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Welcome to RBC’s Markets in Motion podcast, recorded April 15th, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast, we run through our initial thoughts on Biden’s plans to raise corporate taxes, a hot topic in our conversations with equity investors all year. The big things you need to know: We think Trump’s tax cuts played an important role in fueling strong equity market returns in 2017 through 2019, and our work suggests Large Cap Growth was one of the biggest beneficiaries. We also believe that Biden’s proposal to raise corporate taxes to fund his infrastructure bill has been impacting rotation within the US equity market recently. Investors have been worrying about higher corporate taxes all year, and the stocks that were the biggest beneficiaries of Trump’s tax reform have stumbled recently, telling us risks are getting baked in now.
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Now, the details.
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Key point #1, US equity investors have been fretting about higher corporate taxes all year.
- Some strategists have argued that the stock market is ignoring the possibility of higher corporate taxes. We don’t think that’s the case at all.
- This topic comes up in just about every meeting I’ve had with investors since late January, and we found evidence of how concerned both investors and our analysts are about higher corporate taxes in the policy related questions in our March analyst and investor surveys.
- A couple of stats from our late March US equity investor survey really stands out in this regard.
- 53% said the fiscal policy backdrop for stocks over the next 6-12 months is negative or very negative.
- A couple of stats from our late March US equity investor survey really stands out in this regard.
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- 93% expected Biden to get something done on corporate taxes.
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- Higher taxes was also the #2 issue keeping investors up at night, lagging only monetary policy.
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Key point #2, we think it’s pretty clear that Trump’s tax cuts helped drive stocks higher in 2018-2019, and also found evidence that Biden’s plans to raise them is contributing to recent market rotation.
- To understand to what extent Trump’s tax reform, and the possibility of higher corporate taxes under Biden, has been getting expressed in stock market performance, we ranked all of the stocks in the Russell 1000 by the gap in their average effective tax rates in 2018-2019 and 2016-2017.
- We found that the Large Cap stocks with the biggest declines in their effective tax rates outperformed from mid 2016, when Wall Street started to sniff out the Trump victory, through mid 2019, the second year that the tax cuts took effect.
- We are also starting to see some underperformance in the biggest tax cut beneficiaries since late February 2021, which is telling us that the risk of seeing the tax cuts get reversed is starting to get baked into the stock market, under the surface, through positioning.
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- Though the timing and duration varied, when we replicate this analysis for the Russell 1000 sectors, we find that most also saw outperformance by the biggest tax cut beneficiaries within them in the 2016-2019 period.
- In more recent trading, we are also starting to see a breakdown in performance of the biggest tax cut beneficiaries within most Large Cap sectors as well.
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Key point #3, our work suggests Large Cap Growth was one of the biggest beneficiaries of Trump’s tax reform – a finding that really surprised us.
- The Russell 1000 Growth index saw a far bigger decline its effective tax rates after Trump’s tax reform was enacted than Russell 1000 Value index. We think this helps explain strong Growth leadership in the 2017-2019 period when Growth valuations were no longer appealing, as had been the case throughout most of the post Financial Crisis era up until then.
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- This isn’t all about Tech. At the Large Cap sector level, Consumer Discretionary and Health Care saw the biggest declines in their effective tax rates. These are two sectors that, like Tech, tend to be more closely aligned with the Growth trade.
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- At the industry level, Pharma and Interactive Media & Services were two of the Large Cap industries that saw the biggest declines in their effective tax rate.
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- On the topic of which parts of the equity market benefited the most from Trump’s tax cuts, it’s also worth noting that Small Cap, particularly Small Cap Value, also saw a big decline in their effective tax rates under Trump.
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- But at the broader index level, we didn’t really see the same performance patterns in Small Cap that we did in Large Cap. If you look at how the Russell 2000 stocks with the biggest declines in their effective tax rates performed around passage of Trump’s tax cuts, it appears that Small Cap never really benefited from the tax cuts to begin with.
- That doesn’t mean tax changes have been irrelevant for Small Cap investors, however. The biggest tax cut beneficiaries within Small Cap are heavily skewed towards Financials.
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- When we look at performance Small Cap sectors other than Financials, we find that trends – both past and recent – are pretty similar to what we already discussed in Large Cap.
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That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.