Apart from COVID-19, presidential election is a pretty hot topic now, especially with the event just five months away. Democratic presidential candidate Joe Biden now has 55% chance of winning the November election, according to online market and political event forecaster PredictIt. Chances are up from 43% a month ago. His winning means the partial rollback of President Trump’s Tax Cuts and Jobs Act.
President Trump’s tax lay lowered the corporate tax rate from 35% to 21%, starting 2018. Analysis by the Tax Foundation revealed Biden’s plan is to hike the corporate tax rate to 28%. Biden is also proposing to levy a minimum tax rate of 15%, a potentially damaging outcome for some major companies that pay little in taxes. Biden's tax plan points at revenues needed to pay down the huge debt incurred to fight the recession.
Impact on Markets
This is surely bad news for markets. Goldman Sachs cautioned that Biden's tax plan, coupled with an expected drag on GDP, would lower next year's S&P 500 per-share earnings by $20 to $150. “Extrapolating current multiples on that kind of earnings decline makes 100-150 points on the S&P 500 a baseline for the impact of a tax cut rollback, all else equal,” wrote Michael Wilson, chief U.S. equity strategist at Morgan Stanley.
The Tax Cuts and Jobs Act of 2017 has lowered the effective tax rate of S&P 500 companies by 8 percentage points to 19% and boosted S&P 500 earnings by 10%, according to Goldman’s Kostin. He noted that declining effective tax rates over the past 30 years have provided S&P 500 earnings a 24% lift and made up for half of the 400-basis point increase in net profit margins.
Against this backdrop, below we highlight a few ETF areas that were the biggest beneficiaries of tax cuts in the past years and are thus in a vulnerable position if Joe Biden wins and a tax hike is enacted.
Banks were a key beneficiary in the lower tax environment. The tax hike may also cause a decline in long-term interest rates due to safe-haven trades. This would shrink net margins and lower banks’ profits. SPDR S&P Regional Banking ETF (KRE - Free Report) should be watched closely in the coming months.
Domestically geared healthcare companies that focus on services benefited from the lower tax rate. These companies have limited international exposure and considerable capital expenditures, per Reuters. Invesco S&P SmallCap Health Care Portfolio (PSCH) is thus a loser now.
Healthcare services was also one of the most-taxed industries. According to MUFG Securities, tax reform probably has boosted managed care companies’ earnings by 30%. In the absence of this, SPDR S&P Health Care Services ETF (XHS - Free Report) could lose ahead.
Retailers, especially department stores, too used to pay considerably higher taxes among the S&P 500 companies given their large domestic networks.Notably, Under Armour paid a tax rate of 23% in 2018 (the first year of tax cut), down from 39% the prior year.
Biden dislikes the idea of a behemoth like Amazon (AMZN - Free Report) owing money in federal income tax, instead of paying it. VanEck Vectors Retail ETF (RTH - Free Report) may see stressful trading in the medium term.
Overall tax cuts and a shift to the territorial system boosted share repurchases in the past two years. While tax hike would reverse this trend, coronavirus-led slowdown also put a halt in buyback activities. PowerShares Buyback Achievers Portfolio (PKW - Free Report) might come under pressure.
Biden’s election could bring about other possible changes, including a higher tax rate on capital gains and dividends for the highest earners and changes in non-tax regulatory policies, per a Fox Business article. So, it may cause problems to the popularity of high-dividend ETFs like Vanguard High Dividend Yield Index Fund ETF Shares (VYM - Free Report) .
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