It’s not just COVID-19 and the subsequent economic slump that are occupying investors’ minds. Investors are also beginning to worry about the risks surrounding the 2020 US presidential election.
Recent polls show that the presumptive Democratic nominee, Joe Biden, is poised to win, and the prevailing view is that this would have a negative impact on the stock market. However, our analysis suggests this assumption is premature. Historically, no political party has been exclusively good or bad for markets.
So why do investors view Democratic presidents as cause to be bearish? One reason is that they tend to enact more business-unfriendly policies, such as tax increases and regulation, which can weigh on corporate profitability.
Although this is a reasonable expectation, the reality is far more complicated. Presidential policies matter more than just party affiliation. Some markets and industries may emerge as relative losers, while others may be more insulated.
How Have Markets Performed Ahead of a US Presidential Election?
Stock prices have on average fallen in the final three months leading up to an election whenever the incumbent political party lost, but rallied if the incumbent party won. This is irrespective of whether the president was a Republican or Democrat.
Markets Have Been Good at Predicting US Presidential Outcomes
S&P 500 Index real % change three months before election
Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. Sources: Datastream Refinitiv, Robert Shiller dataset and Schroders, 7/31/32-10/31/16. Notes: Real (adjusted for inflation) price change from 7/31-10/31 of every election year. Period covers 22 presidential elections, 13 in which the incumbent party won and 9 in which they lost. S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks.
So, if investors believe Trump will lose in November, history would suggest that markets are more at risk of selling off than rallying in the upcoming months.
Who Is Better for Investors? A Democratic or Republican President?
A longer-term analysis, however, suggests that things are not so clear-cut. Although you might think Democratic presidents are worse for equity markets, the evidence suggests the contrary.
Since 1933, Democratic presidents have, on average, seen higher stock market returns than Republican ones. For example, the average real (adjusted for inflation) total return for the S&P 500 Index under Democratic presidents was 10.2%, versus 6.9% under Republicans.
Since 1933, Democratic presidents have on average seen higher stock market returns than Republican ones.
Democratic Presidents Saw Higher Stock Market Returns Compared to Republican Presidents
S&P 500 Index annual real total return, %
Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. Source: Datastream Refinitiv, Robert Shiller dataset, and Schroders, 7/31/93-10/31/19. Notes: Real (adjusted for inflation) total return from 1st year in office to 7/31 of final year in office so as to exclude the election effect (President Trump's term is shown through 12/31/19).
The problem is that nearly all of this average outperformance advantage can be explained by the boom years under Bill Clinton and the subsequent dotcom bust and Global Financial Crisis under George W. Bush. Excluding these two presidencies, the difference in returns is practically zero.
Neither political party is exclusively good or bad for markets. Instead, what matters more is the policies presidents choose to enact and their net impact. For example, although President Trump’s tax cuts were widely seen as a positive development for markets, his handling of foreign policy and trade issues had the opposite effect.
Neither political party is exclusively good or bad for markets. Instead, what matters more is the policies presidents choose to enact and their net impact.
What Impact Would Biden’s Main Policies Have on Equity Markets?
Taxes: The largest risk facing equity markets is the potential for US corporate tax rates to increase. In 2017, Trump lowered the tax rate from 35% to 21%, delivering a major boost to US earnings per share (EPS)1 and stock prices. However, Biden has said he would like to partially reverse this policy in early 2021, which could have significant consequences for equity investors.
For example, UBS estimates that raising the tax rate to 28%, alongside other proposed tax changes, would lower S&P 500 Index profits by 8%. On top of this, Biden has proposed to raise the minimum wage, which would also weigh on corporate profits. Together, such moves could potentially increase the appeal of non-US equities, after years of the US outperforming the rest of the world.
At the sector level, communication services, healthcare, and consumer staples would see their earnings impacted the most. Meanwhile, energy, real estate, and utilities would likely not be materially affected.
Some Sectors Look More Vulnerable Than Others to a Rate Hike
Estimated earnings impact from Biden’s tax plan
Forecasts included should not be relied upon and are not guaranteed. Source: UBS and Schroders. Data as of 7/9/20.
All of this, of course, depends on the Democratic party securing a majority of seats in the Senate, without which they are unlikely to pass major tax legislation.
Besides, there is a possibility corporate tax reform would take a back seat in Biden’s first year in office while economic rescue packages are prioritized.
Healthcare: The pandemic has disproportionately affected lower-income families and exposed the inequality in access to healthcare in the US. As a result, Biden is expected to double down on drug pricing control and to create a public health insurance option to compete with private companies.
Both policies are negative for pharmaceutical companies and health insurers, but would still require congressional approval and, in any case, have a milder market impact compared to more far-reaching alternatives such as the “Medicare for All” scenario championed by Bernie Sanders.
Tech: We have already highlighted the immense concentration of the US equity market in the five largest technology companies—Microsoft, Amazon, Apple, Google, and Facebook—which account for 20% of the total US market value.
For many months, the prevailing concern was that the Democratic nominee would usher in new antitrust rules against these tech giants and, at worst, break them up into smaller businesses.
However, Biden’s general stance on tech has remained relatively unclear. At the same time, the coronavirus has dampened the anti-tech momentum, not least because of our increasing reliance on digital services, as millions of people are confined to their homes.
Despite this, the Democratic Party has moved significantly to the left on this issue and can be expected to pressure Biden to ramp up regulatory scrutiny.
The low taxes paid by these firms are also likely to be a focus. For example, Biden has proposed to double the global minimum tax on offshore profits from 10.5% to 21%.
Foreign Policy: With 66% of Americans having an unfavorable view on China, geopolitical tensions between the US and China are likely to continue under a Biden presidency, especially with regard to technology and trade practices.
On the other hand, there is a high probability Biden will restore economic cooperation with Europe and Asia, while also easing up on tariffs. This would inject a degree of predictability and stability into global affairs, which would be a welcome relief for global markets after a volatile few years.
And if global trade activity picks up in response, this could be the catalyst for investors to return to some export-oriented emerging markets that were adversely affected by the US-China trade dispute.
What Are the Different Possibilities Facing Investors If Biden Wins?
The perception that a Biden win would be a bad outcome for markets is not substantiated by the historical record on Democratic presidents. Investors should instead focus on his policy agenda and its potential investment implications.
If there is a Democratic sweep of Congress, US share prices are likely to price in an increase in corporate tax rates. This would bolster the appeal of non-US equities, especially if coupled with reduced trade frictions.
On the other hand, if Republicans retain control of the Senate, tax reforms are unlikely to pass. But, as most foreign policy decision-making resides with the president, we can still expect an improvement in international relations.
This combination of the tax status quo and a defrosting of international relations would be the best-case scenario for global markets.
Over the medium term, sector-specific issues may arise that could weigh down on the valuations of US healthcare and tech stocks. Investors should remain on guard if they are overly exposed to such areas.
1 Earnings per share is a measure of a company's profitability, calculated as profit divided by the number of outstanding shares.
Important Risks: Investing involves risk, including the possible loss of principal. • Foreign investments may be more volatile and less liquid than US investments and are subject to the risk of currency fluctuations and adverse political and economic developments. These risks may be greater for investments in emerging markets. Investments in particular sectors may result in increased volatility and risk of loss if adverse developments occur.
The views expressed herein are those of Schroders Investment Management, are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. The views expressed may not reflect the opinions of Hartford Funds or any other sub-adviser to our funds. They should not be construed as research or investment advice nor should they be considered an offer or solicitation to buy or sell any security. This information is current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Schroders Investment Management or Hartford Funds.