The dust from the Nov. 3 election is beginning to settle. However, President Donald Trump has yet to concede the outcome. In addition, a number of congressional races have not been called, and the political power of the Senate hangs in the balance. That said, there is a high degree of confidence that there will be a change in power in the White House and President-elect Joe Biden will be sworn into office on Jan. 20.
What does the election mean to markets? Monetary and fiscal policy are paramount to financial markets, and we know from history that markets perform well when financial conditions are easing, regardless of politics. Over the last 75 years, the S&P 500 posted an 11% annualized return, telling us the market doesn’t have to like the president or what’s going on in Washington, D.C., to perform well – rather, they are driven by other fundamentals. It’s also important to note that investors’ time horizons are much longer than political time horizons; elections are every two years and things can change. Even with a contested election, we are much more focused on the meaningful market drivers such as a vaccine for COVID-19 and monetary policy.
We are at a standstill following the election when it comes to the second round of stimulus dollars, but we do believe that bipartisan support favors another round by year’s end.
Regarding health care policy, given that we anticipate a divided Congress, we don’t see material changes. In terms of foreign policy, it appears Biden will be tough on China but perhaps take a more multilateral approach. When it comes to energy, we know that one of Biden’s top priorities is climate change. We believe the needle tilts toward clean energy, which would be beneficial for environmental, social and governance strategies, but if we have a divided Congress, it may not create a significant change in the short term. Tax policy also is a key consideration, and Biden has been firm on making changes. He campaigned on higher corporate tax rates and higher tax rates for individuals making over $400,000 a year. Again, with a divided Congress, these changes could take some time.
Higher corporate tax rates may be a headwind to corporate earnings, as an increase of the corporate tax rate to 28% could result in a drag on S&P 500 earnings in the range of 4%-13%. However, there may be some positive developments, offsetting higher taxes. Reduced tariffs and higher fiscal stimulus amounts could be advantageous for earnings.
Biden’s proposal for capital gains tax rates is significant, going from 20% to 39.6% for those individuals making more than $1 million a year, which would be a near-record high. Looking back, the last time the capital gains tax rate increased was in 2013, and in 1987 before that. In these two time periods, the higher rate did not alter the general trend in equity prices. In fact, in 2013, the market was up 30%. Notably, in both of these cases, the market was in the middle of a secular bull run, and the increase in taxes was not the cause of the market becoming weak. Given this data, we believe the impact on stock prices depends on other market factors and largely comes down to if we are in a bullish or bearish trend in the market. Today, we believe we are in the early stages of an economic recovery, and therefore a bullish market, and there are more significant market drivers. Given these factors, a higher capital gains tax could create short-term volatility but not in the long term.
Financial condition index
The trend is clear here: It’s not about the election but rather financial conditions, such as interest rates, the cost and availability of credit, and financial institutions’ willingness to lend. Right now, we are seeing a softening of financial conditions and prolonged easing of conditions from the Federal Reserve, which supports the economy and markets.
For the remainder of the year, we do expect short-term market volatility but advise our clients to look keep a long-term focus.
KC Mathews is chief investment officer at UMB Bank in Kansas City. The bank operates two Springfield branches and a private wealth management center.
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