Political Calculations: S&P 500 Bounces Around with Prospects for More Fiscal Stimulus

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12 October 2020

S&P 500 Bounces Around with Prospects for More Fiscal Stimulus

The S&P 500 (Index: SPX) closed the trading week ending Friday, 9 October 2020 at 3,477.13. That falls within three percent of its 3 September 2020 all-time record high close of 3,580.84.

The index rose, fell, and rose again with the prospects for another round of fiscal coronavirus stimulus coming from the U.S. government during the week. That action puts the level of the S&P 500 in the upper half of the latest redzone forecast range of the alternative futures chart - the latest update to which shows the projections of the dividend futures-based model through the end of 2020:

Alternative Futures - S&P 500 - 2020Q3 - Standard Model (m=+1.5 from 22 September 2020) - Snapshot on 9 Oct 2020

What the alternative futures chart doesn't yet show is what could result for markets following the outcome of the U.S. elections. Here, if candidate Joe Biden wins, we would anticipate a partial repeat of 2012's Great Dividend Raid.

That event was triggered in November 2012 after President Obama won re-election, which all but ensured an increase in federal income tax rates in 2013. Influential investors pulled ahead as much dividends as they could before the end of the year, which caused stock prices to rise sharply.

That would be the portion of the Great Dividend Raid we would reasonably expect to repeat during the fourth quarter of 2020 in the "Biden wins" scenario, because he has pledged to increase both personal and corporate income tax rates, and also the tax rates that apply upon both dividends and capital gains.

All these tax hikes would potentially devastate the market in 2021, but that would depend upon the actual tax changes that would be enacted. In 2013, President Obama's fiscal cliff tax deal raised personal income tax rates, but lower tax rates held for dividends and capital gains, making it advantageous for influential investors to channel investment returns through them rather than through personal income. With that fundamental support, the stock market avoided crashing and was able to grow.

We think things would be very different in 2021, given that Biden's political party has shifted so far to the left over the intervening years, which would all but ensure downward pressure on stock prices. To avoid crashing under the Biden tax regime, even more government-funded fiscal stimulus and more monetary stimulus from the Federal Reserve would be required to offset the contractionary impact of the tax hikes, which will need to be provided at levels several times larger than the projected changes in the amount of taxes to avoid that outcome.

Meanwhile, we wouldn't expect to see anywhere near the same tax avoidance-driven volatility in the market during the rest of 2020 or in 2021 if President Trump is re-elected. That is mainly because investors would not expect drastic changes to established tax policies and thus wouldn't need to "rush for the exits" before the end of 2020. It would also be less prone to crash in 2021, though that would depend in part on the Federal Reserve continuing to provide monetary stimulus. The Fed's minions sent out mixed signals on that count during this past week.

We don't think the chances of either presidential candidate winning is doing much to affect stock prices at this time, with stock prices more or less in a holding pattern outside of the influence of the noise from the fiscal stimulus negotiations. As a general rule, political events may contribute noise to the markets, but until major changes in tax rates become an immediate concern affecting investor expectations for the future, they won't contribute more than day-to-day noise to the S&P 500.

Speaking of investor expectations, here are the market-moving headlines we pulled from the past week's newstream:

Monday, 5 October 2020