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MONTHLY INVESTMENT BRIEF

MAY 2021

Corporate and personal taxes are expected to rise in the US over the next 12 to 18 months.

Corporate taxes look set to increase under the American Jobs Plan. Among other things, the plan provides for an increase in the tax rate from 21% to 28% and a higher minimum tax on foreign profits. We have already commented extensively on the estimated impact on earnings (a reduction of around 10%), which for the time being remains largely overlooked by investors as growth momentum is strong.

In terms of personal tax rates, the reform could prove more dangerous for equity markets. Under the American Families Plan, Biden is proposing to raise the marginal rate to 39.6% for taxpayers earning $400,000 or more, and also to dramatically increase the tax rate on capital gains for those earning more than $1 million from a base rate of 20% to 39.6%. The 3.8% tax on investment income that funds Obamacare would remain, taking the total capital gains tax rate to 43.4% for this group of taxpayers. We are almost tempted to say "Welcome to France"! This increase is likely to have significant repercussions. For individuals earning more than $1 million, the proposed change in the capital gains tax rate would bring the rate back to the level that prevailed in the late 1970s. Given the current valuation of stocks, it seems hard to imagine that such a shift would not trigger a short-term sell-off of stocks to lock-in profits at lower tax rates.

We have identified other risks that could limit risky assets’ upside potential, such as new variants, tapering in the US, and tougher credit conditions in China, but none of these appear to be much of a threat.

Accordingly, we remain constructive on equities for the coming 6 to 12 months and advise investors to continue overweighting stocks vs. bonds. Within equities, we are overweighting value stocks vs. growth stocks, cyclicals vs. defensives, and small and mid caps, even though some of the readjustment of performance in small caps has already played out. Meanwhile, we remain short the US dollar.

Within a global equity portfolio, we continue to overweight non-US equities (in Europe and emerging markets) with a view to a catching-up phase, as – let’s face it – their current lag had not been expected when the year began.

Lastly, we are keeping duration low in the portfolios and limiting our credit exposure to short-dated high-yield bonds.

As you can see, we expect rotation (we’ll call it cyclical rotation) to resume. We are therefore raising our weighting of banks, with a more comprehensive angle to capture sector disruption, which is proving to be more horizontal than vertical. Payments, digital finance, fintech – the bourgeoning promises in finance are unlikely to disappoint this time. Goldman Sachs’ 30% ROE tells us how good the going is in banking. At 0.6 times book value in Europe, there is still time to build up a stake.

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