Reading the rhetoric ahead of the US election

The central issue for investors is how the presidential candidates, Democrat Kamala Harris and Republican Donald Trump, will approach tax and regulation.

Broadly, Harris stands for higher taxes and more regulation, a likely headwind for US (and global) stocks and a tailwind for long-dated government bonds from lower budget deficits. Trump, meanwhile, wants tax cuts and less regulation, a boon for profits and stocks, but a bane for Treasury bond returns.

Which party controls Congress will play a crucial role in determining whether the winning candidates’ policies are implemented and becomes reality or ends up as rhetoric.

According to opinion polls, the election outcome will be incredibly close. If the result is disputed by either side, it could lead to market volatility.

Taking stock of the upcoming US election

Ongoing concerns about a possible US recession, the direction of US interest rates and toppy tech-sector valuations all weighed on stocks over the summer.

But with the US Federal Reserve (Fed) having started its rate cutting cycle, US growth appearing resilient and the valuations of tech stocks moving lower, the focus for markets has now shifted to the US election in November. 

Records are going to be broken whoever wins the keys to the White House. Harris is aiming to be the first woman to become President and the first sitting Vice President since George H.W. Bush in 1988, the last one to do it since President Martin Van Buren in 1836. If Trump is elected, he will be the second re-elected President to serve non-consecutive terms since Democrat Grover Cleveland in the late 19^th century. 

Investors, however, are trying to understand what a new administration could mean for portfolios. Some of the candidates’ remarks are simply rhetoric, but it is plausible that either Harris or Trump could implement substantial policy changes when the new presidential term commences on 20 January 2025. 

The central issue for investors, and a clear distinction between both candidates, is how they would approach tax and regulation. The electorate must decide whether to Make America Tax Again under Harris or Make America Deregulate Again under Trump. We look at their recent speeches and comments from their respective party platforms to sketch out some post-election scenarios and accompanying market risks.

Making America Tax Again

Harris has not disclosed a full fiscal plan, though her proposals broadly mirror President Joe Biden’s 2025 budget. These include: i) higher taxes for high-income earners (both income and capital gains). ii) a hike in the statutory corporate tax rate to 28% from 21% currently.¹ iii) raising taxes on share buybacks to 4% from 1%.² 

In terms of the potential market impact, Goldman Sachs (GS) calculates that corporate tax reforms under Harris would lower S&P 500 earnings per share (EPS) by about 8%.³ 

Moreover, there is a risk that the increase in buyback taxes could lower demand for stocks: US corporates have been the biggest buyer of US equities since 2000, with cumulative net demand of nearly $6 trillion.⁴

On balance, new tax increases would easily exceed the cumulative cost of tax cuts for the middle-class, so that fiscal policy will be tightened and growth dampened. On the upside, the rate at which the government racks up public debt would slow, and this should ease some long-term funding issues in the US Treasury market.

Conversely, Trump’s fiscal plans entails making permanent the individual income tax cuts from the expiring Tax Cuts and Jobs Act of 2017. It also includes lowering the corporate tax rate to 20%, or potentially to 15% for companies that make their products in the US.⁵ GS estimates a 15% corporate tax rate will boost S&P 500 EPS by 4%.⁶

Offsetting these tax cuts is a plan to raise tariffs on all imports. Nevertheless, in his nomination acceptance speech in July, Trump surprisingly called for tariffs to be used as a tool to force China to invest in US automobile plants. Perhaps this shows he is willing to separate the economy from national security concerns. While it is a long shot, if he can reach a deal to secure higher investment from China it could resolve the US-China trade dispute and ironically, encourage globalisation of capital (under Trump’s terms) to boost growth. 

The downside of Trump’s tax reforms is that it could come with more public debt and potentially higher inflation if companies pass on tariff increases to the consumer. This could also weigh down on economic activity.

