London - With 99 days remaining until the US presidential election, many investors are questioning the implications of possible election outcomes on the equity market. These discussions inevitably turn to potential changes in policy and, in particular, taxation.
Vice President Biden has proposed raising the corporate tax rate from 21% to 28%, unwinding much of the benefit from the Trump tax cuts a few years ago. Whether this will actually happen is open to debate. According to research from Strategas, investors are giving a slightly better than 50% probability of a Democratic sweep in November — Presidency, Senate and House of Representatives. We wonder if investors have considered these scenarios and positioned their portfolios appropriately for the possibility of this outcome.
US corporate tax rates in the near term
In the near term, we suspect any upward pressure on US corporate tax rates is related to the outcome of November's election. A lot can and will happen between now and November 3, and we believe volatility in US stocks is likely to increase. However, we do not think the potentially negative impact of higher corporate taxes on earnings is currently being priced into US stocks — particularly considering that international equity trades at a multi-decade discount to US equities, even before any prospective reduction in earnings.
Government debt a long-term concern
In the longer term, upward pressure on US corporate tax rates is more likely related to something that few investors are currently focusing on — the level of government debt. According to Credit Suisse, the International Monetary Fund estimates that the US government debt to GDP coming out of the COVID-19 crisis will be 43 percentage points higher than the eurozone's.
In addition, the IMF projects the US budget deficit is 7.1 percentage points higher. An obvious way for the US to address this debt level is to increase corporate taxation and to spend less, both of which will be impediments to economic and earnings growth.
After a sustained period of outperformance of US equity markets relative to international equities, we believe that now is the right time for investors to evaluate rebalancing their portfolios and diversifying into or expanding their international equity positions.
Bottom line: The prospect of higher corporate taxes and lower earnings in the US in the years to come, against the backdrop of a multi-decade low in the relative valuation of international stocks, make this repositioning compelling and timely.