Locally based CPA firm since 1956

August was not such a great month in the markets. The Dow lost 4.1% while the S&P 500 lost 4.2% and the
Nasdaq Composite lost 4.6%. The markets weren’t doing too badly until Federal Reserve Chairman delivered his
speech on Friday the 26th . Shortly afterward the markets began to drop precipitously. Fed Chair Powell
reiterated in his Jackson Hole speech that the central bank is committed to curbing inflation and will continue to
raise rates even in a recessionary environment.

During the month President Biden also signed the Inflation Reduction Act (IRA) which is a legislative package
that includes climate spending, prescription drug pricing reform, and tax reform. The IRS seeks to raise
approximately $737 billion in revenue over ten years through a 15% corporate minimum tax on companies
earning over $1 billion in profits, a 1% tax on stock buybacks, greater IRS enforcement, and allowing Medicare
officials to negotiate directly on prescription drug costs.

The tax on buybacks will be particularly relevant for equity investors given the role share repurchases played in
enhancing profit growth during the post-Global Financial Crisis cycle. The big question is whether this buyback
tax will lead companies to reduce share repurchases and increase dividend payments going forward.
Dating back to 1954, dividends paid to tend to rise by about 5% for every 1% change in the capital gains tax. This
suggests that dividend payments could increase more than the market expects when this tax goes into effect
next year. At the same time, it also seems reasonable to expect that stock buyback activity could be pulled
forward from 2023 into Q4 2022.

We would be remiss if we didn’t mention the upcoming midterm elections. According to Bloomberg, since 1962,
the S&P 500 index has historically underperformed in the year leading up to midterm elections. The
average annual return of the S&P 500 in the 12 months before a midterm election is 0.3%—significantly
lower than the historical average of 8.1%. According to data by Yardeni Research, the worst month for the
market historically is September with the market being lower 51 years of the last 93 during the month of
September with an average decline of 4.7%.

The post-midterm election period is a very different story. The S&P 500 has historically outperformed the
market in the 12-month period after a midterm election, with an average return of 16.3%. This is especially
true for the one and three-month periods following midterm elections, which historically have significantly
outperformed years with no midterm election.

We obviously can’t control, nor can we predict the market, but we can control our strategy. We have been
reducing exposure to growthier names while upgrading our exposure to companies that generate free cash flow
typically found in defensive sectors and historically hold up better in tough times.

Check out my monthly MarketWatch blog at: http://wcmtexas.com/marketwatch
Have a question? Let me know! Email me at kcompton@wcmtexas.com.