The Outlook: August 2020 Economic commentary
How might the US election and a possible Biden presidency impact markets?
With November’s US election now less than three months away, the influence of politics on financial markets seems set to shift up a gear. Elections can impact equity markets via several channels: a new government can usher in changes to economic, fiscal and regulatory policy which can influence corporate profits; and more generally, an environment of political uncertainty can have an adverse effect on investor sentiment.
As is well known, markets dislike uncertainty. And coming amidst a global pandemic, this year’s election season carries the potential to generate more uncertainty than normal. Against the backdrop of the sharpest contraction in GDP on record and strong criticism of his handling of the coronavirus crisis and ‘Black Lives Matter’ protests, it is perhaps not surprising that President Trump is now trailing his Democratic rival, Joe Biden, by around eight points in the polls.1,2 However, a Biden presidency is far from assured. Opinion polls underestimated Trump’s support in 2016, 3 and a lot can happen between now and November. If the virus comes under control, the economy could bounce back quickly, bolstering support for the president.
Doubts over the validity of the election result could be an additional source of uncertainty. US intelligence agencies have recently warned that Russia is using a ‘range of measures’ to undermine the Biden campaign.4 Furthermore, the use of mail-in, or postal, votes is likely to be more prevalent during November’s election due to the pandemic, but Trump has opposed additional funds for the US Postal Service to process increased volumes (he thinks mail-in votes will disproportionately help the Democrats). This has led to accusations that the president is undermining democracy and raises the possibility that the announcement of the election result could be delayed.5
More worrying still, Trump’s false claim that mail-in voting is a source of widespread electoral fraud has raised concerns that he is preparing the ground to contest the result if it does not go his way.6Such a turn of events could clearly usher in a period of market volatility.
Biden’s economic agenda
From a longer-term perspective, it is a possible change in economic policy that could have a more lasting impact on financial markets. In this regard, Biden has several noteworthy policies that could mark a meaningful shift from the status quo.
As regards taxation of companies, Biden is proposing a rise in the corporate tax rate on domestic income from 21% to 28% (reversing half of the 2017 Trump tax cut), while also doubling the tax on intangibles income from foreign subsidiaries of US corporates to 21% and imposing a minimum 15% corporate tax on book income of large companies.7
In addition, a Biden administration would raise taxes on wealthy households. Social security payments would increase and individuals earning over US$400,000 a year would see their income tax rate rise from 37% to 39.6% (reversing the 2017 Trump tax cut). On top of this, proposed changes would also mean that the tax on long-term capital gains would nearly double from 20% to 39.6% for those earning more than US$1.0 million a year.7
At the other end of the income spectrum, Biden wants to increase the federal minimum wage to US$15.00 an hour from the current US$7.25, as well as improving workers’ rights and enhancing their bargaining power.
On the spending front, Biden envisages an ambitious infrastructure programme, including upgrading public transport, power and communication systems. In contrast to President Trump, Biden would re-join the Paris climate agreement. He plans to spend US$2.0 trillion in his first term to develop green energy, build sustainable homes and increase energy efficiency with a view to setting the country on the path to net-zero carbon emissions by 2050.
Threats and opportunities
With all of this in mind, it is understandable that some investors are nervous about the prospect of a Biden presidency. Calculations from UBS suggest that the Biden tax changes would cut S&P500 profits by 8.0%, with the communication services, healthcare and consumer staples sectors hit the hardest. In turn, lower earnings could see a reduction in dividends, share buybacks and capital expenditure.
Furthermore, an increase in the minimum wage carries the potential to squeeze the margins of companies that are either unable to pass on cost increases in the form of higher prices or unable to offset higher wage bills with increases in productivity. Some observers worry that a steep hike in the minimum wage will lead to higher unemployment; estimates by the Congressional Budget Office (CBO) indicate that a rise to US$15.00 an hour could lead to the loss of 1.3 million jobs. However, the relationship between minimum wage increases and employment is a complex one, and the evidence from various academic studies has been mixed.
Moreover, any decline in employment would need to be weighed against the positive impact of increased earnings for those workers that remain employed; the aforementioned CBO study concluded that the wages of 17 million workers would be lifted as a result of the rise. JP Morgan reckon that a boost to spending from higher wages will ultimately be a net positive for S&P500 earnings.
In turn, an increase in infrastructure spending will boost aggregate demand and potentially lift the long-term growth rate of the economy. Companies in the civil construction and engineering sector, as well as providers of materials and plant, would clearly be direct beneficiaries of the drive to improve roads, bridges and public transport. In addition, Biden’s environmental agenda promises to provide a boost to alternative energy providers and ‘green’ technology companies.
Conversely, moves to tax carbon emissions and ban new oil and gas leases on federal territory would be bad news for the oil majors. At the global level, the share prices of companies operating within the alternative energy sector have outperformed their conventional counterparts; a Biden victory could provide a further fillip to this trend.
Healthcare sector profits could also be hit under a Biden administration. Plans to strengthen federal government’s power to negotiate lower prescription drug charges and bring US drug prices closer into line with those charged in overseas markets would threaten the margins of some pharmaceutical companies.
The degree to which a future President Biden will be able to oversee big changes in fiscal and regulatory policy will be dependent on whether the Democrats can take control of congress (at the moment, congress is split, with Democrats in the majority in the House of Representatives, and Republicans controlling the Senate). Betting markets currently anticipate that the Democrats will win both houses. However, this is far from certain, and if congress remains divided, the biggest change ensuing from a Biden victory might be in the area of trade policy, where the president has more autonomy.
Biden has taken an increasingly tough stance on Beijing recently, but he is expected to adopt a more multilateral, diplomatic approach to the world’s second largest economy, and has indicated that tariffs imposed on China by the Trump administration could be removed. US-China relations are likely to remain strained under Biden, but the prospect of a reduced tariff threat, combined with a focus on rebuilding international relationships, could see both importers and exporters alike breathe a sigh of relief.
Summing all this up, market volatility has a tendency to increase during the run-up to a US election and this year has the potential to be more volatile than most. If Biden and the Democrats continue to lead in the polls, the prospect of higher corporate and capital gains tax could lead to pre-emptive selling pressure in US equities. Combined with the likelihood of a less hostile trade policy under a future President Biden, this could mean that the outperformance of US equities versus other regions witnessed in recent years comes to an end.
However, the extent to which policy actually changes the outlook for the economy and corporate profits will depend not only on who wins the presidency but also on who controls congress and the makeup of Biden’s cabinet. Biden’s current proposals suggest a ‘Democratic sweep’ could result in clear winners (e.g. green technology, alternative energy) and losers (e.g. oil majors, big pharma).
This said, even with a Democrat congress, policies might need to be watered down to secure approval. Amidst elevated levels of unemployment, the administration’s initial focus might prioritise stimulus over potentially disruptive tax hikes. Also, it is worth remembering that a key factor driving markets higher in recent months has been the unprecedented support provided by the US Federal Reserve (see our commentary of June 2020), and this is unlikely to change any time soon, regardless of who wins in November. The election might be a catalyst for near-term volatility and a possible change in market leadership, but it is unlikely to be a lasting obstacle to the ongoing recovery in global equity markets.