close
close
migores1

The Subtle Reason Stocks May Fall If Kamala Harris Raises the Corporate Tax Rate to 33%

Less than a month from today, on November 5, voters will head to the polls to determine which presidential candidate — current Vice President Kamala Harris or former President Donald Trump — will lead our country for the next four years.

Of course, not every decision made in the Oval Office or by our elected officials in Congress matters on Wall Street. However, the economic policies put in place by the incoming president and Congress have the potential to affect corporate profits and thus the stock market.

While there are potential pros and cons to both candidates’ economic proposals, the one plan raising a lot of eyebrows on Wall Street is Harris’ call to raise the corporate tax rate by a third — from 21 percent to 28 percent.

Although the current US corporate tax rate is at its lowest level since 1939, increasing it by 33% has the potential to send the stock market into disaster for a very odd reason.

Vice President Kamala Harris speaking to reporters.Vice President Kamala Harris speaking to reporters.

Vice President Kamala Harris speaking to reporters. Image Source: Official White House Photo by Lawrence Jackson.

Stocks could fall if Harris raises corporate tax rate — but not for the reason you might think

Kamala Harris’ plan to raise corporate taxes stems from persistent and growing federal deficits.

Except from 1998 to 2001, the federal government has spent more than it has brought in in revenue every year since 1970. The national debt is now around $35 trillion, with the annual cost of servicing that debt being about 1 .05 trillion dollars since August 2024, according to the US Treasury Department. This trajectory will not be sustainable in the long term.

Based on Treasury Department estimates, raising the corporate tax rate by one-third to 28 percent would increase federal tax revenue by a cumulative $1.35 trillion over the next decade.

However, raising corporate taxes could have unintended and/or unforeseen consequences for Wall Street.

The logical expectation if the corporate tax rate goes up is that businesses will have less capital to allocate to the meat and potatoes that get them through. Specifically, we will see a lower rate of new hires, fewer acquisitions, and less capital spent on research and development. Hiring, acquisitions and innovation are usually what increase the bottom line for businesses.

But there’s a less obvious concern that could drive stocks lower if the corporate tax rate rises to 33 percent. Less capital available to work for publicly traded companies could reduce or eliminate what has been a key source of earnings growth in recent years: share buybacks.

Chart of AAPL Stock Repurchases (Quarterly).Chart of AAPL Stock Repurchases (Quarterly).

Chart of AAPL Stock Repurchases (Quarterly).

For companies with flat or growing net income, share buybacks can increase earnings per share (EPS). As a company’s number of shares outstanding decreases over time, its EPS should increase, making it more attractive to investors.

On a 12-month basis (TTM) ending March 2024, S&P 500 (SNPINDEX: ^GSPC) companies completed buybacks worth $816.5 billion, which is technically down from a TTM peak of $1.01 trillion for the period ending June 2022, based on data from S&P Global.

More importantly, 50.9% of the buybacks completed in the first quarter of 2024 went to the 20 largest companies by market capitalization in the S&P 500. The buybacks were used to fuel earnings growth for the largest and most influential businesses from America, but this is not. It’s not guaranteed to continue if Harris wins in November and has the votes on Capitol Hill to raise the corporate tax rate by a third.

For example, the world’s largest publicly traded company by market capitalization, Apple (NASDAQ:AAPL)has repurchased $700.6 billion of its common stock since the start of 2013 and reduced its outstanding shares by 42.2% in the process.

If Apple had not bought back any shares in the past 11 years, its consensus EPS for fiscal 2024 (ended September 30) would be less than $4, not the current $6.68. Perhaps no company has been fueled more by share buybacks in recent years than Wall Street’s largest public company.

If there’s one clear reason for this concern, it’s that a study from Fidelity found that the benchmark S&P 500 rose by an average of 13% after every corporate tax increase since 1950. While this is no guarantee that stocks would rise if Harris raised the corporate tax rate from 21% to 28%, history strongly favors the continuation of the current bull market.

A person shooting an arrow and circling a steep descent in an action diagram. A person shooting an arrow and circling a steep descent in an action diagram.

Image source: Getty Images.

This could be even more worrisome than the prospect of reduced share buybacks

While share buybacks have artificially boosted EPS for Wall Street’s biggest companies for years, and a higher corporate tax rate could slow buyback activity, that may not be Wall Street’s most immediate concern . Rather, a historically expensive stock market could be the catalyst that sends stocks into a correction or bear market, regardless of who is elected president on November 5th.

To be fair, there are a lot of ways investors can measure value, and each has different levels of risk tolerance. But based on readings of the S&P 500’s Shiller price-to-earnings (P/E) ratio, we’ve seen only a few instances in more than 150 years when stocks have collectively been this expensive. The Shiller P/E ratio is also known as the cyclically adjusted price-to-earnings ratio or the CAPE ratio.

Most investors rely on the traditional P/E ratio as a quick and easy way to determine whether a stock is relatively cheap or expensive compared to its peers and its own history. However, the traditional P/E ratio only considers TTM earnings, which can be skewed or negatively affected by shock events, such as the temporary shutdowns that occurred during the pandemic.

The Shiller P/E ratio is based on average inflation-adjusted earnings over the past 10 years. Covering a full decade of EPS history minimizes the impact of shock events, resulting in a more accurate measure of value.

S&P 500 Shiller CAPE chartS&P 500 Shiller CAPE chart

S&P 500 Shiller CAPE chart

When the closing bell rang on October 3, the S&P 500 Shiller P/E was 36.6, more than double its average of 17.16 when tested back to January 1871. Even though lower interest rates and internet access democratize For information has increased the risk appetite of ordinary investors, a Shiller P/E of nearly 37 is a huge read.

Looking back to 1871, there have been only six times the S&P 500 Shiller P/E has exceeded 30 during a bull market rally, including today. Following the previous five appearances, the S&P 500, Dow Jones Industrial Average (DJINDICES: ^DJI)and/or Nasdaq Composite (NASDAQINDEX: ^IXIC)lose between 20% and 89% of their value.

While the Shiller P/E is not a timing tool — that is, stocks can remain expensive for weeks, months or, in rarer cases, years — it has an impeccable track record of foreshadowing big declines in the S&P 500, the Dow. , and the Nasdaq Composite.

While it’s possible that Kamala Harris’ plan to raise the corporate tax rate to 33% would be bad news for Wall Street, the biggest enemy for investors right now is historically expensive stock valuations — and it’s unlikely for this to change soon.

Should you invest $1,000 in the S&P 500 right now?

Before buying stocks in the S&P 500 index, consider the following:

The Motley Fool Stock Advisor the analyst team has just identified what they think they are 10 best stocks for investors to buy now… and the S&P 500 was not one of them. The 10 stocks that made the cut could produce monster returns in the coming years.

Consider when Nvidia made this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you would have $765,523!*

Stock advisor provides investors with an easy-to-follow blueprint for success, including portfolio construction guidance, regular updates from analysts, and two new stock picks every month. The Stock advisor the service has more than four times return of the S&P 500 since 2002*.

See the 10 stocks »

*The stock advisor returns as of September 30, 2024

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and S&P Global. The Motley Fool has a disclosure policy.

The Subtle Reason Stocks May Fall If Kamala Harris Raises the Corporate Tax Rate to 33% was originally published by The Motley Fool

Related Articles

Back to top button