Americas CIO View

The polls have spoken: Have the people?

The key swing state polls suggest a decisive Biden victory

Of the 12 swing states, which hold 189 electoral votes, Biden is leading in the polls in 10 of the 12 states and by a large gap in most of them (135 electoral votes). Trump is leading in only two of these states (54 electoral votes). These swing state polls suggest a decisive Biden victory. We see the polls as an important indicator of likely results, but it is still far from certain.

A Biden victory suggests larger, but later stimulus than otherwise likely

We are disappointed that further stimulus (support) was not added this autumn and now appears unlikely until after the election. We believe the United States still needs large, but also timely and well targeted stimulus to recover its peak gross domestic product (GDP) by 2021 end. We still expect more stimulus regardless of the election's outcome eventually. We hoped to avoid complete or prolonged interruptions of certain programs, such as the Paycheck Protection Program or sharp drops in enhanced unemployment, that could cause more permanent business closures and make household job transitions more difficult and trigger credit losses, stopped rent payments, etc. Election season fighting has delayed stimulus to after the elections and if Democrats sweep, it is quite possible that more stimulus does not come until after the late January inaugurations. Thus, a Biden stimulus is likely greater in dollars, but timing and targeting likely less optimal in our view.

Higher domestic corporate tax and dividend / capital gains tax rates likely

Changes to the U.S. statutory corporate tax rate are likely to affect companies based upon their domestic vs. foreign mix of pretax profits. Not their effective tax rate. If the U.S. corporate tax rate climbs from 21% to 28%, then a company earning 100% of its profits in the United States will keep 72% instead of 79% or a 9% reduction. Whereas, if a company earns 60% of its pretax profits in the United States the reduction to its after-tax profits will be 5.4%. It is easy to change the statutory tax rate, but framework and other corporate tax code changes are complicated and likely incremental over time if at all. The United States adopted a territorial system after 2017. A higher minimum tax on foreign profits is possible, but this interacts with other nation's tax policies and U.S. companies still have the option to redomicile.

Higher dividend and capital gains tax rates are likely if Democrats sweep. It is possible that dividend tax rates (if treated as income) exceed long-term capital gains rates. We do not expect capital-gains taxes to change from paid when realized to pay based upon paper gain/losses year-to-year. Thus, we think higher taxes on profit distributions is a burden that weighs more heavily on companies with high dividend-payout ratios; as capital-gains taxes likely stay deferred and the long-term capital gains tax rate stays equal to or less than dividend tax rates. It remains to be seen if anti share repurchase policies emerge, but companies with the ability to productively reinvest capital will be at a greater advantage.

We see higher corporate and dividend tax rates weighing more on value then growth stocks. Financials and most other value stocks derive more of their profits domestically than tech and most other growth stocks. Most value stocks have higher dividend payout ratios then growth stocks, as value investors usually seek value companies for their dividend yields. Thus, these two most likely tax hikes hit value more than growth stocks. Real Estate Investment Trust's (REITs) are not affected by these possible corporate or dividend-tax changes. We also see the regulatory risks for financials and energy greater than for tech and even health care.

Higher inflation and steeper yield curve with Democrats is possible, but uncertain

Greater stimulus, higher inflation and a steeper yield curve are popular arguments for improved value vs. growth performance with a Democratic sweep. However, the outlook for inflation and yields is extremely uncertain. We think if inflation does rise that Treasury yields will rise in tandem and that the U.S. Federal Reserve (Fed) is unlikely to suppress long-term yields under these conditions. In other words, we do not think the Fed is aiming for more negative real yields, but rather just higher inflation and inflation expectations within bond yields. We think real yields will climb modestly under these conditions to about 0% on 10-year Treasury Inflation-Protected Securities (TIPS) slowly over time. Under this scenario of healthy growth, moderately higher inflation and modest long-term yield normalization we think financials will perform best among value sectors.

Infrastructure: Both parties want it for years, so why hasn't it happened already?

Infrastructure is not an election issue in our view. The will and the means have long existed, but not the projects. Given the wave of airport renovations now behind and stressed big city and mass transit system budgets, we think federal aid is needed. After the elections, especially if Democrats sweep, we expect muni bonds to benefit from federal aid. We see utilities as a safer play on U.S. infrastructure investment than most industrials / materials.

 

Appendix: Performance over the past 5 years (12-Month Periods)

 

09/15 - 09/16

09/16 - 09/17

09/17 - 09/18

09/18 - 09/19

09/19 - 09/20

U.S. Treasuries (10-year)

5.4%

-3.0%

-3.0%

14.0%

10.1%

U.S. Treasuries (2-year)

0.9%

0.2%

0.0%

4.4%

3.6%

U.S. Treasuries (30-year)

12.5%

-6.3%

-3.6%

24.8%

16.3%

Past performance is not indicative of future returns.

Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 10/19/20

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