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October 30, 2020

Elections – how they impact investing and the stock market

The presidential election next week is going to be monumental for many reasons, but it’s more clear than ever that the two presidential candidates are running on very different promises and platforms. Investors are gearing up for a fickle, sensitive financial market in the short term and a potential extended recession over the next term.

No matter who wins the election, the results will have implications across a broad range of sectors. Let’s look at some potential scenarios in greater detail:

Two key periods: the time leading up to the inauguration in January and the longer term

In the short term, the main cause of uncertainty in the market is not only about which candidate is going to win, but also about the election process itself. President Trump has already called into question the legitimacy of mail-in ballots and has not entirely committed to a peaceful transfer in case of a Biden victory. These comments decrease the trust that institutions and individual investors have in the political system, which leads directly to decreased trust in the stock market.

In the longer term, the policy of the winning party will have the biggest impact on the markets. Predictions are not certainties, but it’s likely that a Democrat victory would affect sectors due to its environmental and tax policy.

For example, Biden’s proposal to increase the corporate tax rate to 28% from 21% might initially get a negative reaction from the market. On the other hand, here’s Moody’s prediction on Biden’s tax plan:

“If Mr. Biden wins and Democrats control both the House and Senate, G.D.P. would be 4.5 percent larger at the end of 2024 than under current policies, with gains from stimulus spending outweighing drag from tax increases.”

Another area where the two candidates differ in opinion and policy is climate change. Biden’s policy includes introducing stronger reforms and incentives related to clean energy. This scenario could also mean greater investment in clean energy, a potential infrastructure spending bill, and higher chances for healthcare reform. Longer-term, this is expected to have positive returns for the US and global economy.

Historical stock market returns

Historically, the stock market has advanced steadily over the years regardless of the party in the White House: A hypothetical $1,000 investment in U.S. equities in 1926 would have grown to nearly $9 million as of June 30, 2020, according to data from Morningstar. This shows one thing conclusively: it’s important to keep your investments in the stock market if nothing has changed for you personally.

Humans are affected by emotions and uncertainty, so it’s no surprise that many people cash out their investments while ‘waiting out’ the volatility. 2020 has the added volatility from the COVID-19 pandemic and widespread unemployment.  This is illustrated in the charts below.

Source

Here are some statistics that are important to note regarding the elections and investment decisions:

According to Businesswire, an overwhelming majority of investors believe that the Presidential election will impact the stock market (93 percent) and their investing habits (84 percent) in one way or another.

Leading up to the election, less than half of investors (45 percent) plan to make changes to their investments. 62 percent of investors, however, plan to make investment changes within 12 months following the election, indicating that the election result is likely to influence their investing decisions.

In the context of investment performance, investors generally believe that a Republican President is better for their investments compared to a Democrat (47 percent and 37 percent, respectively). This view, however, differs among generations. Younger generations believe a Democrat win will be better for their investments (46 percent), while older generations lean towards a Republican victory (49 percent).

More on Taxes

Since taxes have been such a hot topic issue in this election and the last, let’s explore in greater detail.

During the four years of a Trump presidency,  federal tax rates on corporate and individual income and capital gains came down dramatically. The nonpartisan Tax Policy Center projected that, in 2018, taxes would be reduced by about $1,600 for the average household.

Democratic party nominee Biden has proposed increasing the top tax rate for corporations to 28% from 21%. Tax credits and deductions available to the middle to low-income taxpayers in the first years after Biden’s plan is initiated will offset the increase in corporate taxation.

When analyzing Biden’s tax plan for middle-income taxpayers, the Tax Policy Center projects that this group can expect an average tax cut of $600 under a Biden win. For taxpayers in the lowest income groups, that could rise to $750 under Biden’s proposals.

High-income earners would carry the heaviest burden of Biden’s tax policies. The group estimates those earning $330,000 to $790,000 would pay $9,000 more in taxes. And the numbers are even steeper as the income rises; those earning more than $790,000 would pay $265,000 on average in taxes.

The Takeaway

The important takeaway from this discussion is that when it comes to investing, the stock market will likely recover and grow no matter who is in the White House. The recession caused by COVID-19 is a real threat and might extend into the next 2-3 years depending on the policies of the winning party. However, investors shouldn’t be spooked into doing something dramatic. As long as you have a diversified portfolio, your long term strategy should remain the same.

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