Make America Deregulate Again

Broadly speaking, the Democrats stand for greater regulation compared to the Republican party. Harris has proposed raising the federal minimum wage and implementing price controls on groceries. In the short term, this could lead to more take-home pay for consumers, but history shows that price controls don’t work. President Richard Nixon tried it in August 1971 when he introduced temporary price controls for 90 days. Ultimately, it led to supply shortages, further prices controls and inflation. 

In contrast, Trump has a track record of deregulating. In his first term, his administration cut some major regulations, including lower fuel efficiency standards for vehicles, scaling back environmental permit requirements, whilst easing financial and tech regulations.

We expect further deregulation under a second Trump term, but with more bite this time. That’s because the conservative leaning Supreme Court (SC) made new regulations difficult to impose and existing rules easier to challenge.

Significant Supreme Court rulings affecting regulations

i) The SC made clear in 2022 under the “major questions doctrine” that federal agencies required the approval of Congress to tackle issues of “vast economic and political significance”. In effect, this reduced the power of the federal government to regulate certain industries, such as energy.

ii) The SC gave an opinion that ended “Chevron deference” in June 2024 - a legal precedent established in 1984 that gave sweeping powers to federal agencies to interpret as they wished when laws passed by Congress were ambiguous.

Post-election scenarios

Many of the campaign proposals will be dependent on which party gains control of Congress. Currently, the US has a divided government, where the Republicans hold a majority in the House of Representatives, while the Democrats hold the Senate and the White House. If one party gains a majority in all three branches of Federal government this is commonly known as a “clean sweep”.  There are four broad scenarios for investors to consider.

1. Republican clean sweep. This could be a tailwind for stocks as company earnings benefit from potential tax cuts. However, it could prove to be a headwind for longer-dated government bonds due to the risk of higher inflation and larger budget deficits over the medium term
2. Trump divided government. Gridlock is likely to be somewhat constructive for stocks because the risk of a sharp change in fiscal policy should be limited. Deregulation could be a tailwind for the oil and gas, financial and tech sectors. This scenario could be a headwind for renewables if regulations supporting environmental policy implementation are slowed.
3. Harris divided government. Similar to point two, gridlock should also benefit stocks. Sector-wise, consumer discretionary stocks could benefit from a higher income boost to consumption assuming that tax cuts for the middle-class and a higher Federal minimum wage are passed. Tech stocks could suffer if anti-trust regulations are tightened and data privacy rules for consumers are strengthened. 
4. Democratic clean sweep. Stocks could be negatively affected by concerns of higher taxes, but this should pass over time. That’s because Harris would probably struggle to pass an extreme set of tax hikes through Congress, as Democrat moderates could push back on some of it. Trump faced a similar situation in 2016. Despite the Republicans controlling both houses in Congress, Trump’s proposal for $7 trillion in tax cuts was eventually scaled back to $2 trillion.⁷

Conclusion

Stocks may be volatile both in the lead up and after the election. Financial markets could be affected by sizeable tax and regulatory changes if one party obtains a clean sweep. 

Until then, a key risk to watch out for is a disputed election that leads to sporadic social unrest. Certainly, opinion polls show a statistical tie in the crucial battleground states that will likely determine who wins the keys to the White House.

We are wary of the political rhetoric surrounding the election and are instead focusing on how policy could affect investment returns. Historically, the performance of the real economy, valuations and changes in interest rates are more important drivers of the stock market, rather than who the president is. In a way, the market works as a barometer to sift between what is rhetoric and reality.

Sources and footnotes

1 Tax Foundation.org, Kamala Harris tax plan ideas: details and analysis; 10 September 2024
2.3.6 Goldman Sachs, Potential implications of corporate tax reform for S&P 500 earnings, 4 September 2024
4 LSEG, Evelyn Partners, September 2024
5 C-Span.org, Former president Trump remarks at the Economic Club of New York, 5 September 2024 
7 Capital Economics, Harris plans major tax hikes, 30 August 2024