Investors in US stocks are trying to gauge the strength of a “storm” on the horizon as President Joe Biden pushes for tax hikes that would in part undo a historic windfall distributed to US companies by his predecessor.
Stocks this week has sailed to new heights as fund managers ignore risks ranging from rising borrowing costs to high valuations and a new wave of coronavirus sweeping across parts of America and other major global economies.
But Biden’s proposal to raise the corporate tax rate from 21% to 28% and enact a global minimum tax poses a new threat that some analysts say could derail the steady rise in U.S. stocks.
“Everyone’s sort of at a picnic right now and you can see the potential for a storm to come,” said Ann Miletti, head of active equities at Wells Fargo Asset Management. “But you’re trying to time the direction of the storm and whether or not it’s going to hit you in 2021 or 2022, or if you might miss each other all together.”
Tobias Levkovich, chief US equity strategist at Citigroup, added that “the investment community is too optimistic” and shows “no concern about plausible tax increases proposed by the Biden administration.”
The Trump administration’s tax cuts, passed by Congress in the decreasing days 2017, gave a significant boost to business results by reducing the statutory federal tax rate by 35%.
The tax rate paid by medium-sized U.S. businesses, which includes federal, state and local levies, fell to 27% in 2018 and has remained at that level since then, from 40% previously, according to KPMG accounting.
Titanic American companies, which are included in the S&P 500 index of large-cap stocks, pay even less tax on average, as many have sprawling international operations that allow them to take advantage of more favorable tax regimes abroad. .
The S&P 500 tax rate stood at 17.5% in the third quarter of 2020, while that of the tech sector, which has a particularly amorphous tax base due to its relatively small physical operations, was not than 14.8%, according to Howard Silverblatt at S&P Dow Jones Indices.
Tax cuts adopted in 2017 boosted earnings per share of S&P 500 companies by 10 percent the following year, according to Goldman Sachs’ June 2020 analysis. “Since 1990, the decline in effective tax rates has accounted for 2 percentage points of the 4 percentage point increase in net profit margins and 24% in total profit growth of the S&P 500,” noted the new bank. -Yorkese at the time.
Now, investment banks offer their clients a wealth of research on the potential implications of a new tax regime.
Goldman believes that if Biden’s tax plan is passed in its current form, he could shave up 9 percent of S&P 500 earnings per share next year. A corporate tax rate hike of just 4 percentage points – up from the 7 points proposed by Biden – could push the S&P 500 EPS down 3% from what analysts have already predicted for the index this year, Citi’s Levkovich said.
“We see rising taxes as one of the biggest risks hanging over the second half of the year and into 2022,” said Emily Roland, co-chief investment strategist at John Hancock Investment Management .
She added that the impact could be large enough to curb the companies’ rehire plans. “The risk is that as tax rates go up, companies don’t fully re-engage based on the impact on margins,” she said.
So far, any effect on stock prices has been muted, with the S&P 500 hitting several record highs in the last week alone. Analysts say this is because Wall Street is in a wait-and-see mode on the size of the rise that Biden can ultimately overcome with an extremely slim Senate majority.
Senate Democrat Joe Manchin has already rejected a 28% corporate tax rate, calling instead for a 25% cap.
Despite these potential headwinds, the strength of the economic rebound, coupled with the huge fiscal and monetary support provided by policymakers, has silenced any alarm bells about the stock market record. S&P 500 company profits for the first quarter, which will begin to be reported in the coming weeks, are expected to have climbed nearly a quarter from the same period last year, according to FactSet data.
This has spawned a complacency that Andrew Slimmon, senior portfolio manager at Morgan Stanley Investment Management said, could potentially prove dangerous.
Expected volatility in US stocks – as measured by the Vix Index – has fallen sharply, with Wall Street’s fear gauge now sitting below its long-term average of 20. Amid the market turmoil induced by the coronavirus last March, it reached such a high peak. like 85.
“When the green light is flashing it’s all clear to invest and when unexpected bad news comes up the market can’t resist it,” Slimmon said. “The biggest risk is that investors seem to think the coast is clear.”