What Might SP 500 EPS Estimates Look Like in 2021 with Higher Corporate Tax Rates ?

Briefing.com published a summary of each Presidential candidates tax plan and potential impact on Monday, October 26th, 2020.

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Both candidates want to regulate technology as evidenced by this morning’s theater with Twitter, Alphabet, and Facebook CEO’s.

Tighter regulation is a “PE-compressing” event for the tech sector, which in English means that – while growth rates could continue unphased the next few years – the stocks would trade at lower multiples and valuations just based on the regulation.

It is interesting watching some sectors trade: marijuana stocks have gotten a bid, maybe due to Biden’s prospects, or even Mitch McConnell’s prospects.

Looking at Merck’s response to strong earnings yesterday (big beat and raise) might be telling us President Trump’s prospects are better-than-suspected. The President wants lower prices for prescription drugs, which as a “free-market” Rightie, makes me pretty uncomfortable.

Biden and the Corporate Tax Rate

Thinking about 2021 SP 500 EPS estimates there is no question the biggest haircut would come from a reversion in the corporate tax rate back to 28% – 29% passed under the Tax Cuts & Jobs Act (TC&JA) in late 2017, from today’s approximate 21% rate.

Here is how actual and estimated SP 500 EPS estimates from IBES data by Refiniv look currently:

2021 SP 500 EPS (est): $165.83, +26% y/y growth

2020 SP 500 EPS (est): $131.13, -20% y/y decline

2019 SP 500 EPS (actual) $162.93: +1% y/y growth

2018 SP 500 EPS (actual): $161.93, +23% y/y growth

2017 SP 500 EPS (actual): $132, +12% y/y growth

2016 SP 500 EPS (actual): $118, +1% y/y growth

By showing actual annual SP 500 EPS numbers for 2017 and 2018, readers get to see the impact that the lower corporate tax rate had on SP 500 earnings for the year. 23% – 25% y/y growth was helped by almost half from the lower corporate tax rate of 21%.

Biden / Harris have already said they wish to return the corporate tax rate to 28% – 29%, which if it happened would likely reduce expected the 2021 SP 500 EPS estimate to somewhere between $140 – $150 per share, which doesn’t include their desired changes for higher ordinary income tax rates and the projected increase in the capital gains tax rate, again all of these income tax increases being “PE-compressing” events for 2021.

Summary / conclusion: Higher tax rates under Biden / Harris is the biggest risk for the SP 500 for 2021. A jump from the current 21% rate to the former 28% – 29% rate (and the effective corporate tax rate always moves around as evidenced by last night’s 14% effective tax rate for Microsoft), but investors should expect higher tax rates and lower EPS for the SP 500 in 2021 should Biden / Harris be elected.

For sensitive readers, this is not a political statement either. It’s just SP 500 math. Higher tax rates equals lower EPS, ceteris paribus.

Since 2016, and not including 2020’s expected 20% y/y decline, the “average” SP 500 EPS growth is 9%, just a bit above the long-term average of 7% used within valuation models. If we include the expected 2020 -20% y/y decline in the years since 2016, the “average” rate of SP 500 EPS growth over those 5 years falls to 3%.

2021 could be a grim year if we have the 6th year in a row of low-single-digit SP 500 EPS growth, and that would be optimistic. The proposed increase in the corporate tax rate could result in SP 500 earnings growth in 2021 being negative for the calendar year.

Ed Yardeni had a good call back in late August ’20: he thought at that time the SP 500 had seen it’s high for the year and that we wouldn’t see another all-time-high until 2021.

Much depends on the composition of Congress and whether a “Blue Wave” is more moderate or further to the left.

The reason equal time wasn’t given to the Trump Administration today, is that I don’t think much will change if the President is re-elected. Even with a Blue Congress, the President still has the veto pen.

I do think “SP 500 risk” is all about higher corporate tax rates in 2021.

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