private sector that’s thinking about loosening its belt.

As we discussed last week, Biden is drafting a historical infrastructure bill to rebuild “crumbled” America. His plan is to spend $2.25 trillion. Even if he only passes half of it, it will be America’s most expensive buildout since the New Deal.

The prospect of such relentless spending bodes well for companies’ earnings, but it would likely come at a cost.

The cost of spending trillions of “printed” greenbacks

Such a spending spree would bring two side effects.

First, the “printed” dollars would finally reach the economy, which in theory would lead to inflation. Inflation (or inflation expectations), in turn, would push interest rates up. And higher rates would make stocks less attractive (broader explanation here).

Second, Uncle Sam already runs a huge budget deficit. That means it spends more money than it earns. And that gap is the largest in history. To avoid digging himself into a deeper hole, Biden is proposing to fund his grand plan by ramping up taxes for big corp.

In short, his tax reform suggests three sweeping changes:

  • Higher corporate tax rate—raise the corporate tax rate from 21% to 28%
  •  Minimum global tax—impose the global minimum tax on big tech and other multinational companies to end offshoring
  • Minimum book income tax—impose a 15% minimum tax on the income of public companies so they can’t exploit loopholes (for example, despite making gazillions of dollars, Amazon
    AMZN
    paid 0$ in federal taxes in 2017 and 2018)

So while this spending spree would be great for stocks, they would likely pay for it with higher taxes and higher interest rates. And some companies will suck up a much higher toll than the others.

The dangerous intersection in the stock market

To pin down the most ill-fated stocks here, let’s doodle a quick Venn diagram.

The diagram is made of three circles that represent three groups of stocks:

  1. those that would suffer most from higher interest rates
  2. those that are targeted by Biden’s tax reform
  3. those that would benefit little from government spending and reopenings.

And at the intersection, you have the unfortunate ones that are down on their luck on all the above. Here’s what that looks like:

The typical stock that would make the intersection has three distinct traits:

To give you some examples…

Based on their quant models, UBS’s team of equity analysts made a list of S&P 500 stocks that share all those traits. This flock includes big tech names like America’s gaming giant Activision Blizzard
ATVI
, Apple (AAPL), and Facebook (FB)—as well as multinational chains like Starbucks (SBUX) and Chipotle (CMG).

So unless you have a good reason, stay away from stocks you think could end up on the “intersection” for now. If Covid blows over as expected and Biden passes his spending whims, there’s a good chance these stocks will bleed.

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