Will Higher Taxes Damage Your Portfolio?

Do higher taxes equate to negative stock market returns? Does any one economic variable accurately predict stock market performance?

A number of Net Worth Advisory Group clients have indicated they are concerned about the impact higher taxes could have on the stock market.  News organizations and campaign rhetoric create the impression that there is a cause and effect relationship between taxes (or whatever the hot discussion topic is) and stock market performance.  Since 1926, the stock market has obtained positive returns during a calendar year 72% of the time. Here are the facts about how various economic variables have impacted investment returns:

·         PERSONAL INCOME TAXES:  From 1926-2011 there were 20 years where personal income taxes (for incomes over $150,000, adjusted for inflation) increased over the previous year.  The stock market went up 13 of those years, or 65% of the time.

·         CORPORATE TAXES: From 1926-2011 there were 11 years where corporate taxes increased over the previous year.  The stock market went up 6 of those years, or 55% of the time.

·         LONG-TERM CAPITAL GAINS: From 1926-2011 there were 11 years where the long-term capital gains tax rate increased over the previous year.  The stock market went up 9 of those years, or 82% of the time.

·         INTEREST RATES: From 1956-2011 there were 27 years where interest rates (measured by the Treasury Bill) increased over the previous year.  The stock market went up 24 of those years, or 89% of the time.

·         INFLATION: From 1926-2011 there were 43 years where the inflation rate increased over the previous year.  The stock market went up 33 of those years, or 77% of the time.

·         NATIONAL DEBT:  From 1940-2011 there were 38 years where the national debt as a percentage of gross domestic product (GDP) increased over the previous year.  The stock market went up 30 of those years, or 79% of the time.

·         DEFICITS SPENDING: From 1926-2011 there were 38 years where deficit spending increased over the previous year.  The stock market went up 30 of those years, or 79% of the time.

·         COMPANY PROFITABILITY:  From 1961-2011 there were 25 years where the earnings of S&P 500 companies increased over the previous year.  The stock market went up 21 of those years, or 84% of the time.

·         COMPANY DIVIDENDS:  From 1961-2011 there were 21 years where S&P 500 companies increased their dividends over the previous year.  The stock market went up 17 of those years, or 81% of the time.

·         UNEMPLOYMENT:  From 1948-2011 there were 20 years where the unemployment rate increased over the previous year.  The stock market went up 9 of those years, or 45% of the time.

As the data indicates, there is no single economic variable, positive or negative that consistently predicts stock market performance. The market may produce positive or negative returns in 2013, but it’s not likely to be because the personal income tax for high income families increased.

It’s worth noting that the only economic factor that led to a declining market more frequently than not is rising unemployment. While the unemployment rate remains at 7.8%, high by historical standards, it has been steadily decreasing since October of 2009 when it reached 10%. Additionally, the only other individual indicator that seems to have even a marginally significant negative impact on stock market returns is an increase in the corporate tax rate; if President Obama can get Congress to agree with him, he would like to decrease that rate from 35% to 28% next year. Consequently, history indicates that neither rising unemployment nor increased corporate tax rates will apply in 2013 and should not hamper stock market returns.

MY ADVICE

History has taught us over and over again that time in the market is much more important than timing the market.  It has also taught us that one of the biggest mistakes investors make is to say “these conditions have never existed before and this time is different.”  Need a recent example? Remember the general consensus investors reached about Europe near the beginning of the year? It may surprise you that Europe (as measured by the Vanguard MSCI Europe ETF) has returned over 17% year to date, significantly outpacing the growth of the S&P 500.

I believe the best game plan is to develop a fundamentally sound diversified portfolio, only investing money you don't anticipate spending for at least 10 years, and stay the course.