Down The Stretch They Come
October 2020
2020 has proven to be a challenging year, both on a personal and professional level for many of us, and as we turn the page to October, persistent uncertainty and a wall of worry for investors aren’t going anywhere. As September wound down, COVID-19 cases were on the rise across Europe, leading to calls for economic shutdowns to be reinstated across the continent, generating weakness in European equities and the euro relative to the U.S. dollar as hopes for a sustained economic recovery were reset. Europe’s struggles to contain a resurgence in COVID-19 cases has offered the United States an unsettling glimpse into what may potentially lie ahead stateside as we enter the Fall and Winter, raising questions as to whether additional shutdowns might be required over coming months to curtail the virus’ spread.
If lingering questions surrounding the shape and sustainability of any U.S. economic recovery weren’t generating enough investor anxiety, we now find ourselves less than one month away from November’s Presidential election. Debates leading up to the election will be closely monitored and potentially market moving as candidates outline their agendas. While words spoken on the campaign trail should be taken with a grain of salt, insight into what each candidate will prioritize and promise from a policy perspective will be merged with market participants’ own biases to inform tactical portfolio positioning. As the election draws nearer, a choppy trading backdrop could materialize for equities as portfolio managers shift sector exposures, attempting to identify winners and losers in advance and allocate capital accordingly. Leading up to November 3, portfolio repositioning could create a volatile trading backdrop, but no matter the election outcome, powerful tailwinds provided by ultra-easy monetary policy and a ballooning Fed balance sheet remain intact. This, along with subsiding political uncertainty, could pull cash currently hiding out in money markets and Treasuries back into stocks.
The high degree of uncertainty over the outcome of the November elections makes placing probabilities on potential outcomes with any degree of confidence a daunting task. While much of the market’s angst has been centered around who might be President, the balance of power in the Senate will also loom large for equity investors into year-end and beyond. If recent polls are to be trusted, Joe Biden will be elected President, Republicans will hold a narrow majority in the Senate, and Democrats will retain control of the House. In this scenario, changes to tax policy would become less likely, while infrastructure spending with a focus on ‘green’ or clean energy projects would ramp up. In a “Blue Wave,” or Democratic sweep scenario, the corporate tax rate and tax rates on capital gains would likely increase, ‘Big Tech’ would likely be more heavily regulated, fracking on government lands would likely be banned, and spending on clean energy projects would be a priority. Should a status quo election materialize - President Trump is reelected, Republicans maintain control of the Senate and Democrats retain the House, additional tax cuts would be a possibility, fracking on government land would likely continue, infrastructure spending would be a priority, but with less focus on clean energy initiatives, while regulation of ‘Big Tech’ could remain on the agenda as a bi-partisan concern.
Joe Biden has announced his intent to raise the corporate tax rate from 21% to 28% on “day one” of his Presidency, while also pushing for higher tax rates on capital gains, but these changes would require the balance of power in the Senate to shift toward the Democrats to come to fruition. Changes to the tax code, even under ideal circumstances, require time and debate. Given the challenging economic backdrop, a more acceptable ‘middle ground’ on the corporate rate could be closer to 25% under a “Blue Wave” scenario and could be a 2022 event. S&P 500 earnings estimates would be ratcheted down, possibly by 10-15% should a 28% corporate rate be adopted – less if a 25% rate is implemented. Lastly, should a Democratic sweep occur, investors with imbedded capital gains could pull forward anticipated future sales into 2020, electing to pay the current capital gains rate versus holding positions into 2021 and risking a potentially larger tax bill on sales of securities.
Over the next month, we’re likely to be inundated with news, noise, opinions, and (mis)information, most of which is meant to do little more than foster fear and create uncertainty, which could lead to overreaction. Some historical perspective can be valuable in times such as these. Since 1948, there have been eighteen Presidential elections, with the sitting President reelected nine times. The average S&P 500 return one-year post-election has been 10%, with the index higher thirteen times, flat once, and down four times one year later, an impressive 77.8% ‘hit ratio.’ Historically, avoiding the urge to de-risk by reducing equity allocations and increasing exposure to cash or short-term Treasuries in periods leading up to elections has been rewarded, and we expect discipline to be rewarded this time as well.
Source: Bloomberg, Factset
