Don't Worry, Stocks Already Priced the Biden Tax Hikes

Tax hikes are coming! Tax hikes are coming! Yikes, Yikes, Yikes! Pundits tizzy it up over President Biden’s rumored plan, fearing multi-faceted new, huge hikes will whack stocks. They warn budget reconciliation means Biden can slam-dunk it all with Democrats only. Take a deep breath: Internal Democratic divisions will dilute any tax legislation that passes. But, even if I’m wrong on that, it still won’t whack stocks. Let me explain. 

Pundits say rising stocks, at new all-time highs, “ignore” looming tax overhauls, teeing up future market shocks. That’s silly. Stocks don’t ignore anything.  But pundits’ focus on plans for huge Uncle Sam spending—heavily paid for with more taxes. Biden, of course, campaigned on bumping up the top personal income tax, corporate tax rate, and taxing capital gains at personal income rates for individuals earning over $1 million—almost doubling that rate.

Many fear that is just the start—fearing rumored proposals for taxing financial transactions, like stock trades. Or a wealth tax Senate Democrats introduced last month. Others fear estate and gift tax exemption maximums get slashed—while raising rates on transfers exceeding those ceilings. Some even fret him making all these increases retroactive to 2021’s start. Most investors say hikes hurt stocks.

Scared yet? Quiver all you want but, remember: Markets never forget and never, ever “ignore” headline stories. They were weighing potential Biden plans even before he unveiled his campaign trail tax stances—in 2019! All throughout 2020’s campaign, Biden and other Democrats whose campaigns fizzled hyped hikes. About the only folks unaware he would push a hike now spent most of recent times in some soundproof bunker in Siberia without WiFi—and can’t sway much--much. 

Markets’ primary job is pre-pricing widely known information. As I wrote here February 28^th, that is one of the last year’s chief lessons. Yet still, so, so many investors ignore it. Value fans. Vaccine chasers. Now it’s those who fear tax changes will whack stocks. Presuming that is bear-market fuel presumes markets are near-totally inefficient, given the long-lasting and abundant chatter over tax hikes. Fortunes have been lost on such theses—and investment careers wrecked. We just saw that in the hedgies who bet against GameStop on widely held theories about storefront retail’s weakness. Fixating on what everyone knew set them up for a surprise.

Taxes touch investors directly, globally. Few folks like them. So tax changes never escape scrutiny. This is why history shows that changes to taxes—whether corporate, income or capital gains, hikes or cuts, of any type or size, and counter to common belief—have no pre-set market impact. Stocks pre-price them and defuse them. Don’t take my word for it. Consider the data.

As I showed you last October, America has hiked corporate taxes—Biden’s first target—13 times since good stock market data start in 1925. In the ensuing 12 months, the S&P 500 rose 9 times and fell 4. Returns averaged 11.1%, slightly north of their long-term 10% annualized average.

Like personal income taxes. America has hiked the top bracket 14 times since 1925. Stocks averaged 16.8% in the year following the hike, rising in 10 of 14. The trend you are noticing here—nicely positive returns that occurred regularly following hikes—applies to capital gains, too. Something resembling the modern capital gains system came into force in 1954. Following the 10 hikes since, stocks have averaged 10.7% returns, falling just once.

Even when Congress hikes corporate, personal income and capital gains together, they lack power to wallop stocks. There have been 11 simultaneous hikes to at least 2 of those tax types. The median return 12 months after is 11.8%, with stocks rising 9 times.

Does that seem counterintuitive? Try this: The returns following hikes beat those 12 months after cuts! Stocks averaged just 3.2% gains following the 11 corporate tax cuts since 1925. Personal income tax cuts? We’ve done that 16 times. Average returns after them were flat. Following capital gains tax cuts, returns averaged just 6.7%—pretty bland!

To be clear: I’m not taking a pure contrarian view that tax hikes are bullish. But these data show you the conventional wisdom arguing hikes are auto-bearish is just dead wrong. They lack anything close to the surprise power needed to hit markets hard. If anything, the stock pain was long before the legislation as the initial pre-pricing digested the odds of this, that or the other.

It is fine to hold the opinion that tax hikes aren’t good generally--on Main Street and otherwise. (For disclosure, I generally share that view outside of capital markets impacts—while viewing some taxes as preferable to others for business and consumers.) Maybe you think rates are too high (or low!) to be fair. Maybe you could even make the argument that hikes are suboptimal for the economy. But markets don’t traffic in fairness—nor do they weigh what’s optimal for the here and now. They deal in what is likely, pre-pricing the probably future it into stocks near-instantly.

So if—and it is a big “if” (see my prior writings here and elsewhere)—tax hikes that aren’t hugely diluted before becoming law actually pass in 20201, don’t fear for your portfolio. Glacial moves that everyone watches with keen self-interest lack the power to hit stocks hard.