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Home / Markets / Stock Markets /  The stock market’s leaders appear most vulnerable to Biden’s tax plan

A corporate tax increase stemming from a Democratic victory in November could undermine one of the strongest drivers of this year’s market recovery, market analysts say.

Democratic presidential nominee Joe Biden has proposed raising the corporate tax rate to 28% from 21%, imposing a new minimum tax on U.S. companies and increasing taxes on foreign income of many U.S.-based multinationals, among other plans.

Mr. Biden’s plan would produce estimated double-digit percentage declines in profits in the information-technology, communication-services and consumer-discretionary sectors, BofA’s analysis found. Those sectors, which are leading the charge in the S&P 500 this year, are home to Apple Inc., Microsoft Corp., Google parent Alphabet Inc., Facebook Inc. and Amazon.com Inc.

Such a hit could challenge the leadership of those stocks—which have helped insulate the market during the pandemic—and test the durability of the 2020 rally.

The S&P 500 has surged 50% from its low in late March and is up 3.6% for the year.

“The concern there is that you have these growth-oriented sectors that have been the primary drivers since the March lows," said Chad Oviatt, director of investment management at Huntington Private Bank. “Do they still have the same tailwinds that they’ve had, or does the idea of tax implications produce a headwind for them that the markets aren’t currently pricing in?"

Three S&P 500 sectors
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Three S&P 500 sectors

The Biden campaign cited a recent Moody’s Analytics report in saying the candidate’s plans would lead to growth and job creation. “Joe Biden’s focus is on the real economy and how it impacts the economic well-being, hopes and aspirations...of all American working families," a campaign official said. “There is no reason that an economic plan that asks everyone to pay their fair share while doing more to reach full-employment quicker with more jobs and stronger growth should not help everyone from essential workers to investors."

As the coronavirus pandemic shut down much of the economy and pushed an increasing share of life online, investors flocked to technology-focused stocks that were positioned to benefit. Amazon shares have surged 69% in 2020, while Apple and Microsoft are up 54% and 31%, respectively. Facebook has climbed 27%, and Alphabet has gained 8.7%.

Effective tax rates
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Effective tax rates

Corporate earnings are the biggest driver of stocks over the long term. However, in recent years, stock prices have climbed faster than profits. Apple shares, for instance, have doubled since 2018, while its profits have been relatively stable.

Broadly, earnings are expected to begin rebounding next year from 2020’s coronavirus-induced slide. Analysts polled by FactSet expect profits among companies in the S&P 500 to rise 26% in 2021.

Investors will get a fresh look at the health of the big tech companies and others later this month, when third-quarter earnings season kicks off in earnest. This week, they will examine jobless-claims data to gauge how quickly the labor market is recovering.

Many investors have said conditions are prime for a revival in value stocks, pointing to an improving economy, accelerated potentially by the deployment of a coronavirus vaccine. Value stocks, which outperformed their growth counterparts in September, are often defined as those that trade at a low multiple of their book value, or net worth.

Source: BofA Global research
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Source: BofA Global research

Predicting a strong economic recovery would boost cyclical stocks, Morgan Stanley Wealth Management bought shares of industrial, materials and financial companies in the spring while trimming its position in technology, said Chief Investment Officer Lisa Shalett.

The proposed tax changes “would help accelerate that sector rotation because the relative impact would probably be larger on some of the companies that have dominated," she said.

Mr. Biden’s proposal for higher taxes on foreign income is expected to hit tech stocks particularly hard. The tech sector derives just 43.5% of its revenue from the U.S., compared with 60.3% for the S&P 500 as a whole, according to FactSet estimates.

Another wild card for big tech companies is the possibility of a crackdown by regulators. The Federal Trade Commission is gearing up to file a possible antitrust lawsuit against Facebook, and federal and state authorities have investigated Google over a range of potential antitrust issues, The Wall Street Journal has reported. Facebook has defended its acquisitions, saying apps like Instagram became more popular because Facebook improved them. Google has said its products expand competition and level the playing field for small businesses.

Goldman Sachs Group Inc. analysts have also raised the possibility of a shift in momentum in the stock market, partly because of Mr. Biden’s call for raising the top capital-gains tax rate.

Past increases have hit the market’s leaders ahead of the increase particularly hard, the analysts wrote in a recent report.

Still, investors caution against drawing firm conclusions about how stocks would perform in the wake of any tax changes. They also note Mr. Biden would be unlikely to succeed in raising taxes unless Democrats also win control of the Senate, and that even then, any further downturn in the economy could lead to a delay in attempting an increase.

In 1993, President Clinton signed a deficit-reduction package that raised the corporate income tax. The S&P 500 posted a small loss in 1994 but went on to notch double-digit percentage gains each year for the rest of the decade, which was a time of technological innovation and rising globalization.

“All else being equal, tax increases are a negative for equity investors, but all else is never equal," said David Donabedian, chief investment officer of CIBC Private Wealth Management. “There’s always other stuff going on."

Other investors say the pace of the economic recovery, success at countering the coronavirus and the Federal Reserve’s commitment to keeping interest rates near zero will play a larger role in determining the stock market’s trajectory.

Plus, even when an election result is known, it isn’t always clear how the markets will react. Mr. Trump’s surprise win four years ago prompted a sharp drop in stock futures overnight. But stocks rallied the next day and went on to soar to records, boosted by the 2017 tax cuts and strength in the global economy.

Another moving piece of the puzzle: Mr. Biden’s proposals call for trillions of dollars in new spending, including a plan to combat climate change while rebuilding the country’s infrastructure.

“A large increase in fiscal spending, funded in part by increased tax revenue, would boost economic growth and help offset the earnings headwind from higher tax rates," the Goldman analysts wrote.

Write to Karen Langley at karen.langley@wsj.com

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