Fra Natixis
The 2020 US elections will take place on November 3, and concerns about how the results might affect markets are widely prevalent. As of mid-August, it seems the consensus narrative is filled with fears of a potential “blue wave” – Democratic Party majorities in both the House and Senate joining forces with a Biden White House, moving full speed ahead with a progressive reform agenda that will weigh heavily on equity markets. The simplicity of this synopsis helps to make it repeatable and easily understood. However, when it comes to the market effects of election outcomes, we believe a more nuanced analysis is worthwhile.
The Volatility Vote
For starters, we’re not arguing that the potential for significant volatility as we approach the election doesn’t exist. Close or contested results in the presidential race could certainly produce kneejerk whipsawing in markets. What’s worth pointing out is that such volatility is not unexpected. In fact, there’s evidence volatility markets have already priced in this possibility. While the ongoing COVID-19 crisis is likely placing upward pressure on the whole of the VIX term structure,1 projected increases through October and November are clearly reflective of expected election turbulence and projections as of mid-August remain elevated through early 2021. The takeaway? Market participants are expecting election volatility.
VIX Term Structure
Source: Factset
Could markets face short-term pressure from election results and noise? Sure. But we’re not trying to time the kneejerk reactions. The bigger question is: How might the results – specifically, a newly minted Biden administration – affect markets?
Biden and Taxes
For businesses and investors, taxes are of primary importance. With government spending at unprecedented levels in light of the COVID-19 pandemic, it should be no surprise that we’re likely to hear more talk about how to pay for it. What’s more, debates about government spending today encompass not only the federal pandemic response; they include issues such as income inequality, infrastructure, and healthcare.
Regardless of where one stands on these issues, taxes remain one of the biggest concerns with respect to any negative market reaction to the election. While specifics will continue to be rolled out, we have a general idea of the basic tenets of Biden’s platform should he be elected president. His tax plan is a two-pronged approach focusing on corporates and high income earners.
On the corporate side, raising the corporate tax rate from 21% to 28% in conjunction with a 15% minimum rate and increased taxes on foreign earned income certainly creates a headwind. After all, it has the potential to shave off about 9% of S&P 500® earnings. On the individual side, Biden’s proposals target the highest income earners, with much smaller impacts on low to middle incomes.
On a cursory review, Biden’s tax plans certainly appear to weigh on corporate profits and the top 1% of earners. The problem with this cursory view is that it observes these tax changes in a vacuum and ignores potential offsets to these headwinds.
Minimum Wage and the Consumer Coalition
First, remember lower income earners have a far higher marginal propensity to consume. Put another way, tax changes on higher income households are likely to have a much smaller effect on overall consumption. Secondly, there’s a long list of other potential offsets driven by other key facets of the Biden agenda.
Take for example the federal minimum wage. While increasing minimum wage from $7.25 to $15 sounds like a devastating blow to corporate margins, many states have already adjusted their minimum wage above the federal minimum. On a GDP weighted basis, the current minimum wage in the US is closer to $10. An increase to $15 would likely result in incremental pressure on margins, but probably not as large as the headline number suggests.
Moreover, the market is dominated by low labor-intensive companies, particularly US labor-intensive companies. As such, these companies are much less exposed to the margin pressures presented by a higher minimum wage. Highly domestic labor-intensive industries such as food services, retail, and recreation also happen to be significant employers in the US economy, though they are much smaller components of US equity markets. Thus, a minimum wage increase would put margin pressure on smaller market weight industries while giving consumers more money to drive increased demand for all kinds of products and services – likely a net positive for markets.
Infrastructure and Fiscal Spending
Regardless of the outcome of the presidential election, infrastructure has the potential to finally move across the finish line. While this has been the hope for years, infrastructure garners bipartisan support and could be a strong policy lever to help drive long-term growth emerging from the current crisis.
In the case of a Biden victory, potential offsets to tax increases may exist here as well. His spending proposal, not only for infrastructure but for climate, healthcare and education, totals more than $3 trillion over 10 years. It’s probably safe to assume that much of this spending would make its way into corporate earnings as well, helping to offset tax pressures.
US-China Relations
Lastly, while a Biden administration would likely maintain a hardline stance against China, rhetoric would probably be softened, with some tariffs potentially rolled back. A more diplomatic and multilateral approach to US-China relations could also help to alleviate the uncertainty premium that has persisted in recent years. Not only has this uncertainty resulted in a meaningful shift higher in volatility, but business investment plans have been affected as well. A Biden presidency could – at the very least – reduce this uncertainty premium and help to provide increased stability, which would be beneficial from both an equity market and corporate spending perspective.
Remember the New Normal
Of course we can debate some of the assumptions made here, and clearly there are other market risks that could result from a “blue wave” election outcome. One of the biggest is the potential for increased regulation, particularly with respect to the financial and tech sectors. Still, we believe any potential policy action – be it taxes, regulation, or otherwise – remains contingent on the forward path of the COVID-19 public health crisis and the ongoing economic recovery. Remember, many of Biden’s policy stances were first crafted in a pre-crisis world, one that no longer exists. Regardless of which party claims victory in November, business recovery and job growth are likely to be prioritized over policies that could derail the nascent recovery and jeopardize midterm elections.
The Beat Will Go On
We believe a Biden administration would be decidedly more centrist than any doomsday narrative involving extreme left-wing policies presumes. Although headlines will try to convince you otherwise, markets care far less about personal politics, who sits in the White House, or which party controls Congress than they do about making money.
