The Stock Market's Leaders Appear Most Vulnerable to Biden's Tax Plan

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Raising the corporate tax rate to 28% from 21% is one tax proposal of Democratic presidential nominee Joe Biden, shown during a Wisconsin speech on Sept. 21.



Photo:

mark makela/Reuters

Major U.S. technology stocks look vulnerable to a corporate-tax increase that might result from a Democratic sweep in November, potentially undermining one of the strongest drivers of the market’s recovery this year.

Democratic presidential nominee Joe Biden has proposed raising the corporate tax rate to 28% from 21%, imposing a new minimum tax on U.S. companies and increasing taxes on foreign income of many U.S.-based multinationals, among other plans.

Together, the tax proposals would reduce expected earnings among companies in the S&P 500 by 9.2%, according to estimates from BofA Global Research. And the pain would be more acute in some sectors than others.

Mr. Biden’s tax plan would lead to estimated double-digit percentage declines in profits for the information-technology, communication-services and consumer-discretionary sectors, BofA’s analysis found. Those groups, which are leading the charge in the S&P 500 this year, are home to

Apple Inc.,


AAPL -3.23%

Microsoft Corp.


MSFT -2.95%

, Google parent

Alphabet Inc.,


GOOG -2.13%

Facebook Inc.


FB -2.51%

and

Amazon.com Inc.


AMZN -2.99%

A disproportionate hit to earnings could challenge the leadership of those stocks—which have helped insulate the market during the pandemic—and test the durability of the 2020 rally. The S&P 500 has surged 50% from its low in late March and is up 3.6% for the year.

“The concern there is that you have these growth-oriented sectors that have been the primary drivers since the March lows,” said Chad Oviatt, director of investment management at Huntington Private Bank. “Do they still have the same tailwinds that they’ve had, or does the idea of tax implications produce a headwind for them that the markets aren’t currently pricing in?”

The Biden campaign said the candidate’s plans would create jobs and lead to growth. “Joe Biden’s focus is on the real economy and how it impacts the economic well-being, hopes and aspirations…of all American working families,” a campaign official said. “There is no reason that an economic plan that asks everyone to pay their fair share while doing more to reach full-employment quicker with more jobs and stronger growth should not help everyone from essential workers to investors.”

As the coronavirus pandemic shut down much of the economy and pushed an increasing share of life online, investors flocked to technology-focused stocks that were positioned to benefit. Amazon shares have surged 69% in 2020, while Apple and Microsoft are up 54% and 31%, respectively. Facebook has climbed 27%, and Alphabet has gained 8.7%.

Corporate earnings are the biggest driver of stocks over the long term. However, in recent years, stock prices have climbed faster than profits. Apple shares, for instance, have doubled since 2018, while its profits have been relatively stable.

Broadly, earnings are expected to begin rebounding next year from 2020’s coronavirus-induced slide. Analysts polled by FactSet expect profits among companies in the S&P 500 to rise 26% in 2021.

The three S&P 500 sectors that have led the index this year are projected to be the most vulnerable to Democratic presidential nominee Joe Biden’s tax proposal.

30%

Consumer

discretionary

Information technology

Consumer

staples

Communication

services

Materials

S&P 500

Health care

0%

INDEX PERFORMANCE, YEAR TO DATE

Industrials

Financials

–30%

Energy

–60%

–13%

–11%

–9%

–7%

ESTIMATED EARNINGS IMPACT OF BIDEN TAX PROPOSALS

Note: BofA Global Research estimates exclude the utilities sector and real-estate investment trusts.

Sources: FactSet (index performance); BofA Global Research (earnings impact)

The three S&P 500 sectors that have led the index this year are projected to be the most vulnerable to Democratic presidential nominee Joe Biden’s tax proposal.

30%

Consumer

discretionary

Information technology

Consumer

staples

Communication

services

Materials

S&P 500

Health care

0%

INDEX PERFORMANCE, YEAR TO DATE

Industrials

Financials

–30%

Energy

–60%

–13%

–11%

–9%

–7%

ESTIMATED EARNINGS IMPACT OF BIDEN TAX PROPOSALS

Note: BofA Global Research estimates exclude the utilities sector and real-estate investment trusts.

