Online trading and investment specialist, Saxo Bank, published its fourth quarter outlook for equities, FX, currencies, commodities and bonds, in which it assessed forward-going risks, such as the impact of the upcoming US presidential election.
Speaking on the unsettling effect the 2020 election might have on markets, Saxo Bank Chief Economist, Steen Jakobsen, said: “We fear that the U.S. election is the biggest political risk we have seen in several decades, as the end of the economic cycle meets inequality, social unrest and a market feeding frenzy driven by the policy response to this deep economic crisis: zero interest rates, infinite government and central bank support.”
Saxo Bank have identified probabilities for three different paths between now and Inauguration Day, with a contested election and a Biden clean sweep both coming in at 40% apiece, while a Trump victory lagged behind at 20%.
The view of the Bank’s Chief Economist is that both candidates are the ‘diametric opposite’ of what the US needs, with both aiming for high spending, both looking to rely on fed support, and both, according the the Bank, not seeking ‘deep reform’.
Which election result would be the best for equities?
According to Saxo Bank, equities have adjusted to Trump’s erratic character, and have done ‘quite well’ despite ongoing US-China tensions causing friction for US companies’ supply chains. They add that large corporations have benefitted from lower taxes and less government oversight.
Further, they believe a Biden statutory tax rate hike from 21% to 28% on corporate income, an increase in Global Intangibles Low-Tax Income tax from 10.5% to 21%, and a hike in corporation tax, from 10% to 15%, could create significant headwinds for high-cap equities.
The company’s Head of Equity Strategy, Peter Garney, commented on the effects of these tax increases: “Combined, it is estimated that these tax changes would create a 9% drag on S&P 500 earnings – and that is before second-order effects, including change in investor sentiment, potentially hit valuations. These would hit communication services, healthcare and information technology the hardest, as those companies have the lowest tax rates in general and are big users of intangible assets. The open question is whether Biden dares implement the tax changes during a weak economic backdrop.”
On the other hand, blue chip investment management firm, BlackRock (NYSE:BLK), said that investors should reject over-simplistic ‘tax-centric’ election logic, which states that a Democrat clean sweep would be seen as market negative.
Instead, in such an instance, BlackRock believes that investors would have to deal with higher taxes and tighter regulation, but that this would be balanced out by predictable foreign policy and greater fiscal support. The main implications, they say, will be in fixed income and leadership in equity markets, with long-term rates being pushed high and leading to a ‘modest steepening’ of the Treasury yield curve.
Also, while additional tax and regulations might pressure high cap companies, domestically-oriented small cap firms might benefit the most. Blackrock finishes by saying that:
“This scenario would add to reasons to prepare for a higher inflation regime and reinforces our strategic underweight of developed market nominal government bonds. The tectonic shift to sustainable investing will likely persist regardless of the result, but could be supercharged under a Democratic sweep scenario.”
Further, we ought to note that tax rises don’t necessarily mean companies pay more tax. Indeed, even when Trump lowered the corporation tax rate from 16% to 10%, the average tax actually paid by S&P 500 companies in the US has consistently remained between 3-4%. Thus, while a company might price in a dip in shares, this shouldn’t be reflected as clearly on the balance sheet, as most of their tax structures are far more sophisticated than the services attempting to collect tax from them.
Third, it is historically noted that Democrat presidencies often coincide with economic downturns. And, as such, often preside over strong recoveries in equities, which would offset the negative impact of new taxes on share prices (see below):
Stock market performance under different presidents: pic.twitter.com/5VFVqwq2Oj
— Steve Burns (@SJosephBurns) October 4, 2020