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It could lead to higher taxes, fewer share buybacks and lower corporate profits
Thursday 16 Jul 2020 Author: Daniel Coatsworth

Investors’ ferocious appetite for tech stocks is helping to drive up the US stock market. The second quarter earnings season is now underway and could easily knock this rally off course if the tech companies disappoint with their earnings growth, profit margins or outlook, due to heightened expectations.

Whether that happens or not, there is a potentially much stronger force just around the corner which could truly derail markets and that’s a Biden presidential election victory.

Markets may not be worried about such an event now, but this situation could change as we draw closer to the November vote. What happens to US markets typically sets the tone for investors in other parts of the world.

Donald Trump’s tax cuts for individuals and businesses have been good for the US stock market as well as for companies doing business in the US and listed on foreign exchanges such as London.

Democratic presidential candidate Joe Biden currently has a lead in the election polls, according to Real Clear Politics, and he wants to reverse some of Trump’s tax policies.

Corporate tax rates would go up, higher earners would pay more tax, many companies would see margins squeezed as the minimum wage is lifted, and a sharper focus on environmental issues would likely be negative for fossil fuel companies.

Biden has also shown a desire to make large companies pay more tax, including big tech firms. In a recent speech, he said: ‘It’s way past time we put an end to the era of shareholder capitalism. The idea the only responsibility a corporation has is with shareholders, that’s simply not true, it’s an absolute farce. They have responsibility to their workers, their community, to their country.’

Many US companies have used tax savings to buy back shares which has in turn boosted returns for shareholders. A less favourable tax regime could therefore remove a major catalyst for stocks.

A report from investment bank Goldman Sachs suggests Biden’s tax plans would cut earnings per share of S&P 500 companies by 12% in 2021, presenting another headwind for markets.

Trump’s hard line on US trade talks with China may have contributed to a lot of stock market volatility before the pandemic and so a Biden victory could lift hopes of a better relationship between the two countries, although that is far from certain.

As it currently stands, Biden becoming the next US president has the potential to cause shockwaves in global markets. It might make investors reduce their US exposure and shift more attention to other geographic regions, thereby triggering a rotation away from a market that has delivered superior returns for the past decade and potentially looking at ones that have underperformed.

Given the UK still has considerable risks around Brexit trade deals investors may instead prefer to look at somewhere like Continental Europe. Germany’s DAX index is down nearly 4% this year compared to an 18% gain from the Nasdaq in the US. That certainly looks like a good place to do some homework for investment opportunities before the money starts to travel from the US across the North Atlantic Ocean.

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