By the end of September, the 2020 US presidential election had already witnessed many twists and turns. However, the news breaking on October 2 that President Trump and First Lady Melania Trump had tested positive for COVID-19 added a new layer of uncertainty to this cycle.
Like the long list of October election surprises — most recently, the Comey Letter in 2016 — this announcement will have a short-term impact on polls and markets. However, the five policy issues discussed in my earlier blog could shape the trajectory of market segments for years to come. Here we offer implementation ideas to position portfolios based on the outcome of the presidential election.
Policies: Biden plans to increase taxes for corporations and high earners, while Trump has called for further tax breaks.
Probability: Passing new tax legislation depends on whether Republicans can maintain control of the Senate — a toss-up as of now. Currently, the probability of the House remaining under Democratic control is 85%.1 So, a split Congress leaves little room to get a tax deal done. However, if the Senate goes to the Democrats and Biden wins, his tax policy plans are likely to be implemented.
Plays: Biden’s policies suggest that investors focus on low tax-sensitive sectors, such as Real Estate. That sector’s earnings may be less affected if tax rates rise, given that its average effective tax rate in 2019 was just 4%.2 Tax-exempt bonds may be another Biden play, as those securities would likely become more attractive sources of returns, considering that the interest paid to investors is not subject to federal taxes.
If Trump wins a second term, high tax rate areas — such as Consumer Staples (29% effective rate) and Retail (24%) — may do well, as their earnings could be positively impacted by paying less in taxes. Additionally, lower individual tax rates could spur consumption and be a benefit to certain consumer-focused markets.
Source: Bloomberg Finance L.P. as of October 2, 2020. Characteristics are as of the date shown and may be subject to change.
Biden: Consider the Real Estate Select Sector SPDR Fund [XLRE], and for a tax-exempt exposure with a potential income boost, consider the SPDR Nuveen Bloomberg Barclays High Yield Municipal Bond ETF [HYMB].
Trump: Consider the Consumer Staples Select Sector SPDR Fund [XLP] and the SPDR S&P Retail ETF [XRT]. XRT has 65% of its exposure in mid- and small-cap stocks,2 with no security contributing more than 2.5% of the portfolio’s overall risk profile3 – mitigating the impact of one single stock upending this play.
Policies: More of a globalist, Biden is likely to repeal current tariffs, while Trump’s “America First” foreign policy agenda will likely feature more tariffs.
Probability: The White House’s sweeping trade powers make it easier for presidents to enact their policies.
Plays: If Biden wins, the negative price action we witnessed when tariffs were levied on Chinese equities may be reversed. As shown below, Chinese stocks fell significantly relative to the US in both March and June 2018 (the first and second round of 25% tariffs on steel imports and then 818 Chinese products). Similarly, given the number of tariffs placed on European products and services, that region could see a boost in sentiment if Biden wins.
Source: Bloomberg Finance L.P. as of October 2, 2020. Past performance is not a guarantee of future results. Index returns are unmanaged and do not include fees.
If Trump wins a second term, focus on the more domestic segments of the US market that are less exposed to international supply chains. As shown below, breaking down the US market by size and style, mid- and small-cap exposures have the lowest revenue generation from outside the US, while value trumps growth in terms of a domestic footprint.