By Tim Courtney, Chief Investment Officer
Historically, there have been no reliable market patterns that can provide guidance on market behavior in the months leading up to and following an election. That is not to say markets don’t react at all to elections and potential policy changes. Markets are always attempting to account for several factors that could affect the value of future earnings.
Below, we examine three factors that are receiving a lot of attention as we approach the U.S. presidential election.
- Change in corporate tax rates. The Tax Cuts and Jobs Act (TCJA) enacted in late 2017 lowered corporate tax rates from 35% to 21%.1 Former Vice President Joe Biden’s tax proposal would raise corporate rates to 28%.2 While this would not affect all companies and sectors equally, earnings overall would be lowered from current baseline numbers. Estimates vary, but we think a good forecast is close to an eventual 10% overall annual decrease in earnings3 versus baseline numbers.
Broad market earnings are volatile to begin with, so relative to historical fluctuations and economic effects, the potential tax law change wouldn’t cause an overwhelming shift in earnings. Still, the higher taxes would be a drag on future earnings and, if the presidency and Senate changes hands, investors would likely begin to account for this over the next several months.
- Interest rates and the U.S. dollar. Another round of stimulus spending has been a focal point over the last several weeks, and some version of fiscal stimulus is almost certainly coming. This will help household confidence and balance sheets, which need to be healthy for a broad recovery to occur. However, it will also result in higher deficit spending and could begin to affect interest rates, inflation and the value of the dollar.
Interest rates have begun to creep higher with the 10-year Treasury now yielding 0.84%, up from 0.65% last month.4 While cash and bond investors will welcome higher rates, the greater interest could be eaten away if the dollar weakens and inflation makes a comeback. As of now, the dollar has been holding steady but is down about 10% since late March.5
- Regulation of larger companies. The House of Representatives recently released a list of companies they believe hold “monopoly power” and have a clear dominance in the marketplace.6 With tech names accounting for roughly 28% of the market weight and 57% of expected 2020 earnings of the S&P 5007, the largest companies are likely to draw greater scrutiny moving forward, likely from both parties.8
The market has had no discernable reaction to this so far, and potential regulatory and legal actions would likely take years. This is a growing risk, however, and markets will begin to account for this when it is clearer how regulations may eat into future earnings.
We continue to estimate how these factors may impact our portfolios. While any or all of these could move market prices over the next several months, there are always other variables (a vaccine probably being the biggest) that could overshadow their effects.
- Tax Foundation (data as of 10/21/20) – Everything you need to know about the Tax Cuts and Jobs Act
2. Tax Foundation (9/29/20) – Details and analysis of Democratic presidential nominee Joe Biden’s tax proposals
3. Cornerstone Macro (10/21/20) – The Biden agenda, growth, and profits
4. CNBC (10/22/2020) – 10-Year Treasury yield hits highest level since June amid strong economic data, stimulus optimism
5. Yahoo! Finance (data as of 10/21/20) – US Dollar Index
6. CNN Business (10/6/20) – Congress' Big Tech investigation finds companies wield 'monopoly power'
7. S&P Global (10/22/2020) – Sector breakdown and sector earnings
8. CNBC.com (6/30/20) – U.S. lawmakers agree Big Tech has too much power, but what to do about it remains a mystery
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
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