Home > Potential Tax Rate Increases Weighing on US Stocks

Potential Tax Rate Increases Weighing on US Stocks

The US stock market indices are close to their all-time highs ahead of the July 2021 NFP report. Despite headwinds, such as potential tax rate increases, the put-call ratio is at the lowest since Q3 2000.

The US equity market continues to find buyers on every dip. The easiest way to explain the stunning rise of the stock market during the pandemic is via the interest rates levels.

Interest rates are the price paid for deferred consumption. But when they are reduced to zero (or below zero, as some major central banks did), such a move has a deep impact on society. Businesses and households are scrambling to find out other ways to gain an extra yield in investments. The preferred way during the pandemic was to invest in the stock market.

Some headwinds do exist—for example, potential tax increases.

The chart above shows the share of each sector on the total market capitalisation of the S&P500 index. It suggests that there is room for tax increases that may affect the stock market. However, any change in regulation is likely to affect the US large-capitalisation stocks, so small and medium businesses may end up unaffected.

Overvalued Long-Duration Equities

Speaking of the large-capitalisation stocks in the United States, long-duration stocks are the most overvalued ever. Coupled with the potential tax increase, it is yet another reason to worry about a possible bubble in the stock market.

Lowest Put-Call Ratio in Two Decades

Despite warning signs and potential headwinds ahead, such as the Fed’s tapering of the asset purchases, the wind behind the rising market continues to blow. In fact, judging only by the put-call ratio, at its lowest in the last two decades, the bullish run may easily continue.

The put-call ratio reveals investment sentiment. A declining ratio suggests more call options contracts are bought than put options. As a reminder, when buying a call option, investors expect the price to increase. When buying a put option, they expect the price to decrease.

The decline in the put-call ratio suggests that more upside is possible. Considering that summer trading months just began, we may see further upside in US equities until at least the Jackson Hole Symposium in August.

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