Rates? Sure. Taxes? Maybe.

By:

Chief Strategist at Interactive Brokers

Another day, another decline.  It’s the Monday of a short week for many global markets[i], and US equities are off to a particularly rocky start.  The obvious culprit is one that has become increasingly obvious – 10-year Treasury rates rose by another 7 basis points, pushing them above 2.75%.  Yet it is entirely possible that many pundits are ignoring a more fundamental factor weighing upon markets this week – Tax Day. 

There, I said it – the dreaded three letter word.  But it seems disingenuous to ignore a factor that affects everyone’s finances, especially when it looms over an already volatile market.  US taxpayers are all too familiar with the usual April 15th tax deadline, even if it is actually on the 18th for most of us this year.[ii]  From a stock market viewpoint, the tax deadline looms this week, and that could be posing a problem for stock prices.

Bottom line – many investors owe more tax than usual this year thanks to last year’s bull market, and that money has to come from somewhere.  If those taxpayers are fully invested, they need to sell some of their holdings to pay their looming bills. 

The problem is actually a high quality one.  Making money in markets is a good thing.  Many investors realized either short- or long-term gains on profitable investments that they sold in 2021.  Yet they may find themselves short of available cash, because is customary for investors to reinvest their profits into other investments — particularly when interest rates on savings are close to zero.  The tax issue can be particularly acute for those who utilized short-term options for speculation or income and those who employed short-term trading strategies.  They could be facing substantial bills for a year’s worth of successful trading. 

As with any market hypothesis, it is difficult – if not impossible — to prove with certainty that money is being raised to pay taxes and whether that selling is sufficient to be causing the markets’ declines.  If it is true, though, we would expect to see the selling abate this week.  The last day that one can sell stocks for settlement on April 18th would be this Wednesday, the 13th.  Those of us who prefer a bit more certainty, preferring to have the cash safely in their account before writing a substantial check to the government, would likely be selling today and tomorrow.  If we see a bounce in equities even without much cooperation with bonds, it would provide evidence towards the theory that taxes weighed upon the markets.

Those who disagree with this theory can point to two factors.  First, the deadline to invest in traditional IRAs is the same as the tax deadline.  IRA investments would certainly provide support to asset prices.  Yet I discount that effect.  For there to be a meaningful benefit from IRA investments this week, it would mean that there are a substantial amount of investors who have not yet already made those investments and who have excess investable cash for their IRAs.  If the money is simply being moved from a taxable equity investment to one within an IRA, it is a net wash from a macro perspective.  Furthermore, IRA contributions are limited to $6,000 annually ($7,000 for those over 50)[iii] while taxable investment profits fortunately have no government limitation.  That means that the outflows caused by tax liabilities could far exceed IRA inflows.

A second counterargument could be that tech stocks are getting hit disproportionately relative to the broader market, which reflects valuation concerns caused by higher interest rates.  That may very well be true.  But it is not unreasonable to think that many personal portfolios are heavily weighted in popular tech stocks, and that those would be popular sources of cash.  That too could be contributing to the underperformance.

Nobody likes paying taxes, but law-abiding citizens do so, even if begrudgingly.  Big profits lead to big tax bills, and it’s time for the taxman to ask for collection in the coming days.

[i] Good Friday in North America and much of Europe

[ii] According to the linked article, the deadline was moved because D.C.’s Emancipation Day holiday falls on the 15th this year.  If you live in parts of New England – not my part, mind you — that date is further extended to the 19th because of Patriot’s Day in Massachusetts.  But by all means, don’t take my word or that of a news article about anything tax related.  Consult a tax professional.

[iii] Note to self – make 2022 IRA contribution

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