Running out of steam
Wall Street’s dramatic recovery in April and May has run out of steam. You don’t have to look far for why that might be. The resurgence of Covid-19 infections, to the extent that the US now accounts for a quarter of all cases, would be reason enough to worry that the market’s rally has gone too far, too fast. But there’s something else preying on investors’ minds as we pass the mid-year point - November’s Presidential election.
Six months ago, the conventional wisdom made Donald Trump a shoo-in for a second term. A historically low unemployment rate and the stock market hitting new records is the traditional recipe for an incumbent’s re-election. But as Bill Clinton’s election strategist James Carville said, when instructing campaign workers what to focus on in 1992, ‘it’s the economy, stupid.’ He was right. George Bush senior soon found out that a sky-high post-Gulf-War approval rating was no defence against rising unemployment on election day.
If recession were the only concern for the Trump campaign this year, the President might still be ahead in the polls. But this year’s mix also includes a woefully mis-handled pandemic response and a tin-eared if not overtly racist reaction to the killing of George Floyd at the hands of the Minneapolis police. The occasionally tongue-tied septuagenarian Joe Biden may not be central casting’s first choice to unseat America’s maverick President, but he has been handed the closest thing to a free pass that any challenger could have hoped for. Trump’s approval rating, at less than 40pc, is close to the low point of his time in the Oval Office. Biden now enjoys a near double-digit opinion-poll lead.
Investors are concerned about what a Biden Presidency might look like. On the face of it, and from a narrowly market-focused perspective, they are right to be concerned. Goldman Sachs calculates that the difference between Trump and Biden can be measured as a $20 fall in 2021 earnings per share for the S&P 500 index from $170 to $150. Let’s assume that investors respond to that by also reducing the multiple of earnings they are willing to pay for a share of the action and we might expect Wall Street’s benchmark to fall from last month’s peak of just over 3,200 to let’s say 2,700 (18 times $150). That’s nearly 15pc lower than the S&P 500 stands today.
If sentiment were to slide further, perhaps on the back of a second wave of infections or a deterioration in relations with China, even that might seem optimistic. Three-fifths of investors polled in a recent survey by RBC Capital Markets said Biden would be bad for the market compared with just 24pc when it seemed a more remote possibility last December. Nearly three quarters (73pc) said the election was a concern, higher than the 68pc who cited Covid-19 and 63pc who were focused on rising unemployment.
What are investors worried about? First, and foremost, tax. Biden has made clear that he would reverse the 2017 Trump tax cuts that have done so much to drive the stock market higher in the President’s first term. For companies, that would mean handing back half of a reduction from 35pc to 21pc in the statutory rate, although the impact on the effective rate most businesses actually pay would be smaller. For wealthy individuals, it would involve a return to the previous top rate of 39.5pc (from today’s 37pc) - hardly punitive by European standards and only affecting people earning more than $400,000 a year, but a marginal negative nonetheless.
Some companies would also find themselves squeezed by a proposed increase in the minimum wage to $15 an hour from a barely life-sustaining level of around half as much today. There would be sector-specific challenges too, with Biden likely to reverse Trump’s environmentally-blinkered support for fossil fuels and to increase the squeeze on big tech.
It would be wrong, however, to see the election as a black and white contest between a market-friendly Trump and the workers’ champion Biden. The Democratic challenger represented Delaware in the Senate between 1973 and 2009, a state that famously provides big business with a tax-friendly home. He was probably more left-leaning than Barack Obama, under whom he served as vice-President for eight years, but he is no Bernie Sanders or Elizabeth Warren. The $1.3trn of infrastructure he has pencilled in over 10 years is also long overdue in a nation of crumbling bridges and pot-holed highways and represents a massive opportunity for job creation in the construction sector.
The key to the impact of a Biden Presidency on the stock market is what happens in the Senate race in November. A clean sweep for the Democrats would open the door to a more challenging agenda from an investor’s perspective. Democrat control of the White House, Senate and House of Representatives has typically been associated with much lower returns than during periods when the Republicans control all three pillars of government (3.4pc versus 12.2pc in the two years following elections). The more common bi-partisan gridlock in Washington brings the averages much closer together - an 8.3pc gain in the two years following all Republican wins versus 5.8pc for the Democrats.
The reality is that the agenda for at least the early years of the next Presidency will be set not by the occupant of the White House but by what Harold Macmillan famously called ‘events’. The need to continue with fiscal and monetary stimulus, to build a robust medical infrastructure and to manage $18trn of Federal debt will tie the hands of whoever wins in November.
*References to dollars are in UD dollars unless otherwise stated.
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