Only a few weeks remain before voters decide the fate of the Oval Office, with Kamala Harris and Donald Trump vying for the presidency. While not every political decision affects Wall Street, the economic policies rolled out by the incoming administration can significantly sway corporate profits and the stock market.
The Unseen Downside of Raising Corporate Tax Rates
Vice President Kamala Harris’s proposal to boost corporate taxes aims to address the mounting federal deficits. The U.S. government has operated in the red in all years except 1998-2001 since 1970, accumulating a colossal $35 trillion national debt by 2024. Servicing this debt annually costs approximately $1.05 trillion, a steep burden that spells trouble for the future.
Ramping up the corporate tax rate to 28% could funnel an additional $1.35 trillion into federal coffers over the next decade according to Treasury Department forecasts.
However, the repercussions of heightened corporate taxes extend beyond the obvious. An upsurge in tax rates typically translates to diminished business capital allocation, leading to slower hiring, fewer acquisitions, and reduced research and development expenditure — all pivotal engines for business growth.
Yet, a less conspicuous consequence looms large: the jeopardy posed to a vital source of earnings growth in recent years — share buybacks.
Companies depend on ongoing or increasing net income for share repurchases to enhance earnings per share (EPS). As firms buy back shares, their EPS climbs due to a declining outstanding share count, making them more appealing to investors.
Until March 2024, S&P 500 companies had undertaken $816.5 billion worth of buybacks, a dip from a peak of $1.01 trillion trailing twelve months ended June 2022 data from S&P Global reveals.
More critical is that half of the Q1 2024 buybacks originated from the 20 largest S&P 500 companies by market capitalization. These buybacks have been instrumental in propelling earnings growth for America’s industry giants, although this trend could shift if Harris’s tax hike materializes.
Take Apple, the largest publicly traded firm by market cap. Since 2013, Apple has bought back $700.6 billion of its stock, slashing its share count by 42.2%. Had Apple skipped buybacks, its fiscal 2024 consensus EPS would stand at under $4 instead of the present $6.68.
On a brighter note, Fidelity’s study suggests that following each corporate tax increase since 1950, the S&P 500 soared by an average of 13%. While this doesn’t guarantee bullish market conditions if Harris implements the tax hike, history leans favorably towards a thriving market scenario.
The Deeper Concern Beyond Diminished Buybacks
Although EPS inflation from share buybacks has artificially boosted major institutional earnings, a potential corporate tax spike could disrupt this trend.
Exploring the Risk of Historically Pricey Stock Markets
The Dangers of Overpriced Stocks
In the world of investing, the state of the economy is like a desert mirage – seemingly promising but potentially misleading. Despite the lure of the desert oasis, Wall Street is facing a looming threat that surpasses the immediate concerns regarding political activity. This peril arises from a historically overpriced stock market that stands as a looming catalyst, capable of pushing equities into a correction or even a bear market, irrespective of the outcome of the upcoming presidential elections.
Understanding Valuation through the Shiller P/E Ratio
When it comes to evaluating stocks, investors utilize various yardsticks to measure value, each tailored to their risk appetite. However, the S&P 500’s Shiller price-to-earnings ratio (P/E), also known as the cyclically adjusted price-to-earnings ratio (CAPE ratio), has recently raised eyebrows. This metric, based on inflation-adjusted earnings from the past decade, provides a more comprehensive perspective, buffering the impact of sudden shocks often witnessed in markets.
A Historical View of Stock Market Valuations
Reflecting on historical data, the S&P 500’s Shiller P/E ratio stood at a staggering 36.6 on October 3, more than double the long-term average since January 1871. While factors like lowered interest rates and increased retail investor participation may fuel risk-taking behavior, a Shiller P/E nearing 37 is a glaring anomaly that demands attention.
The Ominous Forecast of Pricey Stocks
Reviewing trends dating back to the late 19th century, there have been only a few occasions where the S&P 500’s Shiller P/E breached 30 during a bull market, with the present being one of those instances. Following such peaks in the past, major indices like the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite plummeted by significant margins, highlighting the grave ramifications of inflated valuations.
The Unwavering Warning of Overvaluation
While fiscal policies proposed by political figures, such as Kamala Harris’ corporate tax rate hike, may stir concerns on Wall Street, the most formidable adversary for investors currently emerges from the realm of excessively pricey stock valuations. This prevailing scenario is likely to persist, casting a shadow over market participants.