In just over five weeks, voters will decide the future direction of the country for the next four years. The upcoming elections present a pivotal moment, with various policies that could profoundly influence both corporate America and taxpayers alike.
A central point of concern for investors is the potential impact on corporate tax rates. Former President Donald Trump’s Tax Cuts and Jobs Act had significantly reduced the corporate tax rate from 35% to a historically low 21%. In contrast, Vice President Kamala Harris, now the Democratic presidential nominee, has proposed an increase in the corporate tax rate to 28%, positing that this hike could generate essential revenue for the government.
The essential question on many minds is whether an increase in corporate taxes will lead to a downturn in the stock market. To shed light on this concern, we can turn to historical data for guidance.
Harris’s proposal for a corporate tax hike stems from a broader economic context. Since 1970, except for a brief period between 1998 and 2001, the federal government has consistently spent more than it generates in revenue, resulting in escalating national debt, which has reached around $35 trillion. As the cost of servicing this debt continues to rise, proposals like Harris’s aim to enhance federal tax revenues, with estimates suggesting an additional $4.1 trillion from 2025 to 2034, according to the Tax Foundation.
On paper, increasing corporate tax rates might appear detrimental to businesses, as companies may have less capital for hiring and innovation. However, historical analysis often paints a different picture. Research conducted by Fidelity reviewed several periods since 1950 during which corporate tax rates were raised. Surprisingly, five instances of tax hikes—specifically in 1950, 1951, 1952, 1968, and 1993—yielded positive average price returns for the S&P 500 of 22%, 16%, 12%, 8%, and 7%, respectively, resulting in an average gain of approximately 13%. This trend suggests that corporate tax increases have not led to the anticipated drops in stock values historically.
While such historical patterns are not infallible, they indicate that the connection between corporate tax hikes and stock market performance may not be as negative as one might assume. However, investors also face broader concerns beyond tax policy, with the stock market currently operating at high valuations.
Regardless of the election outcome in November, whether with Harris or Donald Trump, the incoming administration will inherit a stock market characterized by high P/E ratios that reflect elevated valuations. The S&P 500 has recently achieved record highs driven by advancements in artificial intelligence and overachieving corporate earnings. Yet, the Shiller price-to-earnings (CAPE) ratio suggests that these valuations are among the highest seen in over a century, signaling potential market correction risks.
In September, the S&P 500’s Shiller P/E ratio was reported at 36.9—significantly above the historical average of 17.16. Instances where this ratio exceeded 30 during bull markets have historically been followed by declines in market value, with losses ranging from 20% to as much as 89%. This pattern emphasizes the importance of caution for investors navigating this high-stakes environment.
As the country moves closer to the elections and subsequent policy shifts, potential investors must weigh the implications of such changes. Amid the uncertainty, focusing on company fundamentals and market valuations will be key.
While there’s a growing debate around the effects of higher corporate taxes, the evidence suggests that it shouldn’t be the sole concern for investors. Historical performance data indicates that increased corporate tax rates have not uniformly harmed stock prices. Instead, the overarching concern may lie in the lofty valuations in the market, making future investment decisions more challenging.
Whether or not you decide to invest in the S&P 500 in the current economic climate, assessing the potential of individual stocks could offer better opportunities. Engaging with stocks that are distinct and poised for growth might yield better returns than relying solely on index performance. In such a dynamic market landscape, strategic investment choices are crucial for navigating the road ahead.