This note will offer some commentary on (1) what election results might mean for future stock prices, and (2) how current tax policy might change under a new regime.
If you are like most other investors, you want to know what will happen in the upcoming election and what that means for your investments. The short answer is it doesn’t matter so much for your stock portfolio. Throughout most of our history as a nation, stock prices have gone up regardless of whether the Democrats or Republicans control Washington. It varies a bit depending on who is in control, but these are modest dispersions (and might even be due to a small sample size.)
Market returns in the long run are driven by inflation, dividends, and the growth of company earnings. In the shorter run the market is driven by expansion and contraction of how earnings are valued by the market. This year we have seen the market put very high earnings multiples on any stock that is perceived to be growing earnings. America has proven resilient and adaptive over time. This year has been a true test in many respects (global pandemic, natural disasters, protests, the list goes on). But we continue to buy stuff. We continue to serve our communities and look for ways to improve ourselves and our businesses. This economic activity is what drives the market over time.
It is easy to say ‘this time is different’ but I’m not willing to bet my retirement on it, and you shouldn’t either. It is hard to avoid focusing on the negatives of election uncertainty, tax changes, virus spread, and geopolitical tensions. Keep in mind that there is more than what you see on the news. We remain optimistic as equity investors because of less heralded factors like unprecedented government stimulus, low interest rates, and low inflation. To steal a line from Raymond James home office: we would not look to make dramatic changes to portfolio allocations based on the election alone and would refrain from emotional responses that alter your long-term goals and objectives. Equity market volatility can occur … but this often ends up being an opportunity for the longer term.
Now let’s talk taxes. President Trump lowered taxes during his first term in office and will likely continue this policy if elected to a second term. Joe Biden, on the other hand, has proposed several changes, summarized here:
- Business/Corporate Taxes:
- Raise the corporate tax rate from 21% to 28% (during Trump’s first term, it was lowered from 35% to 21%
- Possibly repeal 20% Qualified Business Income pass-through deduction
- Revert to the Obama tax brackets, raising the highest bracket from 37% to 39.6%
- Currently employers and employees each pay 6.2% of employee’s earned income towards payroll tax, applicable to the first $137,700 of income. Biden would extend the tax to also apply to any income over and above $400,000 (impacting high wage earners). There would be a donut hole with no payroll taxes between $137,700 and $400,000.
- Most taxpayers currently pay 15% capital gains tax, with higher income earners (close to $500K) paying 20%. Biden proposes that capital gains rates should match ordinary income rates for taxpayers earning over $1 million per year, in effect raising the highest rate from 20% to 39.6%.
- Proposes reducing the estate tax exemption from current level of $11.18MM (possibly to former level of $3.50MM).
- Proposes removal of the “step up” in tax basis for inherited assets. Currently, if you pay $100 for a stock and you pass away when it is worth $1,000, your heirs can sell without tax liability because they are treated as if they paid $1,000. Under the proposal, removal of the “step up” means they are treated as if they paid just $100, owing capital gains tax on the remaining $900. This can be very meaningful for investors with substantial appreciated stock or real estate assets.
Higher taxes means less money in the pockets of businesses and investors, and more money going to the government. This may or may not be a good thing, depending on how the money is spent. Could we see a high single-digit downward adjustment to market prices if these initiatives pass? Maybe. But keep in mind that businesses are quick to adjust and have dealt with much higher tax rates in the past. And for now, these ideas are proposals only– this would not be the first time a political candidate announced bold policy directives and later failed to execute, or simply chose to focus on other priorities. Biden would need a few other favorable outcomes to execute his tax policy, likely a Democratic sweep of Congress and better economic conditions. It is tough to sell a pay cut when current conditions are challenging. Market sectors that are still recovering from Covid-19 would suffer another blow if corporate tax rates increase. A newly elected president may want to focus on less polarizing initiatives during his early days in office.
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The returns of various indexes are provided as benchmarks for comparison purposes. Consult your financial representative for specific details regarding the benchmark used as a comparison in the report. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect investment performance. Individual investor's results will vary.