Joe Biden has put American companies on notice: he's coming for their tax breaks, a promise with the potential to dent profits just when they're showing signs of revival. Wall Street firms have convinced themselves the position is more campaign slogan than policy pledge.
The Democratic presidential candidate will walk back Donald Trump's signature gift to the stock market, the Tax Cuts and Jobs Act of 2017, on "day one" of his administration, according to running mate Kamala Harris. A worst-case model developed by Goldman Sachs Group Inc. suggests doing so could cut S&P 500 earnings growth next year in half, to 12% from 23%.
A hit like that, in the middle of a pandemic, has the potential to rankle markets whose tolerance for stress is thin. Investors have spent 2020 writing off this year's results and hoping the next one will bring a rebound to make valuations more palatable. Anything that reduces the future crop complicates the calculus, threatening a support pillar for equities.
Dire as it sounds, securities firms from UBS Group AG to Goldman Sachs are telling clients the pledge is nothing to fret about. Bulls bent on finding the bright side of a Biden presidency tout a panoply of offsetting measures they say will cushion the hit to earnings, including federal stimulus. Many doubt a rollback is forthcoming at all.
"It's possible that if the economy is wobbly, they could defer that another year, or institute it only when the economy shows a certain degree of improvement," said David Donabedian, chief investment officer of CIBC Private Wealth Management. "The focus has been more on, shall we say, the candy as opposed to the vitamins or the spinach."
While potential tax hikes might theoretically pressure vulnerable companies, right now there's few signs that's happening in the market. During the past three months when Biden's lead over Trump widened in polls, a Goldman Sachs index tracking stocks of firms with lower nominal tax rates rose about 2%, compared with a slight decline in the high-tax basket.
Few of Biden's campaign promises are presented in less ambiguous terms than his plans to undo the 2017 tax law, by which Trump lowered corporate levies to 21% from 35%. And few are as roundly doubted by Wall Street.
Goldman Sachs says Biden's proposal to raise corporate taxes to 28% from 21% is likely to be scaled back, with rates rising to only 25%. According to the firm's economists, Democrats will at most have a narrow majority in the Senate, and will therefore have to make concessions in their aggressive plans. Moreover, the hike won't start getting phased in until 2022. Add a boost in fiscal spending, and S&P 500 earnings would climb by 13% a year through 2024 — close to the baseline forecast from strategists led by David Kostin that assumes no policy changes.
Trump's tax cuts helped S&P 500 earnings soar 24% in 2018, accounting for almost half of that growth, data compiled by Bloomberg Intelligence and Goldman Sachs show. To the extent that a tripling in profits during the last decade helped propel the longest bull market on record, any threat to corporate bottom lines is one to take seriously in the market.
"You can only have so much multiple expansion if earnings estimates have to come down because of the tax increases," said Matt Maley, Miller Tabak + Co.'s chief market strategist. "The market is too complacent."
Corporate leaders are more concerned over the tax policy under Biden. In a survey conducted from Sept. 30 to Oct. 6 by PwC, 62% of respondents expected tax changes from a new administration to pose great risk for their companies. That compared with 39% that viewed Trump as a threat.
Still, others contend that how much of a blow profits take depends chiefly on timing. Bloomberg Intelligence strategists including Gina Martin Adams estimate that an immediate boost to the corporate tax rate would detract 15% from the S&P 500's aggregate per-share earnings over the next three years. However, waiting until 2023 — when elements of Trump's tax package expire — could mean that hit shrinks to just 3%.
At UBS, strategists led by Keith Parker voiced similar lines of defense. While Biden's tax reform would shave S&P 500 earnings by 8% in a worst-case scenario, the team believe only half of the tax plan would go through. With fiscal stimulus helping fuel economic growth that eventually benefits companies, the combined impact on S&P 500 earnings would be a mere decline of 1.5%.
"If the S&P 500 earnings go down about 10% dollar for dollar, you'd expect the S&P to move down accordingly — but with stimulus on the table, you're talking about $2 or $3 trillion in stimulus," said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance. "There's no reason the stock market can't go higher."
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