On 3 November, Americans will not only be voting for whether Donald Trump or Joe Biden should be their next [resident but will also be choosing the whole of the House of Representatives as well as 35 of 100 seats in the Senate.
Odds have been swinging wildly in the wake of Trump’s Covid diagnosis and, before that, the extraordinarily unparliamentary televised debate between the candidates. But of all the possible permutations, the highest probability outcome is also the one that is most likely to cause the biggest policy shift – that of a clean sweep for Biden and the Democrats.
Notwithstanding Biden’s calls for major shifts in wealth distribution, his actual approach is likely to be tempered even under Democratically-held Congress – albeit it would still have important market consequences.
Although a sweep for either party is likely to deliver significant fiscal stimulus – particularly in the form of infrastructure spending – the Democrats will use tax hikes to boost government spending as opposed to Republicans, who prefer to cut taxes to stimulate demand.
Source: Eikon, Pictet Asset Management
Democrats’ tax and spend approach would tend to help the least well off. At the same time, Biden would be expected to expand the welfare state. Although the measures would boost growth, this growth would come at the cost of rising deficits as spending outstrips tax revenue – which the markets would, in turn, take as a mixed blessing.
Meanwhile, higher taxes and labour costs would put downward pressure on corporate margins.
A Biden administration would also be likely to be aggressive on antitrust. This could take the form of new legislation or, more likely, greater scrutiny under existing laws. Tech companies would suffer most from any "windfall profit” tax.
Lower-paid workers would be a clear winner from a Democratic sweep, reversing a long-term trend. The Federal minimum wage would likely rise to $15 per hour from the current $7.25 – although the impact of this is tempered by the fact that many states already set high minimum wages.
Biden is unlikely to significantly reverse Trump’s anti-trade agenda. There is bipartisan support for a tough line on China. But a Biden administration is likely to take a more diplomatic approach to foreign policy negotiations – and not just with China. But there would be more scope for US cooperation with China on healthcare and climate under a Biden Presidency.
Onshoring is a major focus and has broad backing, likely to be implemented through incentives such as tax credits and the Federal government’s refusal to give contracts to companies offshoring jobs to China.
Whatever the composition of government, there is bound to be increased scrutiny of disproportionately low share of profits paid in taxes by large tech companies.
Arguably, pharmaceutical pricing would be targeted by either administration. However, it’s not all bad news. For instance, Democrats are likely to expand the Affordable Care Act and Medicare, which would lead to increased access to drugs and thus greater revenues for pharma companies, even if it doesn’t boost their profitability.
And Biden is likely to pursue considerably more environmentally friendly policies than the current administration, including aiming for 100 per cent zero carbon electricity generation by 2035. He also aims to overtake China as the world leader in the electric vehicle industry by increasing federal procurement by $400bn for key components such as batteries.
Implications for markets
Over the past half a century, most presidential elections have rarely had more than a transient impact on financial markets. However, signs of a Democratic sweep could plausibly lead to a 5-10 per cent sell-off in the US stock market in the run-up to the vote – and thus a 1-2-point compression in price-to-earnings (P/E) ratios – not too far from the 5 per cent selloff ahead of the 2016 election.
Much of that would be down to tax worries. Biden could be expected to at least partly reverse Trump’s cut that took the statutory tax rate from 35 per cent to 21 per cent. That will be important for equity markets – Trump’s tax effects accounted for 5.2 percentage points of 13.4 per cent total returns in the S&P 500 since January 2018.
Biden’s tax proposals would take the statutory top rate up to 28 per cent, which, we calculate, would lift the effective tax rate to 23 per cent from 19 per cent. All else equal, this would depress 2021 S&P 500 earnings per share by 5.2 per cent.
Other taxes, such as a minimum tax on book income or on windfall profits, could add to that downward pressure by a further few percentage points, particularly hurting utilities, communications services and tech companies. However, given the fragile state of the post-Covid economy, Biden is likely take a measured approach to higher rates rather with a one-off hike.
Another risk for stocks is a possible clamping down on share buybacks. Stock repurchases constituted the largest use of the cash windfall from the Trump tax cuts and are likely to face regulatory pushback. That could weigh on equity markets.
Higher taxes on high earners, meanwhile, would hit premium goods and services sectors, while higher capital gains taxes could reduce the appeal of equities. That is likely to be mitigated by continued monetary stimulus from the Fed and fiscal expansion. Small caps (Russell 2000 index), domestic equities and infrastructure sectors should do particularly well, with a likely sector and style rotation into cyclical laggards.
Crucially, monetary policy is likely to stay the same course whatever the election result. The US Federal Reserve made clear its ultra-dovish stance in its recent policy review and is unlikely to raise rates until well after 2023. A Biden government is likely to reinforce expectations that rates will stay lower for longer by nominating the dovish Fed Governor Lael Brainard to take over as chair in January 2022.
The dollar is likely to strengthen as capital is drawn into the US, especially if growth lags elsewhere. Gold, by contrast, could weaken. Pro-cyclical fiscal spending should lead to an increase in the supply of government bonds. That could lead to a rise in yields on longer-maturity bonds and higher breakeven rates of inflation. The combination of a higher dollar and moderately higher long-term rates would weigh on emerging markets.
Arguably the most bearish scenario for markets in the short term – would be a disputed election entailing a constitutional crisis. Markets fell 8 per cent waiting for the result of the Bush-Gore election to be resolved. This time, though, any such sell-offs are likely to produce bargains, as the eventual outcome would likely to be a market-friendly divided government.
Supriya Menon, Arun Sai and Marco Piersimoni are members of the multi-asset team at Pictet Asset Management. The views expressed above are their own and should not be taken as investment advice.