When everything is going swimmingly, even a little bad news can go a long way. This past week the stock market got swung about by information everyone knew was coming.
President Joe Biden made no secret of his plan to raise capital-gains taxes on the very wealthy. It was a campaign pledge, one that got enough attention for Goldman Sachs to release a note looking at thehistorical impact of previous increases on the stock market. (The answer: not very much.) Since then the possibility has been discussed, debated, andwritten about on Wall Streetand beyond.
And yet when news “broke” that the Biden administration was considering raising the top capital-gains tax rate on millionaires to 39.6%,the stock market suddenly declined, with theS&P 500dropping 1.3% from its high of the day to its low in less than one hour.
The damage was transitory—the S&P 500 closed the week off 0.1%, to 4180.17, while theDow Jones Industrial Averagefell 157.18 points, or 0.5%, to 34,043.49, and theNasdaq Compositedeclined 0.3%, to 14,016.81. But it does indicate that the market might be a little sensitive to small changes.
“It was no surprise at all, but it still caused a reaction,” says Dave Donabedian, chief investment officer at CIBC Private Wealth Management. “When you’ve had a run like we’ve had, it’s hard to get upset about a pause.”
It’s not just known bad news that’s causing stocks to fall—it’s known good news as well. It has been a solid earnings season so far, with 85% of companies that have reported topping analyst estimates, far higher than the long-term average of 65% and even the four-quarter average of 76%, according to historical earnings data from Refinitiv.
But as we’ve seen recently, just beating forecasts isn’t enough. Only about half of the companies reporting earnings beats through Wednesday saw their stocks move higher afterward, according to Wells Fargo Securities data. And some big, well-known companies suffered sizable drops following beats, includingNetflix(ticker: NFLX),which tumbled7.4% after reporting on Tuesday, andIntel(INTC), whichdropped 5.3%this past Friday.
Don’t be surprised if earnings—or at least the expectations around earnings—become a bigger problem for the stock market. Earnings are expected to grow by 43% during the second quarter, 55% during the third, and 75% during the fourth, according to Ned Davis, senior investment strategist at Ned Davis Research. But the stock market has gained just 2.4% a year when expectations for profit growth have been 20% or higher. “By the time really good…or bad…earnings are reported…the good or bad news has been largely priced in,” he writes.
If even this has the ability to knock stocks down, what about a real surprise? No one expects one from the Federal Reserve when itreleases its monetary policy statementthis coming Wednesday, and Chairman Jerome Powell will likely stick to the story that inflation is transitory and he won’t have to raise interest rates for a long, long time.
Still, that’s going to get harder. Economic data continue to get better—jobless claims fell to another postpandemic low in the most recent report—and the Fed will have to show that it recognizes that growth, while still having a reason to take things slow. The fact that the Bank of Canada said it would buy fewer bonds and Russia raised interest rates will only make that harder. “The Fed won’t change monetary policy at next week’s meeting, but with the economy reopening, jobs returning, activity booming, and inflation climbing, a sense of anticipation is starting to build,” writes James Knightley, ING’s chief international economist.
Let’s hope it doesn’t turn to trepidation.
Corrections & Amplifications
Fed Chair Jerome Powell may be forced to raise interest rates if inflation continues rising. An earlier version of this article said he could be forced to cut them.