Oct 27, 2024 | 8 min read
Key Takeaways
Company profits trump politics While elections and policy changes may cause short-term market fluctuations, corporate earnings remain the primary driver of stock performance. Market uncertainty typically decreases after elections, regardless of the outcome.
Sector-specific impacts matter more than party labels Rather than broad market effects, political changes create targeted opportunities and risks across different sectors. For example, while stricter immigration policies might challenge labor-intensive industries, they could benefit automation-focused companies. Similarly, technology regulation may affect social media companies differently than semiconductor manufacturers.
Policy changes require nuanced analysis Major policy shifts in taxes, tariffs, and regulation will impact different companies in varying ways. Many businesses have already adapted to potential changes – for instance, diversifying supply chains to reduce tariff exposure – making broad sector predictions less reliable than company-specific analysis.
The Big Picture: Profits vs. Politics
Market fundamentals and corporate earnings
While the stock market often appears deeply intertwined with politics, company profits consistently prove to be the dominant force driving stock performance.
Short-term volatility vs. long-term performance
Political events can certainly create uncertainty, as evidenced by increased volatility around elections, but this uncertainty typically dissipates once results are known, regardless of which party prevails.
Debunking common political market myths
Although it might seem like a simple matter of one party being "better" for the economy, the reality is more complex. Different sectors can be impacted in different ways by specific policies.
For example, a Democratic sweep could benefit US online media companies by potentially banning TikTok, while a Republican sweep might negatively impact clean energy and managed care. Even the traditional idea that gridlock is good for the market is challenged by the potential expiration of tax cuts.
Profits matter more than politics
Percentage of years from 1928 to 2023 where returns were positive based on political party vs S&P 500 profit cycles.
Source: FactSet, Bloomberg, Bank of America US Equity & US Quant Strategy
Major Policy Areas Affecting Financial Markets
Trade & Tariffs: Reshaping Global Supply Chains
Strategic objectives
The US is using tariffs as a tool to reshape its global trade relationships, aiming to reduce dependence on rivals and boost domestic high-tech industries. While this approach may be faster than other strategies like encouraging domestic manufacturing (re-shoring), it also carries the risk of retaliation from other countries and could negatively impact global trade and economic growth.
Business impact and adaptation
Although tariffs are generally bad for company earnings, their potential damage is lessened by the fact that many businesses have already adjusted their supply chains, reducing their reliance on imports from China. While a proposed increase in tariffs by Trump would raise the tax rate on Chinese imports significantly, the overall impact on earnings is estimated to be smaller than in 2018 due to this diversification.
Financial impact analysis
Bank of America estimates the total hit to S&P 500 company earnings at 3.1%, with 1.1% coming from Chinese imports and 2.1% from other countries. The actual impact will depend on factors like how much of the increased tariff costs companies can pass on to consumers and how much their sales in China are affected.
Risks mitigated: China's share of US imports already dropped 8 percentage points since 2018 (from over 21% to less than 14%)
Changes in market share in US imports since 2018 (Trailing twelve month as of Aug 2024 vs calendar year 2018)
Source: Bank of America US Equity & US Quant Strategy, Haver Analytics
Tax Policy: Beyond Corporate Rates
Individual tax cut expiration
While both tax policies and regulatory changes can negatively affect stock market returns, the bigger concern right now is the potential expiration of individual tax cuts from the 2017 Tax Cuts & Jobs Act. These cuts are set to expire in 2025, and whether or not they are extended will significantly impact consumer spending.
Historically, consumer sectors perform better under Republican administrations due to a lower likelihood of tax increases. While extending the tax cuts would benefit wealthier consumers, it could also increase the national deficit, posing a risk to the overall economy.
While not the base case, the TCJA expiration would represent the largest tax rise in history
Projected change in recipients, sum of first 5 years, chained 2012 USD ($bn)
Source: Bank of America Research Investment Committee, Bloomberg, Tempalski 2013, CBO, Penn Wharton. ATRA = American Tax Relief Act (2012); TEFRA = Tax Equity and Fiscal Responsibility Act (1982); TCJA = Tax Cuts Jobs Act; Omnibus = Omnibus Budget Reconciliation Act (1993)
Capital gains tax implications
Proposed changes to capital gains taxes under a Democratic administration could also impact the market. Increasing the tax rate on long-term capital gains for high earners might encourage them to sell their assets sooner to lock in lower rates, potentially leading to a sell-off, especially in the tech sector where individual investors have significant holdings. Although this tax increase would only target high-income earners, they hold a substantial portion of overall equities in the US.
Most popular retail stock holdings: APPL, MSFT, NVDA
% of financial advisors citing stock as top 3 holdings in 8th annual Global Wealth & Investment Management (GWIM) Survey (conducted Jan 31 - Feb 14, 2024)
Source: Wealth Management Marketing Research, Bank of America Equity & US Quant Strategy
Corporate tax landscape
Changes to corporate taxes are also on the table. A proposed increase under a Democratic administration would negatively impact company earnings, while a proposed cut under a Republican administration would boost them. Another potential change is an increase in the tax on stock buybacks, which would have a more manageable impact on overall earnings.
