Markets are still digesting prospects for higher taxes, with some strategists suggesting that pent-up demand in the economy may help offset damage any increase will inflict on equities.
The risk of higher taxes over the next year is rising — and it’s “hard to argue” that markets have already priced in this challenge for investors, according to David Kelly, chief global strategist at JPMorgan Chase & Co.’s asset management unit. In a note Monday, Kelly cited President Joe Biden’s proposal to increase the corporate tax rate to 28% from 21% in order to help fund his infrastructure plan, as well as to adopt a global minimum corporate tax rate of 21%.
“It’s becoming more and more of something that’s on the mind of investors,” Tim Murray, the capital markets strategist for T. Rowe Price Group Inc.’s multi-asset division, told MarketWatch in a phone interview Monday. He said large growth and technology stocks
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that are highly valued stand to be among the hardest hit as they face potentially higher tax rates on their foreign revenue streams.
According to a research report last month from Goldman Sachs Group Inc., several information technology companies in the S&P 500 index
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are vulnerable to Biden’s tax plan proposal because of their large foreign income exposure and relatively low effective tax rates seen for 2022. Microchip Technology Inc.
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Seagate Technology
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and Nvidia Corp.
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are among them, the Goldman report, dated March 19, shows.
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“Like Willie Sutton used to rob banks ‘because that’s where the money is,’ the governments now are looking at these large, very successful multinationals because that’s where money is now…”
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— James Solloway, SEI
Large tech companies that have lowered their effective tax rates in part by moving “recorded revenues” to low-tax-rate jurisdictions are “squarely in the sights of a lot of governments,” including the U.S. and Europe, said James Solloway, chief market strategist for SEI’s investment management unit, in a phone interview Monday. Solloway referenced late bank robber Willie Sutton to underscore why such companies have landed in the crosshairs of governments.
“Just like Willie Sutton used to rob banks ‘because that’s where the money is,’ the governments now are looking at these large, very successful multinationals, because that’s where money is nowadays,” Solloway told MarketWatch.
Read: Here’s what tax hikes could mean for the stock market as Biden pushes infrastructure plan
The “real” prospects for higher inflation and taxes in the short run threaten equity returns, particularly stocks with high valuations, JPMorgan’s Kelly said in his note.
“In the short run, investors need to recognize the potential for some headwinds from higher inflation and higher taxes,” he said. “There is a good chance that legislation increasing both the corporate income tax rate and capital gains taxes for upper income households will pass before the end of the year.”
Solloway expects the tax legislation won’t include everything the Biden administration wants.
“The tax issue is also a very important one, but one that you gotta be careful not to put too much weight on at the moment,” he said. “We don’t know what’s going to be passed.”
Also, it’s not exactly clear who will end up paying for the higher corporate tax rates, Solloway added, saying that will hinge in part on how strong demand is for a company’s products.
“If a company is selling something that people really want, prices are going to go up to reflect the added cost of doing business that’s a result of higher taxes,” Solloway said. “But if you’re in an extremely competitive industry, you may be forced to swallow that higher cost in your own profit margin.”
Read: Stocks edge lower to start earnings week with banks and risk taking in focus
Murray expects the economic rebound from the pandemic will generally “outweigh” decreases in profits resulting from tax increases. He pointed to “pent-up demand” after consumers have saved much more than usual as they stayed home due to COVID as well as government stimulus – important drivers in markets.
“We think it’s going to continue to surprise to the upside,” said Murray.
Meanwhile, the strong rally in equities
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that has spanned more than a year has made valuations “an issue,” said Solloway. He said his concern over stretched valuations would increase should the Federal Reserve change its “rhetoric” surrounding its accommodative monetary policy, or say, “if we had a continued melt-up in assets prices” over the next couple quarters.
