A “Taxing” Week, New ATHs, and Good News for H2 2021

Since March 2020, our song remains the same: It’s a bull market until proven otherwise.

Chief Investment Officer Chris Perras for Oak Harvest Financial Group, a wealth management, financial advisor and investment management firm in Houston, Texas, shares insights into the relationship between rising corporate and personal taxes, and the direction of the markets. Chris also shares our view of the direction of the markets from now through the end of 2021…

Chris Perras: Hey, happy Friday. I’m Chris Perras, Chief Investment Officer at Oak Harvest Financial Group. We are an investment management and retirement planning consultant in Houston, Texas. Welcome to our April 30th weekly Stock Talk Podcast: Keeping You Connected to Your Money. Well, we’ve spent the last three or four weeks in our podcast discussing the normalcy in the markets and the upcoming seasonality in both the economy and the financial markets.

We’ve tried to provide real data to help our clients and listeners better understand that while the period May through October has historically been the weakest six-month period for the S&P 500, that selling out and trying to get back in is almost always one, impossible, and two, fruitless. The facts are that historically, particularly during bull market moves like the ones that we’ve been in since April of last year, while you net miss nothing if you sell tax day and come back around Labor Day, the best long-term strategy and returns are generated by making minor tactical shifts during the summer weakness to keep one’s portfolio largely invested.

With our game plan for the summer months having been laid out, I want to focus this week’s podcast on a topic we first addressed nearly a year ago, very early in the 2020 presidential election race. What’s that topic? That topic’s taxes. The question keeps coming up. What do higher corporate and individual tax rates mean to equity markets in my portfolio? The quick answer to this question is the same one that we gave our listeners over a year ago. They are not particularly impactful over time to investor returns and to the overall stock markets.

I want to repeat that. Long-term changes in individual tax rates and corporate tax rates have had very little meaningful change in equity returns. I know a lot of people want to say Chris, it’s different this time, and so far, these doubters have yet to be proven correct, that it’s different this time. Early this month, President Biden finally released his Made in America Tax Plan, which proposes to raise the corporate tax rate from 21% back to 28%.

While the prospect of higher corporate tax rates has created mountains of Southside strategist pieces and hours of CNBC expert opinions, historically, the level of corporate tax rates has not had any meaningful longer-term impact on the broad S&P 500 performance. During the prior five corporate tax rates increase periods, the S&P 500 on average during calendar years gained almost 13%, and get this during periods of tax rate cuts, the average annual gain was only 4.6% annually.

Yes, the S&P 500 actually outperformed by almost three times when corporate tax rates were rising. Why? Probably because one, companies are incented to spend more money on research and development and capital expenditures, which generally benefits employment and GDP levels. Two, higher corporate tax rates tend to hurt slower growth in mundane sectors such as utilities and staples stocks as their own investment opportunities are generally limited. They have historically paid out more in dividends and stock buy backs versus using excess cash on tax deferred capital investment or employment and sales hiring.

Looking back to the 2017 Trump tax cut, the sectors and stocks of companies that had the highest effective tax rates before the passage of the bill were helped the most. Low leverage, low capital expenditures and low foreign exposure companies benefited the most with gains of two to three times the aggregate S&P 500, according to research and data compiled in September of 2018 by the Peterson Institute of Economics. Stocks of high dividend oriented sectors such as domestic utilities, real estate, and staples were the biggest net beneficiaries of tax cuts.

This makes intuitive sense to me because when corporate tax rates are reduced for these slow and no growth sectors, the main beneficiary was a shareholder who expected higher dividend payouts with the additional free cash flow. Should the Biden corporate tax increase be implemented in part or in full, I would expect a lot of talk from strategists about how technology and consumer discretionary stocks will be hurt. Listeners, be wary of this talk as the data in history suggests that the least economically sensitive stocks such as real estate and utilities will be hurt the most as dividend payout expectations have to be cut.