Immigration Policy: Labor Markets & Growth
Economic impact
Immigration has helped to curb inflation by increasing the labor supply. However, restricting immigration might not increase inflation as much as expected, as it reduces both labor supply and demand. Sectors that rely heavily on labor, like restaurants and retail, could be particularly affected by tighter immigration policies.
Business impact
Policies that restrict immigration, which are more likely under a Republican presidency, could harm companies that depend on a large labor pool. These companies could face higher labor costs and wage pressures, squeezing their profit margins. Reduced immigration could also slow overall economic growth, impacting company earnings.
Sector-specific effects
Bank of America analysts predict that tighter immigration policies could lead to labor shortages in the construction industry, putting upward pressure on wages in the restaurant sector, and negatively impacting retailers catering to lower- and middle-income consumers due to slower population growth.
Net International Migration has rebounded sharply following the end of the pandemic (thousands)
Source: Census Bureau, Harvey Analytics, Bank of Ame rica Global Research
Foreign-born workers have accounted for all labor force growth since February 2020
Civilian labor force, 16+ years of age, change since February 2020 in millions
Source: Census Bureau, Harvey Analytics, Bank of America Global Research
Sector-by-Sector Analysis
The main regulatory focus is likely to be on the financial, energy, healthcare, and tech sectors. While these changes will mostly impact specific industries rather than the overall economy, a shift towards less regulation could improve market sentiment and encourage investment.
Technology Sector
Regulatory landscape
Although tech companies face regulatory scrutiny, the US government's desire to maintain the country's leading position in technology may limit overly restrictive measures. Regulations are more likely to focus on consumer protection issues like cybersecurity and data privacy, particularly for internet, e-commerce, and companies handling user data. Many companies are already proactively self-regulating in these areas.
Competitive dynamics
The global competition in technology, especially with China, may also discourage excessive regulation of US tech companies, particularly in areas like AI, where hindering innovation is a concern. Furthermore, the fact that larger tech companies are better equipped to develop advanced AI models may reduce the risk of them being broken up.
Tech is one of the least regulated sectors
Accumulated Federal US government regulations by GICS sector (as of 2021)
Source: Bank of America US Equity and Quant Strategy, QuantGov
Privacy is the most prominent social controversy for US companies
S&P 500, number of social controversies, 2017-2023
Source: Bank of America Global Research, LSEG Data & Analytics, Privacy Controversies published in the media linked to employee or customer privacy and integrity, considers information where a breach of data has occurred relating to clients, employees, suppliers are considered.
Antitrust concerns
There's been a growing push for stronger antitrust measures in recent years due to increasing concentration of market power in many industries. The current US administration has taken a tougher stance on enforcing these laws, but this could change under a Republican administration, though there's internal disagreement within the party on this issue.
Financials Sector
Banking sector evolution
Smaller, regional banks are more vulnerable to regulatory changes than larger, systemically important financial institutions (SIFIs). This is because SIFIs have already undergone significant regulatory scrutiny and experienced a decrease in their valuations as a result.
Market share dynamics
Interestingly, SIFIs have lost market share to private lenders over the past decade. However, this trend could reverse as rising interest rates make private lending less attractive. Additionally, smaller banks may lose market share to larger banks due to increased regulatory burdens and the challenges posed by higher interest rates.
Energy Sector
Policy impact analysis
Under a Republican administration, the traditional energy sector might see some positive effects, particularly from a potential rollback of decarbonization efforts, which could boost demand for fossil fuels.
However, an increased emphasis on drilling could lead to less supply control, potentially affecting shareholder benefits. The energy sector’s outlook remains complex, influenced more by global oil supply and demand dynamics and geopolitical factors than domestic political changes.
Final Thoughts
Ultimately, while the outcome of the US election will undoubtedly influence market dynamics, its impact shouldn't be overstated. Investors should focus on understanding the specific policy proposals of each candidate and how those proposals might affect different sectors and individual companies. A nuanced approach that considers both the broader political landscape and company-specific factors will be crucial for navigating the market in the coming years.
At Israilov Financial, we closely follow economic and political developments to ensure we stay up-to-date and effectively manage client assets. We take pride in ensuring all client inquiries on major developments are properly evaluated and addressed. Our transparent, flat-fee structure combined with our commitment to timely market insights helps you navigate market transitions with confidence. Ready to optimize your investment strategy? Schedule your complimentary discovery meeting today.
IMPORTANT DISCLAIMERS
Past performance is no guarantee of future returns
The graphs and charts in this commentary are for illustrative purposes only and not indicative of any actual investment. Index returns do not reflect any fees, expenses, or sales charges. It is not possible to invest directly in an index. Stocks are not guaranteed and have been more volatile than other asset classes. Historical returns were the result of certain market factors and events which may not be repeated in the future. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgement in determining whether investments are appropriate for clients.
This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities.
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The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Israilov Financial LLC cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Israilov Financial LLC does not provide tax or legal advice, and nothing contained in these materials should be taken as such.
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