Sources: FactSet (index performance); BofA Global Research (earnings impact)

The three S&P 500 sectors that have led the index this year are projected to be the most vulnerable to Democratic presidential nominee Joe Biden’s tax proposal.

30%

Consumer

discretionary

Information technology

Consumer

staples

Communication

services

Materials

INDEX PERFORMANCE, YEAR TO DATE

S&P 500

Health care

0%

Industrials

Financials

–30%

Energy

–60%

–13%

–11%

–9%

–7%

ESTIMATED EARNINGS IMPACT OF BIDEN TAX PROPOSALS

Note: BofA Global Research estimates exclude

the utilities sector and real-estate investment trusts.

Sources: FactSet (index performance); BofA Global Research (earnings impact)

The three S&P 500 sectors that have led the index this year are projected to be the most vulnerable to Democratic presidential nominee Joe Biden’s tax proposal.

30%

Information technology

Consumer

discretionary

Communication

services

Materials

INDEX PERFORMANCE, YEAR TO DATE

S&P 500

Health care

0%

Industrials

Consumer

staples

Financials

–30%

Energy

–60%

–13%

–11%

–9%

–7%

ESTIMATED EARNINGS IMPACT

OF BIDEN TAX PROPOSALS

Note: BofA Global Research estimates exclude the utilities sector and real-estate investment trusts.

Sources: FactSet (index performance);

BofA Global Research (earnings impact)

Investors will get a fresh look at the health of the big tech companies and others later this month, when third-quarter earnings season kicks off in earnest. This week, they will examine jobless-claims data to gauge how quickly the labor market is recovering.

Many investors have said conditions are prime for a revival in value stocks, pointing to an improving economy, accelerated potentially by the deployment of a coronavirus vaccine. Value stocks, which outperformed their growth counterparts in September, are often defined as those that trade at a low multiple of their book value, or net worth.

Predicting a strong economic recovery would boost cyclical stocks, Morgan Stanley Wealth Management bought shares of industrial, materials and financial companies in the spring while trimming its position in technology, said Chief Investment Officer Lisa Shalett.

The proposed tax changes “would help accelerate that sector rotation because the relative impact would probably be larger on some of the companies that have dominated,” she said.

Effective tax rates and net income, by year

tax rate

INCOME

2019

In billions

S&P 500 avg.

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$34

12

55

18

39

13.33%

16.99

15.94

25.50

10.18

17.50%

2018

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$31

10

60

22

17

11.96%

10.63

18.34

12.81

54.57

17.72%

2017

Alphabet

Amazon.com

Apple

Facebook

Microsoft

53.44%

$13

3

48

16

21

20.20

24.56

22.63

8.40

24.37%

NOTE: Alphabet’s 2017 and Microsoft’s 2018 tax rates were unusually high because of a one-time tax on foreign income under the 2017 tax law.

Sources: FactSet (companies’ tax rates and income); S&P Dow Jones Indices (S&P 500 average tax rate)

Effective tax rates and net income, by year

tax rate

INCOME

2019

In billions

S&P 500 avg.

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$34

12

55

18

39

13.33%

16.99

15.94

25.50

10.18

17.50%

2018

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$31

10

60

22

17

11.96%

10.63

18.34

12.81

54.57

17.72%

2017

53.44%

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$13

3

48

16

21

20.20

24.56

22.63

8.40

24.37%

NOTE: Alphabet’s 2017 and Microsoft’s 2018 tax rates were unusually high because of a one-time tax on foreign income under the 2017 tax law.

Sources: FactSet (companies’ tax rates and income); S&P Dow Jones Indices (S&P 500 average tax rate)

Effective tax rates and net income, by year

tax rate

INCOME

2019

In billions

S&P 500 avg.

