For five months, financial advisors have been getting an earful from clients concerned about the impact of Covid-19 on their portfolios. But another worry has crept into conversations – the upcoming election in November that could pressure U.S. stocks like few in recent memory.
Based on the latest election polling, a big concern for many investors is that Washington could be taken over by Joe Biden and a Democratic-controlled Congress intent on reversing corporate tax cuts and other pro-business initiatives that helped fuel stock prices following Donald Trump’s surprise victory in 2016. Biden has also proposed raising both individual income and capital gains tax rates for those with high incomes.
Goldman Sachs estimates that the Biden tax plan, which among other provisions would raise the corporate tax rate from 21% to 28%, would effectively reduce S&P 500 earnings by more than 10% if enacted.
Polls and betting markets currently suggest that there’s a modest likelihood of a “Blue Wave” election outcome, with both the White House and Senate joining the House of Representatives under Democratic control.
For many investors, the prospect of a Democratic-controlled Washington seeking both tax hikes and greater regulation of carbon-rich industries is unnerving. “A lot of clients are freaking out that Trump is going to lose and that will taint the market,” says Jamie Cox, managing partner with Harris Financial Group, a Richmond, Va.-based financial advisor. “They want to rearrange portfolios and become defensive.”
If Trump can prevent this scenario and pull off another victory, it may bring a modest relief rally, particularly for certain sectors such as oil and gas and defense manufacturers. But there’s the worry that a Trump second-term, which almost certainly won’t occur this time with a big tax cut for corporations, could bring more negatives than positives for markets. This holds especially true if the president continues to pursue a Cold War with China over tensions related to trade, allegations of technology theft, and even the causes of what he has derisively called “the Chinese virus.”
Adding to these concerns is the possibility of an Election Day that takes place under the specter of the Covid-19 pandemic, leading to delayed vote counts and perhaps challenged results. President Trump has already declared that sizable levels of “fraudulent” mail-in voting is going to “rig the election.”
It’s small wonder that investors are expressing anxiety about the election outcome. A recent Goldman Sachs analysis of options activity concludes that implied volatility for the period around the November 3rd election is extremely high compared with prior cycles, primarily because of the coronavirus, “but the particularly high level of implied volatility in the periods before and after the election imply an extended period of election-related uncertainty.’’
According to global bank UBS, which polled more than 4,000 wealthy investors and business owners across 14 markets globally in late June and early July, a rising proportion of respondents, 46%, ranked the U.S. election among their biggest worries, up from 39% three months earlier.
But Cox and other advisors contacted by RIA Intel are advising clients not to alter portfolios based on how they anticipate an election playing out for their investments. History, they point out, has shown that reality often doesn’t match an election’s expectations. And many factors can easily intervene to alter markets including a sharp change for better or worse on the outlook for the Covid pandemic or additional waves of fiscal and monetary stimulus that the federal government stands ready to employ.
“In the next three months, improving Covid conditions and better economic improvements etc. can all push momentum a different way,” says Victoria Greene, a founder partner with G Squared Private Wealth, an investment advisory firm based in College Station, Texas. “Our approach is not to panic and make dramatic swings in your portfolio.”
Adds Brian Rose, senior economist, Americas with UBS Global Wealth Management: “It’s hard to forecast who is going to win and how much of their policy will make it into reality.” Even the prospect for a Democratic sweep, Rose adds, is “no reason to sell equities – a sweep will have a roughly neutral impact on markets with enough benefits because of government spending to offset a potential tax hike.”
Cox, for his part, says he has been talking many of his clients “off the ledge” by reminding them how easy it is miscalculate an election’s impact on markets.
For proof, one needn’t look further back than Trump’s surprise 2016 victory. On the eve of that election, many on Wall Street opined that a Trump victory would be disruptive to markets because of his protectionist views. And to be sure, once it become clear on election night that Trump had pulled off an upset, Dow and S&P 500 futures plummeted on shock and fear. But at 3 a.m. the following morning, when Trump gave a victory address that was surprisingly conciliatory, futures reversed their decline and shot higher. In the following weeks, as Trump began issuing business-friendly executive orders, stocks had far more up days than down ones in what has been called the Trump Rally: the country after all, had elected a president and Congress favorable to lower corporate taxes and less regulation on business.
The pundits even got sector calls wrong. “Many said that big tech would lag because the Trump administration would go after big tech and that steel and coal could do very well because he supported traditional American industries,” says Ryan Detrick, chief market strategist with LPL Financial. “Both of these predictions couldn’t have been more wrong.” Four years on, actions to break up major tech companies such as Apple and Amazon haven’t materialized. And Trump’s stated desires to protect the Old Economy haven’t offset the intrinsic weakness in these sectors.
It’s also hardly a given that a Blue Wave election would be a net negative for the stock market.
“While we’ve seen investors express concern over higher taxes under a Democratic sweep, we believe that recovery spending on stimulus – for health care, infrastructure, climate change and other initiatives – will more than offset these tax headwinds,” says Solita Marcelli, chief investment officer, Americas for UBS Global Wealth Management. Marcelli says that Biden’s spending proposals total nearly $7.5 trillion over 10 years while his tax increases total only 4 trillion.
There’s also the risk of fighting the Federal Reserve, an institution that stands ready to provide additional monetary stimulus in the form of quantitative easing. While John Allen, chief investment officer of Aspiriant, a Los Angeles-based wealth manager, believes that U.S. equities are sharply overvalued, he conceded that the combined forces of fiscal and monetary stimulus could be a “wild card” that keep stocks propped up in the coming year.
Granted, some investors can’t resist tinkering with their portfolios ahead of an election. For those betting on a Blue Wave outcome, UBS recommends overweighting a portfolio to stocks tied to energy efficiency, smart mobility, and renewables both in the U.S. and abroad. According to Greene, municipal bonds may do well in the Democratic sweep scenario as the desire for tax-free income rises in tandem with higher tax rates.
A less probable Red Wave, according to UBS, would benefit energy and financial companies as the threat of tighter regulation recedes, “while space and defense companies could also do well in a Trump second term.”
But the best advice may be to relegate the election handicapping to a tertiary investment concern.
“Trim your risk because that’s the right decision for your allocation and financial plan, not because of pre-panicking over an election,” concludes Greene of G Squared. “Much can change quickly and it is not prudent to knee jerk your financial plan due to potential future what-ifs. Often, making the choice to stick to your plan is in your best interest.”