Markets Much Prefer Clarity to Tax Cuts or Tax Hikes

Cut, cut, hike! Potential tax changes boggle pundits’ minds as the election nears. President Trump’s supporters say his big promised tax cuts are just what we need for the economy and stock market—while his opponent’s proposed hikes would doom stocks. But, Joe Biden’s backers claim his tax and spending increases would fund an explosive market and economic fiscal surge—that Trump’s cuts insure Covid-catatonic economic stagnation. They all miss history—oodles of it—showing tax changes of all kinds hold scant sway over stocks. Here’s how and why.

Most investors envision tax cuts as bullish but hikes bearish. Logic argues lower corporate taxes let firms plow more back into their businesses or boost dividends and buybacks. Similarly, most believe personal income tax cuts leave consumers and investors more to spend—economic rocket fuel. Capital gains taxes? Advocates claim cuts make stocks more attractive, hence bullish. That’s conventional wisdom. Reality is more complicated, showing hikes and cuts have hugely less impact than nearly anyone thinks.

Since good stock market data began in 1925, America cut corporate tax rates 11 times. In the next 12 months, the S&P 500 rose 8 times and fell 3, posting tepid 3.2% average returns. That same span features 13 corporate tax hikes. Twelve months after those hikes, the S&P 500 was up 9 times and down 4—not meaningfully different than after tax cuts. Moreover, post-hike returns averaged much better than the post-cut years—11.1%. Does that mean corporate tax hikes help stocks? Nope. It just demonstrates truth—that a plethora of factors influence stocks over any period—and corporate tax changes alone don’t dictate markets’ direction.

How about personal income taxes? The US cut them 16 times since 1925. Yet no turbocharging. S&P 500 returns in the following 12 months averaged zilch—flat, with stocks rising 9 times and falling 7. Stocks actually fared better after the 14 personal income tax hikes over that stretch, rising over the ensuing 12 months 10 times and averaging 16.8% returns.

Many might suspect that capital gains taxes—which directly affect stock investors—would show more impact. Seems straightforward, but no. Data on them start in 1954. Subsequent 12-month returns were positive after 7 of the 9 cuts since then, overall averaging 6.7%. Following the 10 hikes, stocks averaged 10.7% returns, falling only once.  You wonder why?

The fears and hopes are all priced beforehand.  Congressional tax legislation is long and drawn out in public, always, and widely discussed. Stocks pre-price all widely known information as I always preach. That’s Market’s 101.  Fear of hikes and hope of cuts are both pre-priced, long beforehand.  Legislation almost always ends up less pure than promised.  By the time they pass, big tax plans are usually watered down.  Take 2017.

Was 2017’s surge from Trump’s tax cuts?  Maybe partly.  But that tax package was more complicated than simple tax cuts. Changes to state and local tax (SALT) deduction rules offset cuts for many, for example. Trump wanted the corporate tax rate slashed to 15%. He got only to 21%. He wanted the estate tax killed. It took a hit, but survives. The proposed complexity paralleled by his other 2016, entangling campaign promises raised uncertainty throughout which faded in 2017. Anxiety relief! Stocks always love falling uncertainty. In my view, stocks’ 2017 surge was mostly pre-pricing increased Trump clarity.

As I wrote here July 7th, his unconventional style and tough 2016 tariff talk led investors to treat him then like they usually do a newly elected Democrat—with initial fears of market-harming policy. When reality proved more benign, it triggered a relief surge in his inaugural year—like Democrats usually get.

Big gains following tax hikes can also mislead. After Congress upped taxes in 1932, stocks zoomed 98% in 12 months—seriously skewing average corporate and personal income post-hike numbers. Those gains weren’t about taxes. They were just part of a huge dead-cat bounce off the Great Depression’s bottom.

Maybe tax policy shifts create good or harmful economic and social effects longer term—like maybe you envision. But they’re too telegraphed and, hence, pre-priced to move stocks much.

Tax changes simply take time (despite Biden’s promise to hike corporate rates on Day One which is impossible nonsense comparable to Trump’s 2016 promise to repeal and replace Obamacare on Day One).  This stuff plays out slowly, publicly, in lengthy drawn-out debates. Observers dissect it all every which way but loose, for months. Given today’s slim Congressional majorities—likely to continue post-election, whoever wins—quick, sweeping changes are fantasy.

Plenty of partisan pundits will claim otherwise, saying one candidate’s plan or the other’s will make or break this nascent bull market. Ignore them. For markets, tax drama is a microcosm of elections themselves: The angst says more about bias and sentiment than reality. Markets don’t need cuts or hikes to move higher—just clarity.  They’ll get that before too long. Look to that point now.