Why stocks are at a record even with the dark cloud of higher taxes hanging overhead
At first blush, it would appear weird to see the S&P 500 hovering at record highs even as the index's component companies stare down the barrel of a tax hike from the Biden administration to help pay for a massive $2.3 trillion infrastructure package.
Think a little more on the topic, however, and it actually all makes perfect sense, contends J.P. Morgan.
"While the possibility that corporate taxes are raised at a global level would be negative news for the corporate sector, we see three cushions. First, at an aggregate level the corporate sector enjoys currently an exceptionally strong liquidity position to be able to withstand a potential increase in the tax burden in the future without having to make big compromises on other activities. Second, the losses booked over the past year as a result of the virus crisis, if carried forward, would by themselves reduce the corporate tax burden at an aggregate level for years to come as it happened in the years following the Lehman crisis," says J.P. Morgan strategist Nikolaos Panigirtzoglou.
Panigirtzoglou adds, "Third, to the extent that higher corporate taxes are spent by governments on infrastructure projects that help to increase potential growth, this should overall help to boost corporate revenues in the future; thus, also offsetting some of the negative impact from higher taxes."
The Biden administration's $2.3 trillion "American Jobs Plan" aims to invest — among other efforts — $621 billion into transportation infrastructure, including the repair of roads, bridges, transit and rail. More than $300 billion will be spent to replace lead water pipes and upgrade sewers, invest in broadband access and improve the power grid.
The infrastructure plan is seen as being mostly paid for by lifting the corporate tax rate to 28% from 21%.
"Well, I think that an honest look at corporate America will tell you that they can do more to pay their fair share. Look, remember we are calling for a tax rate of 28%. For most of my lifetime that rate stood at 35% and American companies were perfectly competitive, extremely competitive. So if we can handle 35%, I am pretty sure we could handle 28%," Transportation Secretary Buttigieg tells Yahoo Finance Presents.
Despite the political rhetoric on corporate taxes intensifying in April, stocks have shrugged it all off.
The Nasdaq Composite has rallied 3.5% so far in April, the S&P 500 is up 3.2% and the Dow Jones Industrial Average has gained 2.2%. All three of the major indexes are knocking on the door of 10% gains in 2021. Shares of tech darlings Facebook, Amazon, Apple, Netflix and Google — many of which often take public beatings by politicians for their low corporate taxes —have notched an average 8% gain in April.
While the market's resilience is commendable (and perhaps reflects some of J.P. Morgan's points above), it could also fail to capture the profit reality for companies in a higher tax environment. Those higher taxes are very likely coming in 2022, Goldman Sachs reasons, and they stand to slam profits. If stocks are a forward-looking mechanism — and most would agree they are —then the markets could be in for a rough patch this fall.
"Legislation will be heavily negotiated during the summer, passed in autumn, but only take effect starting in 2022. In the unlikely event that tax reform does not occur, our 2022 S&P 500 annual EPS growth rate would be 12% (to $203). Our current published estimate of $197 assumes taxes rise and reflects a 9% growth rate. However, full adoption of the Biden proposal would cut growth to just 5% ($190)," says Goldman Sachs strategist David Kostin.
Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.
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