Upcoming Presidential Election and Market Returns
With less than 90 days until the 2020 U.S. presidential election, it is natural to inquire how the stock market might react to a change in administration. The U.S. stock market benefited from the Tax Cuts and Jobs Act of 2017 when the highest corporate tax rate decreased from 35% to 21%. Investors are now asking if Joe Biden becomes the next president and follows through with his plan to increase corporate taxes, will the market give up all the gains from the tax cuts?
Let us first look at how long-term investors have fared when their investment period begins at the start of an election year. We looked at data of the S&P 500 Index going back to the 1930’s to observe how these investors did 10 years after making their investment at the start of a presidential election. There were 19 periods in the sample set and in 15 of those 10-year periods, a $10,000 hypothetical investment more than doubled.[i]
Long-term investors should feel comfortable that over a 10-year period, the odds are in their favor. For investors with a shorter time horizon, it is important to develop a well thought out investment strategy that accounts for liquidity needs from the portfolio. Our strategy identifies the dollar amount and timing of planned distributions from a portfolio. If a client will need money from their portfolio in the next five years, we isolate that money from the stock market and invest in the highest quality bonds available. This will help prevent a client from having to sell stocks when the markets decrease substantially.
Coming back to the election, if Biden wins, he plans to increase the corporate tax rate to 28%. This would have an impact of decreasing corporate profits by 7% (the current 21% to the potential new 28% rate). If we do a little math, we can see that about 40% of the S&P 500 profits are earned outside of the U.S., which means only 60% of corporate profits would be affected. Another way to look at it is that we would expect only a 4.2% decrease in corporate profits from a 7% increase in corporate taxes. If we discount that amount to expected 2021 earnings of $164.43[ii] and apply an 18.5 multiple, that would mean an expected market drop of 14.9%; which is not as bad as some people would have thought. We also must consider that it will be difficult for Biden to implement the tax increase right away given our economy is still very shaky. A 14.9% decrease may sound like a big drop, but seasoned investors know the markets are expected to see that kind of decrease on average every couple of years; it is part of investing.
We also looked at periods post World War II when corporate taxes were increased, there were 5 periods and on average 12 months later the S&P 500 Index increased 12.9%. One of the reasons is that most companies do not pay the maximum corporate tax rate, rather their effective rates are much lower.
Source: Surevest and FactSet
Nevertheless, in preparation for volatility around the elections and more COVID headlines, we still have an increased cash position to take advantage of subsequent short-term market declines. As always, we continue to monitor the markets and look to historical data to provide insights as to what might happen over the next few months.
“We have put in a lot of time and research in developing our investment strategies,” said Robert Luna, CEO and Chief Investment Strategist at Surevest. “It is in times like these that we are able to deliver true value to our clients.”
Our advisors have taken the time to develop a well thought out financial plan for our clients and the investment team has made sure the investment strategy is aligned with that plan. “So long as no material changes have occurred in a client’s plan, the best thing to do is to stay the course,” Robert concluded.