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$34

12

55

18

39

13.33%

16.99

15.94

25.50

10.18

17.50%

2018

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$31

10

60

22

17

11.96%

10.63

18.34

12.81

54.57

17.72%

2017

Alphabet

Amazon.com

Apple

Facebook

Microsoft

53.44%

$13

3

48

16

21

20.20

24.56

22.63

8.40

24.37%

NOTE: Alphabet’s 2017 and Microsoft’s 2018 tax rates were unusually high because of a one-time tax on foreign income under the 2017 tax law.

Sources: FactSet (companies’ tax rates and income); S&P Dow Jones Indices (S&P 500 average tax rate)

Effective tax rates and net income, by year

tax rate

INCOME

S&P 500 avg.

2019

In billions

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$34

12

55

18

39

13.33%

16.99

15.94

25.50

10.18

17.50%

2018

Alphabet

Amazon.com

Apple

Facebook

Microsoft

$31

10

60

22

17

11.96%

10.63

18.34

12.81

54.57

17.72%

2017

Alphabet

Amazon.com

Apple

Facebook

Microsoft

53.44%

$13

3

48

16

21

20.20

24.56

22.63

8.40

24.37%

NOTE: Alphabet’s 2017 and Microsoft’s 2018 tax rates were unusually high because of a one-time tax on foreign income under the 2017 tax law.

Sources: FactSet (companies’ tax rates and income); S&P Dow Jones Indices (S&P 500 average tax rate)

Mr. Biden’s proposal for higher taxes on foreign income is expected to hit tech stocks particularly hard. The tech sector derives just 43.5% of its revenue from the U.S., compared with 60.3% for the S&P 500 as a whole, according to FactSet estimates.

Another wild card for big tech companies is the possibility of a crackdown by regulators. The Federal Trade Commission is gearing up to file a possible antitrust lawsuit against Facebook, and federal and state authorities have investigated Google over a range of potential antitrust issues, The Wall Street Journal has reported. Facebook has defended its acquisitions, saying apps like Instagram became more popular because Facebook improved them. Google has said its products expand competition and level the playing field for small businesses.

Goldman Sachs Group Inc. analysts have also raised the possibility of a shift in momentum in the stock market, partly because of Mr. Biden’s call for raising the top capital-gains tax rate. Past increases have hit the market’s leaders ahead of the increase particularly hard, the analysts wrote in a recent report.

Still, investors caution against drawing firm conclusions about how stocks would perform in the wake of any tax changes. They also note Mr. Biden would be unlikely to succeed in raising taxes unless Democrats also win control of the Senate, and that even then, any further downturn in the economy could lead to a delay in attempting an increase.

Mr. Biden’s proposal for higher taxes on foreign income is expected to hurt tech stocks. The former vice president arrived at a Wisconsin aluminum facility on Sept. 21.



Photo:

jim watson/Agence France-Presse/Getty Images

In 1993, President Bill Clinton signed a deficit-reduction package that raised the corporate income tax. The S&P 500 posted a small loss in 1994 but went on to notch double-digit percentage gains each year for the rest of the decade, which was a time of technological innovation and rising globalization.

“All else being equal, tax increases are a negative for equity investors, but all else is never equal,” said David Donabedian, chief investment officer of CIBC Private Wealth Management. “There’s always other stuff going on.”

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Other investors say the pace of the economic recovery, success at countering the coronavirus and the Federal Reserve’s commitment to keeping interest rates near zero will play a larger role in determining the stock market’s trajectory. And the BofA analysts cautioned that their research suggests there is little correlation between tax rates and regulations, and market returns.

Plus, even when an election result is known, it isn’t always clear how the markets will react. Mr. Trump’s surprise win four years ago prompted a sharp drop in stock futures overnight. But stocks rallied the next day and went on to soar to records, boosted by the 2017 tax cuts and strength in the global economy.

Another moving piece of the puzzle: Mr. Biden’s proposals call for trillions of dollars in new spending, including a plan to combat climate change while rebuilding the country’s infrastructure.

“A large increase in fiscal spending, funded in part by increased tax revenue, would boost economic growth and help offset the earnings headwind from higher tax rates,” the Goldman analysts wrote.

Write to Karen Langley at karen.langley@wsj.com

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