First and foremost, it is our opinion that financial news outlets are in the business of grabbing attention, and in that endeavor, rational or moderate predictions rarely succeed. For a news story to generate the all-important “click,” headlines draw on the dual forces of fear and greed – predicting a financial catastrophe under candidate A, or untold investment success with candidate B.
Historical data indicates that markets rarely have such extreme reactions to changes in political control. While headlines can be very unsettling, for reasons outlined below, these types of forecasts should not compel investors to make drastic shifts to their investment plans.
Don’t try to get ahead of a market reaction to an election outcome because expectations for the outcome are already embedded in the prices of securities.
In other words, if market participants already expect candidate A to win, there should not be much market price reaction if candidate A does indeed win.
Currently, the presidential race is very tight, but various prediction markets are showing about a 60% probability of Democratic candidate Joe Biden winning, and about a 60% chance of a Democratic Senate and House of Representatives. While it may seem that a shift of this magnitude could send shockwaves through the market, the reality is that the majority of the money in the market has likely already shifted in anticipation of the event.
History tells us that a shift from one presidential party to the next does not necessarily have the impact on markets that one might expect.
A review of the returns for each presidential term going back to 1953 reveals that there is no identifiable correlation between stock market returns and the political party in power. Furthermore, the variable of whether the President’s party aligns with Congress also does not appear meaningful.
Since 1929, the market has returned an average of 10.3% per year, across every variety of presidential party and congressional alignment scenario imaginable, with very little variation between the returns during each party’s time in office.
Equity markets have rewarded long-term investors for many years, and the notable periods of decline have far more to do with external shocks (such as the Great Depression, the dot com bubble in the early 2000s, and the housing market crash in 2008) than the party in the White House.
The tradeoff that investors must make to enjoy these long-term returns is to invest not only in the good times, but also to remain invested when conditions are less than optimal – and that includes periods of political uncertainty.
What will happen to corporate tax rates?
One of investors’ hot button issues in the coming election is the future course of corporate tax rates.
In 2017, President Donald Trump enacted the Tax Cuts and Jobs Act (TCJA) which, among other things, lowered corporate tax rates from 35% to 21%. This fueled a 23% rise in S&P 500 earnings per share from 2017 to 2018. While candidates have not put forward their official tax proposals, there is speculation that a Democratic victory would mean an increase in corporate tax rates.
We believe that because of the recent course of fiscal and monetary stimulus, there is going to be upward pressure on tax rates regardless of the results of the 2020 election. The most likely course is an increase in corporate tax rates from 21% to about 28%, but not all the way back to the previous rate of 35%.
In valuing financial assets, the question is whether the recent reductions in corporate tax rates were perceived to be temporary or permanent. If these were perceived to be temporary, which is likely, the mathematical effect on stock valuation should be minimal.
The upcoming election is likely to be characterized by increased market volatility as new information percolates into the market, but based on historical trends we believe that markets will be okay in the long-term. It is better to base your investment decisions on a disciplined process, including an examination of fundamentals and valuations, rather than emotionally, based on the mood of the day.
