Investor enthusiasm is riding high following the recent rate cut from the U.S. Fed, but the cost of being too focused on the here and now means overlooking the risks ahead. Indeed, markets seem to be operating on a rather short memory, with the kick-off to the monetary-policy easing cycle quickly supplanting Kamala Harris’s post-debate rise in the polls the week prior as the prime market-moving event.
But with the 2024 U.S. election just a month away, the possibility of a Harris win carries with it the risk of market-unfriendly policies – none more important to the trajectory of stock prices perhaps than the proposed increase in the corporate tax rate to 28 per cent from the current 21 per cent.
To be clear, it needs to be stated upfront that the impacts and analysis I’m about to present are contingent upon a Democrat clean sweep in the election, with Ms. Harris’s party taking the House, Senate, and White House. If elected, her plan to increase corporate taxes would be dead on arrival in a split-Congress outcome on Nov. 5.
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Nonetheless, it always pays to be prepared for what risks are on the horizon. As it pertains to taxes, Ms. Harris’s proposed increases would reverse half of the Trump tax cuts that came out of the Tax Cuts and Jobs Act in 2017.
For context on how much of an impact these changes can have on the S&P 500, using annual data back to the 1930s we can gauge how sensitive the stock market can be to changes on this front. Broadly speaking, and confirming what one would intuitively expect, history shows us that raising corporate taxes tends to have a negative impact on U.S. equities.
The median change in the year that followed an increase in the corporate tax rate was minus-3.5 per cent. In years that saw taxes cut, the median change was plus-12.4 per cent, compared with plus-11.4 per cent when there was no change at all. If the latter is the benchmark, then history shows that stock prices are more sensitive to tax hikes than they are to cuts – underperforming by about 15 percentage points.
Should the election result in a Harris victory and Democratic control in both the House and Senate, and assuming a quick implementation of the proposed tax hike affecting full-year 2025 results, our work shows that a 28-per-cent rate would translate to a decline of 7 per cent in S&P 500 earnings a share (US$255 from US$276). We can also factor in the hit to investor sentiment, with news of an increase to tax rates historically resulting in a 1.1-percentage-point decline in the P/E multiple. Combined with the aforementioned impact to earnings per share, this would imply a 13-per-cent decline in the S&P 500 from current levels.
A quick note on sector details. Given that the Harris proposal is effectively a partial reversal of the Tax Cuts and Jobs Act, if we look at the current median effective tax rate compared with what it was prior to the passing of the act, it is safe to assume that a partial reversal would have a greater effect on the sectors that benefited the most. All else being equal, it means that communication services, technology, and utilities would suffer the greatest impact from a tax perspective. On the other hand, energy, materials, and health care would change the least.
Moreover, with just under half of S&P 500 revenues derived from abroad, Ms. Harris’s policy bias towards a weaker U.S. dollar will also exert a downward influence on the bottom line via a decline in revenue (assuming margins are steady.) Again, a quick look at the sector breakdown reveals the areas with the most foreign-revenue exposure, and thus most at risk, are tech (57 per cent derived abroad), materials (54 per cent), and communication services (48 per cent). Utilities (1 per cent), real estate (17 per cent), and financials (28 per cent), are more insulated from these risks, given their smaller share of international sales.
The aftermath of the Fed’s first rate cut since 2020 has investors laser-focused on the outlooks for monetary policy and its impact on overall market liquidity. Yet, markets have been quick to forget that in just a week prior to the Fed meeting, Ms. Harris – after a Democrat deficit in many polls – suddenly put her party back in the running. Should she emerge victorious in a Democrat sweep, the likelihood of market-unfriendly policies being enacted next year will rise – none more important, perhaps, to stock prices than a seven-percentage-point increase in corporate taxes.
Marius Jongstra is vice-president of market strategy with Rosenberg Research
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