At this record-high level, are US equities more vulnerable to a correction in absolute and/or relative terms? If investors aren’t pricing in a blue sweep, there may be risks. We believe that immediate policy actions after a blue sweep—such as an increase in corporate and capital gains tax rates—would be quickly priced in this year and create temporary pressures. The longer-term trend would likely resume based on the power of the underlying businesses and economic dynamism in the US markets. If, however, we are faced with a disputed election and the tide is tipped into a US dollar bear market, making the US less amenable for investors, we would expect this chart to make a meaningful downward move.
A closer look at the effects of a blue sweep on tax policy
Our team took a closer look at potential changes to tax policy and estimated that a blue sweep could lead to an approximately 8% to 12% hit to the earnings of the S&P 500® Index, which markets will likely discount swiftly. If cuts enacted under the Trump administration’s Tax Cuts and Jobs Act (TCJA) are rolled back, we would expect companies with a high degree of domestic sales and earnings to take the biggest hits, including:
- Consumer staples (particularly packaged food)
- Communication services (telecom and cable)
- Financials (banks)
- Consumer discretionary (domestic retailers and restaurants)
- Information technology (software)
The TCJA also eliminated prior tax disincentives on the repatriation of foreign earnings. Since the law took effect, many US nonfinancial firms with large holdings of cash abroad have deployed repatriated funds for stock buybacks.1 If a blue sweep results in changes to the repatriation tax framework, the pace of buybacks may diminish, possibly curtailing what has been a meaningful tailwind for equities.
How the health care sector may react
Given investors’ increasing focus on the health care sector amid the COVID-19 pandemic, our team also took a closer look at this topic. Overall, a blue sweep would be a clear negative that is not currently priced in, which would lead us to expect a material pullback in health care equities. That said, Biden is not as feared by investors as past Democratic candidates because of his commitment to building on Obamacare, albeit with a public option—a component that makes some investors nervous. If Biden’s pick for a running mate is a strong advocate for “Medicare for All,” then the sector could be immediately impacted by concerns over the long-term implications of a public option. We would expect pharmaceuticals, biotechnology and managed care companies to be particularly affected.
This is an increasing risk for investors to watch. As we enter the second half of the year with a modest underweight to equities, the impact of election risk is becoming a larger consideration. One of the lessons learned from the 2016 US election is that polls don’t tell the complete story, but will influence how the market perceives possible outcomes. Given the binary possible outcomes and long way to go, holding an overweight to gold has been part of how we are looking to hedge this risk (among others).
Stay tuned to SPDR® Blog for more information about the state of the upcoming election and the related investment impacts.