The US fiscal cliff battle drags on. Taxes will rise on 1 January - investors fear if a deal isn't reached in time, higher taxes will cause a recession and bear market. It's a false fear, and false fears are always bullish.
First, the "fiscal cliff" is fake. Politicians made it; they can move it. The cliff first loomed in 2010 and politicians, fearful of angry constituents, kicked it past 2012 elections. They can do it again past 2014 - same logic. Even if there's no deal by year-end, they can delay implementation, by a month or two or 17. It's up to them! They did it in 2011 - they delayed the payroll tax holiday expiration by two months to buy time to compromise on a longer extension. These deadlines are political, fake, and can be moved.
And they want to compromise - particularly Democrats. They have 20 Senate seats up for election in 2014 and Republicans just 13. And nine of those seats are in vulnerable states which Democrats took from Republicans in 2008. Those seats can easily flip back. Democrats don't want to face voters angry over taxes.
Even if there's no deal and taxes rise, there's a vast history of tax rate moves in the US, UK and globally and no evidence that rate moves - up or down - are predictive for immediate future economic or market direction. No recession I can find was ever caused by a marginal tax increase. I don't like higher taxes, but not because they cause recessions. Provably, they don't.
How do hikes affect stocks?
As for stocks, in the US there have been 27 major income tax rate changes since 1928 - 15 cuts and 12 hikes. (I use the US for its longer data history, but it's the same in the UK and globally.) What did shares do after? Overwhelmingly, no matter whether taxes were cut or hiked, shares rose - 70.4% of the time. After 10 of the cuts, shares were positive 12 months later. Shares fell after just five cuts, which means shares were twice as likely to rise as fall after a tax cut.
That doesn't surprise you. What surprises you is shares were up 12 months following nine tax hikes, but fell after just three hikes, i.e., shares were three times as likely to rise after a tax hike, the opposite of what most think. People automatically assume tax hikes weigh on shares, but history and evidence don't support that. In fact, the reverse!
More amazing are capital gains tax (CGT) moves. Since 1928, there have been six cuts and nine hikes - 87.7% of the time, regardless of CGT rate direction, shares were positive 12 months later. Shares rose, five to one, after CGT cuts, but shares rose eight to one after hikes. Some may view that and form a new myth, believing, perversely, shares like tax increases. No. All it means is shares always and everywhere rise much more than fall over time.
Then, too, tax policy is inherently local and global factors matter much more. Tax rate moves are near meaningless for shares. But the fear is bullish - when expected disaster doesn't arrive, that positive surprise can boost shares, such as pharmaceuticals giant Pfizer (PFE).
Pfizer has a prodigious range of top-notch brand names, and a stream of new products will capture growth from an ageing developed-world demographic, plus new emerging middle classes overseas - all wrapped in a classically cheap stock.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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