After a brief lull, Wall Street’s mood is once again swinging between extremes.
I think the bulls still have the upper hand, but the margin of error is getting thinner day by day. There’s a lot of talk about rolling corporate income tax rates back up and even raising the highest capital gains tax to record levels, thereby hitting investors right where we live.
Either scenario would be a drag on the market. If both somehow make it through Congress, the chilling effect will be obvious to everyone.
But unlike a lot of people on Wall Street, I am not afraid of the IRS. Paying more on the corporate side and then again when we lock in our trading profits will sting, but there’s plenty of profit to share.
From Big Boom to Little Boom: Will Taxes and Inflation Kill the Bull Market?
After all, stimulus and the Fed already have unleashed trillions of dollars into the economy. I just saw a report from Goldman Sachs talking about 10% annualized gross domestic product growth in the current quarter.
While the year-over-year comparisons are easy around the pandemic, that’s still a huge number. It is going to take a lot more than federal accountants tinkering with the tax code to take that boom away from us.
And if Goldman Sachs is on the money, we have not seen this level of growth since 1978. A 40-year boom can afford to lose a percentage point or two without turning into a full-fledged bust.
Will Taxes and Inflation Kill the Bull Market? Not Without a Battle
Take corporate taxes, for example. I seriously doubt the Biden administration will be able to take the rate past 25% in a narrowly divided Congress, much less get its sought-after 28%.
In that scenario, we’re looking at a four-percentage-point drag on post-tax earnings growth when, and if, the proposed rules go into effect. If that happened tomorrow, we’d still be looking for roughly 25% higher earnings this year, which is more than enough to support stocks at record-breaking levels.
Maybe the boom will fade in 2022 when and if taxes really become a problem, taking earnings growth with them. We’ll worry about that when it happens.
Will Taxes and Inflation Kill the Bull Market? Not If a New Congress in 2022 Rolls Back Taxes
But here’s the thing about taxes: while they are inevitable, they go up and down. A new Congress can always roll rates back again and give corporate margins a boost.
Meanwhile, the world’s smartest and best-paid accountants will keep proving their worth by taking advantage of every loophole they can find. They’ll come up with new ways to shield profits from the IRS and pass cash through to shareholders.
Likewise, higher capital gains taxes simply give high-income investors an incentive to either sell now or hold on for the political pendulum to swing back in their direction. More active trading strategies will benefit because higher long-term rates eliminate the incentive to hold onto your positions for years instead of months.
Will Taxes and Inflation Kill the Bull Market? Not for Investors Who Forgo Profits
You won’t pay any tax at all if you don’t earn a profit. And if you’re earning substantial “passive” profit as an investor, you’re probably working relatively hard to manage your portfolio.
And there are ways around the IRS. Tax-exempt assets and account structures exist. Look for them to become more important to high-net-worth investors in the future.
Inflation or the IRS: Will Taxes and Inflation Kill the Bull Market?
My YouTube channel is a good place to start for my current thoughts on all of this. For now, I’d simply like to emphasize the inflationary aspect of the world we’re living in now.
These fantastic earnings projections and gross domestic product (GDP) growth rates are a factor of the government printing trillions of dollars through stimulus programs, extremely accommodating monetary policy and simply handing checks to households during the pandemic.
Any economic boom normally generates at least a little inflation because fast growth creates scarcity and forces suppliers to raise their prices. We’re already looking at 4.2% producer inflation, the highest level in roughly a decade.
Will Taxes and Inflation Kill the Bull Market?
So far, most of that price pressure has been absorbed into corporate profit margins, which are already at their third-highest level since 2008. As long as companies have room to swallow inflation, it won’t make it to individual households.
Workers in some industries may even benefit from higher salaries. At least that’s how the theory goes.
Either way, inflation will come first. That’s the threat Wall Street has to negotiate before anything else. Right now, few people seriously expect the inflationary drag to top 3% in the foreseeable future.
In the long term, that’s only average. It is nothing to get worked up about. This is simply how an expanding economy works.
Will Taxes and Inflation Kill the Bull Market? We Have Solutions
Investors normally like an expanding economy because public companies capture the lion’s share of that growth and pass it on to us. Stocks that dominate my IPO Edge come to mind. They’re new to the market, often overlooked on Wall Street and are vulnerable to the market’s mood swings.
But if you’re nervous, consider my Value Authority, where the goal is to lock in dividend yields and buy freedom for the rest of the portfolio to ride the market waves. Dividends may even be spared the worst of the tax proposals on the table now.