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Market MovesApril 26, 2021

Don’t Worry: Higher Cap Gains Tax Won’t Zap the Market, UBS Says

And it probably won’t be as high as Biden wants, Goldman adds.

News that President Joe Biden wants to hike capital gains taxes for the wealthy did not go over well on Wall Street last week. The S&P 500 on Thursday slid almost 1% at the prospect.

But maybe, just maybe, such higher taxes on gains from selling stock and other investment assets won’t slow market appreciation after all. Why? Because cap gains tax boosts haven’t in the past, UBS says. And anyway, it’s unlikely the rate will go anywhere near as high as Biden is proposing, by Goldman Sachs’ thinking.

The administration reportedly plans to raise the top cap gains rate to 39.6%, for those earning more than $1 million yearly. When the current 3.8% levy on high-net investment income is added in (it pays for the Affordable Care Act), that would be quite a bite for well-off investors, whose top rate for these gains has been 20%. Biden is set to unveil his proposal Wednesday during his address to Congress.

The odd thing about the Friday selloff was that Biden’s idea should come as no surprise: He repeated it often on the campaign trail last year.

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“Certainly, there is a sell first, ask questions later mentality to this,” Brian Gardner, Stifel chief Washington policy strategist, told CNBC. “We don’t know the date when it’s effective yet. I think that’s why we’re seeing the reaction right now.”

Meanwhile, a research note from UBS pointed out that cap gains tax raises don’t have much of an effect on the market. The last one, in 2013—a 10 percentage point tax rate increase, to 25%—didn’t stop stocks from climbing 30% for the year, according to the report from the bank’s CIO for global wealth management, Mark Haefele.

“There is no relationship between changes in capital gains and the performance of the US stock market,” Haefele and his team wrote. One reason UBS cited was that cap gains tax only affects a minority of stock investors: taxable domestic investors own just 25% of equities, with the rest controlled by pension plans, endowments, foreign investors, etc., who aren’t subject to the levy.

More important to stock prices, Haefele and his crew reasoned, are economic growth, monetary policy, and interest rates. To UBS, these are “much more powerful drivers.”

Unmentioned was the oft-remarked-upon fact that wealthy taxpayers often have access to the legerdemain of canny accountants and tax lawyers, who minimize the take of the Internal Revenue Service. So that 39.6% rate may end up, practically speaking, much lower for many well-heeled folks.

Goldman, in its report, predicted that the Biden-proposed rate would never stand, and the firm forecasts that the level would end up at 28%. And the new rate regime would not start until the beginning of next year, Goldman opined.

Reason: Both houses of Congress are only narrowly controlled by the Democrats. “We expect Congress will pass a scaled-back version of this tax increase,” Goldman economists, under Alec Phillips, wrote in their note. “While it is possible that Congress might pass the proposal in its entirety, we think a moderated version is more likely in light of the razor-thin majorities in the House and Senate.”

As to the timing of it, Phillips wrote that although “a retroactive increase cannot be ruled out entirely, we believe it is very unlikely that it would apply to gains realized before May 2021 (at earliest).”

Credit Investments to Watch: Private Credit, Securitized Credit, and Alpha-Oriented Mandates

Asset owners should dig their heels into renewables financing, bank capital relief trades, and other less ‘vanilla’ strategies, says Willis Towers Watson.

By Sarah Min

Private credit, securitized credit, and alpha-oriented mandates are all strategies that investors should dig deeper into, as they search harder than ever in a low-interest era for attractive yield in the credit markets, says Willis Towers Watson.

Among opportunities investors should consider in the private credit markets are direct lending strategies, renewables financing, and bank capital relief trades, according to a report, released Monday from the consulting firm, called “Covid and Credit — One Year Later.”

Willis’ analysts did not find direct lending strategies attractive before the pandemic, but the sector has improved since then, they said. The illiquid investments have been slower to price in changes than the public markets.

“You have to make sure that you’re identifying the right strategies because you are locking up capital for the long term, but we find a lot of investors probably have a little bit more liquidity than they actually need,” said Mike Fontaine, director of investment research at Willis. “And so right now is a good time to take a step back, see how much liquidity you actually need, and then potentially added some private credit-type strategies in the portfolio.”

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Another opportunity in private credit: renewables financing, which the firm calls the “rare” strategy that offers investors competitive returns and also allows them to integrate environmental, social, and governance (ESG) elements into their portfolios.

Another niche private credit strategy that has been generating buzz? Bank capital relief trades. The asset class helps banks unlock some relief from the regulatory pressures requiring they maintain higher levels of capital on their balance sheets.

It’s been criticized by regulators in the past for appearing too much like the structured products that came to grief in the financial crisis. But the asset class has also gained wider acceptance on Wall Street in the years since the 2008 recession.

“This is a strategy that, for an investor, may not have really existed as an option, say, 20, 30 years ago, and now it does, and offers you what we think is pretty competitive returns for the risk you’re actually taking,” Fontaine said. “That’s why we like it.”

In lower quality securitized credit, questions remain for investors regarding commercial mortgage-backed securities (MBS), even with the rollout of the vaccine and the general improved outlook of the economy one year into the pandemic. Nevertheless, investors can still find value in offices, hotels, and housing if they partner with skilled active managers that have the resources and expertise to snap up the right properties.

Within alpha-oriented mandates, the consulting firm is changing up its high-yield sleeve. It’s hiring three or four managers with 30 or 40 issuer portfolios to place more concentrated bets across the firms the managers have the highest conviction in. Willis is aiming for better alpha, instead of index-like performance.

It’s also adding specialist managers to track emerging market debt, particularly in Latin America, Africa, and Asia, for on-the-ground expertise.