Could big tech antitrust and capital gains tax proposal upset equities?

The change will not come overnight, but investors with exposure to large technology companies cannot ignore the regulatory change that is coming to the US. In the end, it will be good for competition in markets, but bad for shareholders.

Is Biden’s doubling of capital gains tax an issue for markets?

The big news from yesterday was Biden’s new economic plan focusing on restoring more wealth and income equality by lifting families in the lower half of the population. A core pillar of this reform is through doubling the marginal capital gains tax from the current 20% to 39.6% for the very wealthy individuals which get a majority of their entire income from capital gains and not labour income. As with Lina Khan and antitrust, this potential change in the capital gains tax is a move to equalize the taxing of labour and capital income. Alan Greenspan famously said in a 1997 Senate hearing that the optimal capital gains tax rate is 0%, so one could argue that the Biden administration is making a hard U-turn on the last 40 years of policy centered around the ideas of Alan Greenspan and Milton Friedman.

In a historical context, the 39.6% marginal capital gains tax rate would take the US back to where it was in the 1970s. The big question is whether it matters to markets or not. The most direct impact is that investors in the US will experience a drop in their after-tax returns and thus capital will accumulate a slower growth rate. In theory the required rate of nominal return on bonds and equities by investors should go up, or at least they want it to go up, but ultimately the required rate of return is driven by supply and demand dynamics.

If in fact the required rate of return increases from the rise in the capital gains tax, then it will be negative for all asset classes during the adjustment phase. But the longer-term growth rate of earnings should not be impacted, and thus nominal returns are unaffected. A change in the corporate tax rate is much more negative for equities and will be discounted immediately, but then earnings growth will again continue a long its long-term trend. The various regimes of capital gains tax and corporate tax rates in the US have almost zero correlation to the long-term trend or changes in corporate earnings, so investors can sleep well tonight.

But one non-public asset class that could be affected by higher capital gains tax rate is the private equity and venture capital, as this group feeds on capital accumulation and thus if the after-tax growth rate is lower the pool of capital available will also shrink over time relative to the demand for capital if we assume the growth of ideas needing capital is unchanged.

Review of earnings from Intel and Snap

The two most important earnings yesterday came after the market close from Intel and Snap. Investors were spooked by Intel’s 20% drop in data center revenue from $7bn to $5.6bn and drop in operating income from $3.5bn to $1.3bn (see earnings slide below). Intel’s data center group is the most profitable segment of the company and investors are worried that it is losing market share and is not competitive enough. The new CEO Gelsinger was direct on the conference call saying that the company is focused on investments to become a technology leader and executing on its new foundry strategy developing computer chips for others in which the company already has 50 customers lined up. Gelsinger also said on the conference call that the computer chip shortage could last years, which is a very different picture than what has been communicated so far by other companies in the global semiconductor industry.

Snap was the first online advertising platform to report Q1 earnings and the company beat on both revenue and EBITDA while providing a Q2 outlook of break-even on EBITDA bolstering investor sentiment that Snap is still both fast-growing and becoming profitable. The tailwind is still evident in online advertising and should lift all online advertising stocks today such as Facebook, Google, Twitter, and Pinterest. To what extent the reopening of the physical world will have on online advertising we will not know until we get Q2 numbers where the base effect is tougher.