With just a month to go, election fever is gripping the nation. On November 5, voters will choose between two stalwarts, Vice President Kamala Harris and former President Donald Trump, to steer the reins of the nation for the foreseeable future.

While not every Presidential decree reverberates on Wall Street, economic policies dictated by the upcoming regime have a direct line to corporate profits, thereby casting a shadow on the stock market to some extent.

On the financial tarmac, where bulls and bears tread cautiously, one proposition is turning heads. Harris’ proposal to inflate the corporate tax rate by 33%, taking it to 28%, has the potential to tip the scales in a manner we might not appreciate at first glance.

Vice President Kamala Harris speaking with reporters. Image source: Official White House Photo by Lawrence Jackson.

The Impact of Corporate Tax Hike on Stocks: Beyond the Obvious

Kamala Harris’ rationale behind heaving taxes on corporations sprouts from the perennial and swelling federal deficits plumbing our economy.

With the exception of a brief respite from 1998 to 2001, the federal outflow has surpassed its inflow since 1970. The national debt now perches at $35 trillion, with an annual debt service cost of approximately $1.05 trillion as of August 2024, according to the U.S. Department of the Treasury. This trajectory veers towards an unsustainable precipice.

Forecasts from the Treasury Department suggest that elevating the corporate tax rate by a third to 28% would jack up federal tax revenue by a cumulative $1.35 trillion over the next decade.

Nevertheless, the repercussions of hiking corporate taxes might reverberate on Wall Street in unforeseen and unintended ways.

The anticipated aftermath of a soaring corporate tax rate is a diminished capital reservoir for businesses to grease the wheels of their operations. Consequently, it could herald a slower pace of recruitment, a dearth in acquisitions, and lesser spending on research and development. Traditionally, hiring, acquisitions, and innovation act as the fertilizer that nurtures business growth.

Nonetheless, there looms a subtler concern that might send the stocks plunging if the corporate tax rate ascends by 33%. Shrinkage in available capital for publicly-traded companies could curtail a pivotal source of earnings uplift in recent times: share buybacks.

Share buybacks have fueled earnings growth for Apple and other bigwigs on Wall Street. AAPL stock buybacks (quarterly); data by YCharts.

For companies with a steady or burgeoning net income, share repurchases can swell earnings per share (EPS). As the tally of outstanding shares dwindles over time, EPS is poised to soar, painting the company as a more alluring investment option.

Bouldering back to the trailing-12-month epoch concluding in March 2024, S&P 500 (SNPINDEX: ^GSPC) entities wrapped up buybacks worth $816.5 billion, a smidge lower compared to the zenith of $1.01 trillion from the tenure finale of June 2022, as per stats from S&P Global.

What’s crucial is that the first quarter of 2024 witnessed 50.9% of the total buybacks traceable to the top 20 firms by market cap on the S&P 500 index. Buybacks have been the fuel for earnings escalation in the titan firms of America, but the same might not hold true if Harris steers the ship come November and garners the votes on Capitol Hill to hike the corporate tax rate by a third.

For instance, the apex publicly traded entity by market cap globally, Apple (NASDAQ: AAPL), has bought back $700.6 billion of its shares since early 2013 and shrunk its outstanding share count by 42.2% in the process.

If Apple abstained from repurchasing a single share over the past eleven years, its consensus EPS for fiscal 2024 (closing on Sept. 30) would stagger below $4, instead of the present $6.68. Perhaps, no other company has witnessed a more robust bottom line uplift in recent times courtesy of share repurchases like the stalwart of Wall Street.

If at all there’s a silver lining to fathom, a scrutiny by Fidelity disclosed that the benchmark S&P 500 scaled up by an average of 13% post every corporate tax elevation post-1950. Despite no guarantees backing a potential stock lift if Harris ramps up corporate tax rate from 21% to 28%, historical testimonies seem skewed toward the continuation of the ongoing bull market.

Image source: Getty Images.

Could This Pose a Graver Threat than Diminished Share Buybacks?

Despite share repurchases artificially inflating EPS figures for Wall Street’s behemoths, a surge in the corporate tax rate could put the brakes on these buybacks

The Dilemma of Pricey Stock Markets

In the intricate dance of the financial world, the current buzz isn’t around volatile political activity, but rather the dangerously bloated stock market valuations that threaten to upend equities into a tailspin. The focal point isn’t who will claim the presidential seat on Nov. 5 but instead the historically exorbitant prices the stock market has been sporting lately. A trend that could sound the death knell for Wall Street, regardless of the political outcome.

Delving into the labyrinth of valuation metrics, the S&P 500’s Shiller price-to-earnings ratio, also known as the cyclically adjusted price-to-earnings ratio, paints a troubling picture. Out of more than 150 years of market history, only a few instances have seen stocks soar to such lofty heights. Unlike the traditional P/E ratio, which merely considers trailing twelve months earnings and can easily be skewed by extenuating circumstances, the Shiller P/E ratio takes the average inflation-adjusted earnings of the past decade into account—providing a more robust valuation yardstick.

As of the recent market close on Oct. 3, the S&P 500’s Shiller P/E ratio hit a staggering 36.6, double its historical average of 17.16, stretching back to 1871. Despite factors like lower interest rates and the widespread accessibility of information due to the internet, a Shiller P/E nearing 37 looms as a colossal warning sign. It dredges up poignant memories of past instances, where the market plummeted following such stratospheric valuations.

The Dark Shadows of History

Glancing back through the annals of history to 1871, one can unearth a grim reel of just six occasions where the S&P 500’s Shiller P/E ratio soared past 30 during a bull market—signaling caution. In each of these historical episodes, ensuing market downturns saw the S&P 500, Dow Jones Industrial Average (DJINDICES: ^DJI), and Nasdaq Composite (NASDAQINDEX: ^IXIC) bleeding out, shedding between 20% to a gut-wrenching 89% of their value.

The Shiller P/E is no crystal ball for timing the market—it lacks the precision to predict when stocks will nosedive but boasts a stellar track record of foreshadowing significant downturns in the S&P 500, Dow, and Nasdaq Composite indices.

The Titanic Battle of Corporate Taxes vs. Soaring Valuations

While concerns loom over Kamala Harris’ proposed corporate tax hike potentially ruffling Wall Street’s feathers, the elephant in the room remains the sky-high valuations strangling investors—a conundrum that shows no signs of abating anytime soon.

What does this mean for investors, especially those contemplating a plunge into the S&P 500 Index? The advice is to tread cautiously. Market history whispers cautionary tales that should not be dismissed lightly while the present stock valuations tower precariously above historical averages.