Biden’s corporate tax hike: What will it mean for the Dow?


I’m reluctant to write much about politics—partly because this is a retirement column, and partly because everyone seems to have gone insane on the subject. 

But we are within a month of an election. The polls are pointing toward a Democratic sweep (more on that in a moment). If that happens, what would that mean for your 401(k), if anything?

Some really sensible research on this subject has just come out from investment bank SG, aka Société Générale.

In a nutshell: Joe Biden’s plan to raise corporate taxes should logically knock about 3 ½% off the value of the S&P 500
SPX,
+0.94%,
they estimate. That’s equivalent to about 1,000 points off the Dow Jones Industrial Average
DJIA,
+0.59%,
currently trading at around 28,600. On the one hand, that’s a loss. On the other hand, it’s about a third of one year’s return.

In the current febrile environment both sides can probably quote this to their opponents’ disadvantage, which is what makes it so interesting (to me, anyway).

Strategist Sophie Huynh walks us through the numbers. Donald Trump’s 2017 tax law cut the headline corporate tax rate from 35% to 21%. Joe Biden is planning to raise it back up to 28% (along with a few other technical things).

But what really matters isn’t so much the headline rate as the actual rate that companies are paying, Huynh argues.

Before the Trump tax cut, S&P 500 companies were paying on average 26% in taxes, she calculates. Trump’s tax cut lowered that to 18%. Biden’s tax hike would bump that back up, but only to around 21%. In other words, he’d restore just under half the actual tax cut.

Should that give stockholders “goosebumps,” she asks?

Well, it would probably lead to a drop in S&P 500 after-tax income of about 4.3%, she calculates. Factoring in growth that would reduce SG’s estimated “fair value” of the S&P 500 by around 3.6%, she says.

When Trump cut taxes in late 2017, she adds, after-tax earnings per share jumped about 8% and the S&P about 9%.

There are, to be sure, some caveats. Huynh points out that real-estate investment trusts have special tax status, so she’s excluded them. Energy companies aren’t paying much tax because they’re losing money hand over fist. Regulators make utilities pass on any tax changes to consumers—maybe not good for your electricity bill if taxes go up, but making the changes largely irrelevant to your utility stocks. And SG, as is common among strategists, excludes financials like the big banks because they are completely different from everything else. (For example, what happens to the yield curve will affect their net income next year a lot more than what happens to marginal corporate tax rates.)

And of course, it’s only a forecast.  

On the other hand, this simple analysis is surely useful to all of us who are long-term investors, with stocks in our 401(k)s, IRAs and so on. A Democratic sweep, if it raised corporate taxes in line with proposals, would cut corporate net earnings and hence, logically, the fair value of stocks. So on the one hand, yes, we should expect an impact: There are no free lunches. On the other hand, we shouldn’t expect the impact to be cataclysmic. Talk of the stock market collapsing (or booming) as a result of a Democratic victory should probably be taken with a grain of salt.

And, despite the public mistrust of the media, I’m not making a partisan point. On the one hand, I’ve written tons of stuff critical of Trump in the past. On the other hand, as far back as 2018 and last year I was more than happy to point out how well the stock market was doing under Trump. I am very critical of media outlets that only report on the “Trump stock market” when it’s doing badly. They do nothing to enhance their own credibility.

The SPDR
SPY,
+0.91%,
which tracks the S&P 500 index, has risen 75% since Trump was elected. The Invesco S&P 500 Equal Weight ETF
RSP,
+0.40%,
which tracks all members of the S&P 500 equally, is up 49%. The small cap S&P 600 index
SML,
+0.40%
is up 34%. These are all good numbers. The stock market did well under Barack Obama and it’s done well under Donald Trump. It is depressing how many people can accept one part of that sentence but not both.

Incidentally, shortly before the election in 2016, I warned that a Trump victory might cause some immediate shock turmoil, as Brexit did to the London stock market. In this I turned out to be (almost) completely wrong. The Dow Jones Industrial Average futures fell about 5% on election night, but that had reversed itself by the morning. So, enjoy a good laugh at my expense.

This shows, among other things, the foolishness of trying to anticipate short term stock market moves.

Long term, the S&P 500 has generated returns of just under 10% a year, so a 3.6% drop would be the equivalent of a third of a year’s average gains. In no rational world would I consider selling stocks in my portfolio because I thought the market might drop 3-4% next month.

There are, of course, other issues at play, including the possible effects on sentiment, interest rates, trade policy, regulations, and so on. But the actual corporate tax proposals probably aren’t huge for long-term investors.

How likely is this anyway? Lots of polls are saying we’re looking at a Biden win and a Democratic sweep. Maybe they’re right. But I’ve learned to mistrust polls. I was in the U.K. during the Brexit referendum in 2016, and the polls showed Brexit losing pretty consistently beforehand. Turns out, lots of people were just lying to the pollsters. Brexit was seen as so socially unacceptable that they wouldn’t admit they supported it, even over the phone to a stranger. A month before the referendum, one poll showed Brexit losing by 20 points. A poll the day before the referendum showed it losing by 10 points. And on the day of the vote, 70% of Brits thought Brexit would lose. Instead, Brexit won the vote by 4 points.

Another reason to ignore predictions about what the presidential election result will be, let alone what that will mean to your 401(k).



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