While it’s too close to call and likely will remain that way, who wins the U.S. presidential election may have a big impact on market valuations. Tax policies between the candidates are significantly different and will have an impact on corporate and personal after-tax earnings.
Once again, it will come down to a small number of voters in the swing states -- and this time it seems like Pennsylvania will be the one to tip the scale. You can bet both candidates will spend more time in these states.
Last week, Joe Biden and Kamala Harris rallied with union workers in Pittsburgh against the purchase of U.S. Steel by Japan’s Nippon Steel. Donald Trump will no doubt try to leverage the assignation attempt, Harris’ anti-fracking history and green agenda in Pennsylvania for whatever that might be worth.
The impact on S&P 500 earnings and how consumers spend their income is levered to the difference in tax policies. Trump plans to cut the corporate income tax rate to as low as 15 per cent, while Harris wants to raise it to 28 per cent.
That alone could mean a double-digit percentage-point swing in S&P 500 earnings. Harris has also stated that she backs a quadrupling of a one per cent tax on stock buybacks.
But tax policy is in the hands of the U.S. Congress. The difference between a clean-sweep election and a divided government also could be stark. More stimulative fiscal policies produced by one-party rule (GOP has a more stimulative platform) could produce faster near-term growth but with higher inflation, bloated deficits and fewer U.S. Federal Reserve rate cuts than under a divided government.
That could hurt longer-term growth. Currently, the forecasts are saying it’s also too close to call, but the tilt in Congress is for the GOP versus slightly to Harris for president.
UBS strategists say a blue sweep would likely have a “slightly negative impact” on the S&P 500. Meanwhile, “equity markets would likely cheer” the lower taxes and lighter regulation prescribed by a second Trump administration. Once Trump’s more Wall Street-friendly policies are “partially offset by concerns about the costs and inflation impacts of higher tariffs and trade wars,” UBS strategists expect just a “slightly positive” impact.
However, some other firms think trade frictions and deportations of unauthorized immigrants might make Trump’s policies an outright drag on gross domestic product (GDP). UBS expects that a Harris victory with a GOP senate would have only a “muted impact on financial markets,” with little chance of increases in corporate or capital gains taxes.
Further, recent U.S. Supreme Court decisions should restrain the regulatory state to a significant degree. UBS strategists say those rulings “will likely curtail the ability of executive branch agencies to interpret federal statutes.”
Historically, the stock market does better with a split government. History shows that a divided government has tended to produce stronger stock market returns than one-party control. Dating back to 1958, elections with divided outcomes have averaged two-year S&P 500 gains of 20.4 per cent.
Elections delivering one-party rule have generated more middling returns, with an average two-year S&P 500 advance of 14.2 per cent. The biggest inflationary risk for markets is a sweep of either side given little fiscal restraint in 2025 and beyond.
The Trump tax cuts are set to expire at the end of 2025. They would cost $4 trillion to extend over the next decade, according to the Committee for a Responsible Federal Budget. Unless revenue from new tariffs helps shrink the fiscal gap, the tax cut extension could balloon the already unwieldy budget deficit beyond seven per cent of GDP.
That could risk a bond-market backlash, pushing up the 10-year U.S. Treasury yield and hitting stock prices along with demand for new mortgages and car loans.
An analysis by the University of Pennsylvania’s Wharton School budget analysis center finds that Trump’s plans would add $4.1 trillion to the 10-year primary budget deficit. The analysis of blue-sweep policies came before Harris fleshed out her tax plan on Sept. 3, but still helps to understand it. Perhaps the key finding is that the $1.2 trillion in corporate tax hikes might hurt.
Wharton finds that GDP would be 1.3 per cent smaller in 2034 than under current policies, amid less investment in productive capital. It also sees wider deficits due to $2.2 trillion in tax benefits for moderate-income families. Moody’s says the effective corporate tax rate would jump from around 12 per cent to above 19 per cent. That would put the U.S. near the top among market-based OECD countries.
Another key difference is the distributional impact. The bottom 20 per cent of households would get an initial 18 per cent income boost in a Harris sweep, Penn Wharton finds. Yet the conservative Tax Foundation’s analysis of the White House’s 2025 blueprint, much of which Harris embraced Wednesday, suggests a weaker economy would erode lower earners’ income gains over time. Under Trump, everyone would get a tax cut, though the bottom quintile would see just a 1.4 per cent increase in income.
In assessing Harris’ policies, Moody’s Analytics attributed to her the full $5 trillion of tax hikes in Biden’s 2025 budget proposal. Moody’s figures that all that relative fiscal discipline would lower interest rates and even unemployment, while after-tax corporate profits would stagnate over the next four years.
To sum it all up at the moment, and while it’s too close to call, the relative fiscal restraint at this point under Harris and a split Congress might be a better overall economic outcome for the average American.
If we do see a sweep on either side, that might be the more volatile outcome for financial assets. Given how close it is and that the outcomes can be vastly different under the scenarios, we think more uncertainty now should mean markets can test key support before we can see new highs.
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