Only 17 days remain until the November election. While 17 days is a lifetime in 2020 and political pundits – still scarred from the 2016 polling debacle – continue to agonize over current numbers and the electoral map, the stock market has embraced a more pragmatic view. If markets feared a Biden win and a potential Democratic sweep, they have now come to terms with that scenario.
Biden’s significant lead in the national polls and a narrower, but still favorable one in the key swing states, has increased the likelihood of a more decisive result. If the initial margin of victory is substantial enough, markets will have no issue with a delayed result as the flood of mail-in ballots are counted. A contested result will certainly rattle the markets, but any subsequent market volatility may prove to be short lived with plenty of investors looking for the opportunity to jump in, as “November volatility” is taken as a given this year.
Rather than diving into the bottomless chasm of what is possible, but not probable, let’s assume the polls do a better job this time around and talk about what comes next given a Biden win.
We know the top policy objective is the passage of a major infrastructure spending bill, partially funded by increased taxes on individuals and corporations. The proposal to tax capital gains at ordinary income tax rates (for taxpayers earning over $1MM) will likely lead to some selling pressure before year-end as investors look to lock in profits in appreciated shares.
Higher corporate taxes are on the agenda too, calling for an increase of the corporate tax rate to 28% from the current 21%. The magnitude and timing of any such change will depend largely on the makeup of the Senate and the state of the economic recovery, which will need to be sustained to provide some cover for raising corporate taxes.
Concerns about the impact of such tax policies on corporate earnings and the market are valid, but the offsetting effects of massive fiscal spending and reduced political uncertainty should not be ignored. Moving past the event risk of a contested election, may be the catalyst needed to reverse the outflows from stocks this year and fit the pattern seen in the previous four elections.
If some investors decide to sell in Q4 to take advantage of a still favorable capital gains tax rate, or on fears about higher corporate taxes, where does that money go? JP Morgan estimates that real (inflation adjusted) yields are negative for approximately $31 trillion of bonds and given where Central Bank policy rates are now globally, any cash holdings are in that camp too.
We know from Powell’s August policy announcement that the Fed will maintain a zero-rate policy at least until 2023, letting inflation run above 2% to compensate for periods of low inflation. The ECB, not projecting Eurozone inflation to reach anywhere close to its 2% target over the next three years, is also evaluating a similar stance. All that means is that money will remain cheap and plenty, continuing to push investors into risk assets, a dynamic that will sway the markets more than any tax policy.
Enjoy your weekend.
Alexander Bass CFA, CFP®
Chief Investment Officer