Wealthiest Americans May Sell Some Stocks

A few minutes after Bloomberg lit up traders’ screens with headlines touting a doubling of capital gains taxes for a fraction of filers, I mentioned that analysts long ago ran the numbers on what such a proposal might entail for tax-related selling of equities.

I cited JPMorgan and Goldman, whose David Kostin last year observed that “although the wealthiest households sold 1% of their assets prior to the rate hike [in 2013] they bought 4% of starting equity assets in the quarter after the change and therefore only temporarily reduced their equity exposures in order to realize gains at the lower rate.”

In his latest, Kostin revisited the subject given the proximity of an official unveil, expected next week when Joe Biden details his American Families Plan.

If implemented as reported by the media, the proposal would double the tax rate on capital gains and dividend income to 43.4% for filers who enjoy more than $1 million in annual income, but Goldman expects “a more modest increase, potentially around 28%,” Kostin said.

Obviously, winners will likely be sold by some of those who would be subject to the higher rate. Goldman identifies Tech and Consumer Discretionary as the sectors which have been “the largest sources of capital gains within the US equity market during the last three, five, and 10 years.”

The updated figure (below) is similar to the visual I highlighted Thursday.

UBS also said high momentum stocks could underperform the market, much as they did from 1986 through 1988 when the capital gains rate was raised. The bank used data from Kenneth French to show high momentum lagging beginning in October of 1986.

To be sure, there are plenty of stocks with the potential to be sold considering how far they’ve run. Think Tesla, for example.

Goldman’s Kostin reiterated that “the wealthiest 1% were the biggest net sellers of equities across US households around the last capital gains rate hike in 2013.” In the months leading up to the hike, those households sold around 1% of starting equity assets. On Kostin’s math, that “would equate to around $120 billion of selling in current terms.”

As a reminder, that cohort (the wealthiest 1% of Americans) own more than half of the stocks (figure above). Suffice to say increased activity on Robinhood probably won’t materially alter that breakdown.

Goldman estimates that the wealthiest households are currently sitting on somewhere between $1 to $1.5 trillion in unrealized equity capital gains. That, Kostin said Friday evening, “equates to 3% of total US equity market cap and roughly 30% of average monthly S&P 500 trading volume.”

Those sound like daunting figures (and some of them are, depending on the context), but if what you’re after is a guesstimate for how a prospective capital gains tax hike will affect benchmarks over the medium- to long-term, you’re likely to come away with a benign take.

The dynamic is pretty straightforward. The wealthiest Americans sell some stocks ahead of the rate hike and then they buy more later, possibly as soon as the following quarter. Kostin noted that “total household equity allocations demonstrated a similar pattern” to 2013 in the two previous episodes of capital gains tax hikes.

Remember: This doesn’t happen in a vacuum. There are countervailing flows and the macro backdrop needs to be considered. Additionally, cash allocations for households are still loitering around the three-decade average, even as yields on that cash render it basically inert.

Goldman suggested Friday that households could sell more than $200 billion of money market funds going forward, with a “meaningful” percentage of that total destined for stocks.