Benjamin Franklin wrote, “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes” in 1789.[i]
I think Franklin, himself a great inventor, could have added another certainty that would have also proved true over these last 232 years — innovation. From the lightning rod to bifocals and from the Franklin stove to urinary catheters, Franklin came up with solutions to make life safer, easier and better.[ii] Imagine what he would think of today’s world that, while still suffering all the pain and sadness of disease so commonplace in his time, has been able to discover and deliver an effective and safe vaccine within one year of Covid-19’s initial infiltration into human beings.
Here we are 232 years later, working our way through a pandemic, and Franklin’s certainties are still that. Deaths continue particularly in the developing world — the latest figures from Johns Hopkins show worldwide deaths from Covid-19 are a stunning and tragic 3.3 million.[iii] Governments have spent enormous sums directly fighting the virus and aiding individuals and businesses that have suffered through shutdowns, and public debt levels have soared.
Meanwhile, the extended tax filing deadline of May 17 is upon us, and the debate about the other certainty, taxes, is taking center stage. How would potential increases in capital gains and corporate taxes affect the economy and the markets? Do we recommend any action now ahead of any final agreement that can muster enough votes to become law?
Do higher taxes hurt stocks?
Unfortunately, the answer is never clear. Why? Tax policy is just one component of an economy and business environment that is continuously factoring in many things. If taxes are going up in an otherwise strong business cycle, the impact may be unnoticeable. Likewise, if taxes are cut in a weak business environment, the hope that they alone can cure the downturn is often met with disappointment.
RBC Capital recently conducted a study of the impact of increased capital gains taxes and concluded that stocks actually rose an average of 11% in the year following an increase. Most recently in 2013, when the tax rose to the current 23.8 percent (from 15 percent) on Americans with the highest incomes, the S&P 500 climbed nearly 30 percent.[iv] This is not to say that the stock market loves capital gains tax increases, but rather that all the factors affecting business cycles in combination can overwhelm changes in tax policy.
This tax negotiation will likely impact corporate taxes, which can clearly have a direct impact on earnings. But businesses can adjust through both price increases and cost efficiencies to lessen the impact of an increased tax rate. We are, of course, monitoring the negotiations — negotiators tend to push off the largest and toughest issues to the very end, and it is unwise to take any potential actions before a deal is done as certain actions may not be so easily undone if the deal takes an unexpected late turn.
In whatever ways tax policy may change, our emphasis on running tax-efficient portfolios will continue to be a mainstay of our investment program, and this will only become more important if tax rates do move higher.
What’s driving this cycle?
In a word, it’s innovation. While government stimulus has helped fill the economic activity gap caused by Covid-19, what is potentially setting us up for a more sustained economic upturn is the mass forced adaptation to the pandemic that has accelerated technologically driven investments by governments, businesses, and consumers.
Fareed Zakaria, the Washington Post columnist, recently wrote a piece entitled: The pandemic has led to innovation. It’s a reason for optimism. Zakaria cites a number of examples from the vaccine development to a salesperson who now makes ten times the number of sales calls per week versus the pre-pandemic period to even New York City ending snow days in schools (too bad for the kids!). While behind the US, Europe is catching up quickly with vaccinations, and its economic cycle should follow accordingly. While the developing world will lag even further, India’s stock market is showing great resilience, and the prospect of significant government reform there is leading to longer-term optimism according to Zakaria.[v]
We have written before about big breakthroughs in innovation including artificial intelligence, robotics, 5G wireless communications, electric vehicles, cloud computing, and life science discovery. Between government stimulus and strong earnings, the investments in these areas should see more advances coming to market sooner and can be an important offset to signs of inflationary pressures building in the economy.
While advances are certain, which ones translate into investment winners is very uncertain. We will always come back to portfolio diversification and being in a position to ride the returns from wherever they emerge. There has certainly been plenty of exuberance in the technology space over the last year. In recent days the technology heavy NASDAQ has pulled back about 7% from its late April highs. Broad-based diversification helps to manage through these inevitable corrections.
What would Ben say?
It has been remarkable how well the global economy has handled the pandemic thanks to innovation in communications and automation and discovery in life science. Barring some other massive dislocation near term, the momentum in this high-tech driven cycle may take us to even more surprising achievements for the rest of the 2020s.
In this world, nothing can be said to be certain, except death, taxes and innovation. I’d like to think the inventor Ben Franklin would approve of this addition to his enduring expression.
John M. Bussel
Chief Investment Officer
[i] Constitution Center — constitutioncenter.org. 2021. Benjamin Franklin’s last great quote and the Constitution — National Constitution Center. [online] Available at: https://constitutioncenter.org/blog/benjamin-franklins-last-great-quote-and-the-constitution [Accessed 11 May 2021].
[iv] Phillips, M., 2021. Why Biden’s Plan to Raise Taxes for Rich Investors Isn’t Hurting Stocks. [online] Nytimes.com. Available at: https://www.nytimes.com/2021/05/03/business/biden-tax-plan-stock-market.html [Accessed 11 May 2021].
[v] Zakaria, F., 2021. [online] Available at: https://www.washingtonpost.com/opinions/global-opinions/the-pandemic-has-led-to-innovation-its-a-reason-for-optimism/2021/05/06/632ce4e8-ae9d-11eb-ab4c-986555a1c511_story.html [Accessed 11 May 2021].
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