Biden’s Tax Plan Spooks the Markets | Barita Insights | April 26, 2021

On April 22 Bloomberg released a report detailing President Joe Biden’s forthcoming Capital Gains Tax (‘ proposal The report noted an almost doubling of CGT for wealthy individuals (those earning at least US 1 million annually) from 20 0 to 39 6 Coupled with an existing surtax on investment income, the increase implies that federal tax rates for investors could be as high as 43 4 The official proposal is expected to be released this week as part of the tax increases needed to fund the President’s “American Families Plan” This comes as no surprise within the current political environment as President Biden made his intentions clear during his campaign Notwithstanding, the speed at which the Biden administration will initiate the proposal and the high rate of the tax caught many market participants off guard last Thursday Today, we assess the implications of this tax increase for markets

Short term market moves
Within minutes of the news, stock indices plunged as investors and traders alike quickly reacted and “sold the news” The reason for the decline is quite simple, a CGT means each time an investor buys/sells financial assets, the government gets a cut An increase in the CGT therefore increases the government’s share of the gains and reduces the investor’s portion Consequently, many investors sold these assets to take some of their profits now, as opposed to later and risk sharing a bigger piece with the government

Perspective
While the markets reacted suddenly and severely to the news, it’s important to note that policy requires negotiations and Biden won’t start at a low point he’ll start high so when the negotiations are really underway, he can compromise without “giving up too much” Within that vein, most analysts believe that the democratic “sweet spot” is 30 Of course, 30 is still well above 20 but similarly, it’s significantly lower than 39 6 Additionally, if we put this into greater perspective, at 30 it just brings markets back to the pre 2018 tax rate Once the market digests the potential change, it should occur to investors that the increase isn’t unchartered territory

History
What’s also quite important to note is that in matters of this nature, history comes in handy If we go back to the last major CGT increase in 2013 the way the market handled the impending increase is quite instructive Specifically, once investors were certain that a CGT was imminent, the S&P 500 fell in late 2012 However, it then rose slightly, closing the year just above where it peaked in April 2012 In 2013 the year of the CGT increase, the S&P 500 boomed growing by 29 6 and has continued to boom up until the pandemic induced decline in March 2020 Consistent with this, Goldman Sachs’ Chief strategist, in October last year, affirmed the bank’s view that any sell off in equities from a CGT increase would be short lived and reversed in subsequent quarters, as history has shown

Options are few
The next major consideration in our view, are options The simple truth is that the COVID 19 pandemic has shifted the investment landscape in such a way that risky assets have become the bedrock of many portfolios globally Will this change? The possibility exists but investors are somewhat boxed in As rates remain anchored to Central Banks’ low short term policy rates, the fixed income market, which had typically been the other side of the coin as it relates to portfolio weightings, has become less attractive from a relative return perspective Additionally, cash has become increasingly worthless in a portfolio, particularly in the short term where we see inflation expectations rising With that said, how does an intelligent investor sell equities to avoid a CGT increase without consideration for the opportunity cost of no longer being invested? We believe the short answer is that they do not The major nuance here, however, is stretched valuations, particularly among tech companies Essentially, while history has pointed to a quick rebound and options are few, elevated valuations in some sectors may cause some additional volatility as we draw closer to an actual tax increase

Concluding Thoughts
In closing, we note that while the S&P 500 displayed increased intraday volatility on April 22 and declined by just under 1 at the end of the day, the Index recovered the losses by April 23 With that said, we believe the historical precedence combined with the limited options should buttress markets Notwithstanding, some sectors could witness some pullback as imminent taxation weighs on already stretched valuations Finally, regardless of the near to medium term market moves, Barita continues to assess the global markets and express our thesis on global equities through the FX Growth Fund which our clients can benefit from directly