Economically sensitive sectors such as consumer discretionary, financials, industrials, and technology have done better during years of tax increases. Additionally, while one might expect bond yields to rally and decline and bond prices to rise as investors become more defensive, the opposite has transpired in the past. Yields have actually tended to rise led by both rising inflation and rising real growth.

Well, listeners, additionally President Biden has proposed massive Greenfield and an expansion of existing social welfare programs through a new tax and spend initiative loosely disguised under the term infrastructure spending. Well, the news networks and newsletters have been fiercely debating the worthiness of these programs and policies. Well, I’m not here to do that. I’m here to calm listeners’ fears that such policies will “tank the market” which they won’t, much in the same way we were trying to preview last year that a blue wave in the 2020 election would tank the market, which it didn’t.

While everyone’s tax situation is unique to their own life, history is that large integral tax increases have also had very little overall effect on the public equity markets. Maybe this is because only about 20% to 30% of all equities are owned in taxable brokerage accounts, with the rest being held in tax deferred retirement accounts held by public and private endowments or held by foreign entities that are not taxed at us rates.

We have a recent history around individual tax rate increases and stock market effects as recently as this past 10 year economic cycle. Yes, 2013 under the first year of President Obama’s second term, a time period we’ve referred to a myriad of times the last 12 months. What happened back then? Raise taxes, President Obama and Congress did, and the S&P 500 gained almost 38% the first year of his second term.

Listeners, that was almost identical to president Trump’s gain of 38% in 2017 as he pushed for lower tax rates. These are exactly opposite presidential policies, both socially and economically, and the exact same net stock market effect the first 15 months of their terms. Is that a coincidence? The investment team at Oak Harvest has said the same thing since last March in 2020, it’s a bull market until proven otherwise.

Since 1991, so over 30 years, when the year-over-year rate of change in the S&P 500 was over 30% year-over-year, it’s occurred 10 times before now. Now we’re in the 11th. Over the subsequent nine months, the average gain from the peak was 8.1% on top of the gains that the market had already reached. All 10 time periods were positive. After 12 months, the average gain was 13.5% on top of the prior peaks gain. All those time periods were positive. That says to our team, putting up some early summer chop and slop will be well-worth the noise.

We’re at that time of the year again. For clients, Tory, James, and myself will be releasing our second video outlining a few of our recent stock candidates we have found for shopping while others were busy worrying about every macro economic event, whether it be inflation, Federal Reserve tapering, or higher taxes. The investment team at Oak Harvest is already looking out to better position for the second half of 2021. We’re looking for companies that investors should be looking at with a glass half full attitude come the back half of the year and in 2022.

While others were running away from technology and medical device stocks six weeks ago when interest rates and inflation were the concerns on TV, we were initiating some positions in large-cap growth stocks. After July 2nd, big investors will once again be looking forward. They will be looking out to the second half of this year and all of 2022, and what are they likely to see? They’re likely to see higher secular growth companies that peaked back in the early third quarter of 2020 and stalled for almost a year that their valuations have compressed. Now they look cheap versus their long-term growth and free cash flow profiles.

Our goal is to keep your money working for you throughout your retirement years and keep you informed about what we are seeing and planning on doing well before you see it or hear it on the financial news channels. Give us a call and let us help you out. At Oak Harvest we are a comprehensive investment management and financial planning consultant, located right here in Houston, Texas. Give us a call at 281-822-1350. We are here to help you on your financial journey through retirement with a customized retirement planning.

Speaker 2: All content contained within Oak Harvest Podcasts expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed. The views and opinions expressed herein may change without notice. Strategies and ideas discussed may not be right for you and nothing in this podcast should be considered as personalized investment, tax or legal advice, or an offer or solicitation to buy or sell securities.

Indexes such as the S&P 500 are not available for direct investment, and your investment results may differ when compared to an index. Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss and past performance is not indicative of future results.