At the start of 2020, both markets and polls had predicted that Trump would be on his way to a second term election victory. Those fortunes quickly reversed by late May, with betting markets now favoring a Democratic and Biden victory. It appears that these polls have become linked with the broader trends in the US Covid-19 case counts. As investors can see in the charts below, Trump’s odds of victory were not affected by the initial virus outbreak, however the duration of the health crisis that has since been amplified by the reacceleration of infections have led to a significant drop in polling numbers. With that said, the surprise 2016 election victory for Trump should be a reminder to never count him out of a race. Moreover, it remains to be seen if the recent deceleration of Covid cases could help Trump’s chances for re-election. With the elections less than 3 months away, it is timely to review the possible implications of a Democratic sweep for the S&P500.

Biden’s Impact on S&P500 Earnings

The consensus view is that a Democrat sweep would be negative for equities. An interesting report from JP Morgan offers a more neutral view as it breaks down the party’s major economic policy proposals and the potential impact it has on S&P500 earnings. (see summary chart below for S&P 500 EPS sensitivity to policy proposals).

Higher corporate taxes. Trump’s Tax Cut and Jobs Act (TCJA) had cut the statutory tax rate from 35% to 21%. A partial reversal of the TCJA should be expected and the prospect is for the rate to rise to 28%. This 7% tax hike could represent an earnings drag of ~$9 for the S&P 500. Moreover, this tax increase could be accompanied by a ‘minimum tax’ and/or a reduction in the GILTI deduction which reduces the taxes owed by multinational corporations and US shareholders of foreign corporations. Altogether, this could cause a further $3 drag on S&P500 earnings.

Federal Minimum Wage Hike. As of 2019, there were 82 million workers who were paid hourly rates. There are about 392,000 individuals earning the current Federal minimum wage of $7.25/hr and 1.2 million individuals who, due to exceptions (eg. tipped employees), earn less than the Federal minimum wage. Increasing the Federal minimum wage to $15/hr by 2025 would boost wages for approximately 17 million workers. In JPM’s view, this may only be slightly negative (-$2) to the S&P500 earnings as these companies would still benefit from a higher aggregate demand for their products and services. Moreover, these companies should be able to contain any margin pressure through their operating scale and productivity management. With that said, this policy could create a further divide between companies that are able to absorb higher wages vs. those with lower pricing power and scale (e.g. large-caps vs. small-caps and private businesses).

Trade policy and tariffs. Tariffs were large headwinds to growth in 2019 as JPM estimated it cost the S&P500 approximately 7-8% in earnings growth. Biden has emphasized that he would reduce trade barriers and rather seek to build an international coalition against China. Hence, some tariff easing should be expected under a Biden administration. A reduction in trade friction costs and lower import prices could equate to a significant boost for S&P500 earnings (+$8.50).

Higher Infrastructure spending. An infrastructure spending bill would accomplish multiple priorities for Biden, including increasing employment, expanding green technologies and updating public transportation. Assuming a $1 trillion plan over 5 years with half of that spending going to S&P500 companies, this could create a gain in earnings of approximately $1/year.

Overall, some of the proposed policies are damaging to earnings, but others boost earnings. It appears that the impact on earnings is a net negative to the S&P500, however, the magnitude does not seem to be disastrous. Historically, politicians will campaign with more extreme proposals, only to converge back to the center after the election. Especially in this environment, a weak economy that is hampered by COVID19 could be a reason to dilute Biden’s policies that could potentially delay business recovery and job growth. With the election still months away, the market has not yet fully priced in a victor and therefore this leaves room for further volatility. Hence, investors should pay attention to these developments and may consider rebalancing portfolios ahead of time.