Transcript
Host: Jeff, good afternoon. Great to be with you. Let’s get right to it.
I want to focus today’s conversation on the upcoming elections in the United States. So what are the potential US national election outcomes and where do they stand currently?
Jeff Schulze: Well, there are four potential outcomes on the table right now: a Democratic sweep, a Republican sweep, Trump with a divided government, and Harris with a divided government. And when you look at the race for the White House, Harris is leading Trump by about two percentage points in the national polling averages. But more importantly, it’s a dead heat in the swing states. So this is going to likely come down to November to see ultimately who wins. But, more importantly, if you’re looking at the prediction markets, the two most likely outcomes are a Republican sweep and a Harris presidency with a divided government. And that comes back to the Senate. The playing field very much favors the Republicans. In fact, when you look at the map, in order for Harris to win and have Democratic sweep, you’re likely going to have to run the table on all states that are up for grabs except for Texas and Florida, which is going to be very difficult—especially when you look at Montana, which is a state that Trump won by 16 percentage points in 2020. So the map really isn’t favorable for a Democratic sweep because of what’s going on in the Senate. But ultimately, we’re two months away from the elections. A lot of things can change, but that’s how the prediction markets are looking at it at the moment.
Host: So I’ve heard recently that the election really comes down to a handful of swing states. How true is that?
Jeff Schulze It’s very true. If you look back to the last election, about 155 million Americans voted and the outcome was determined by a few hundred thousand votes from seven key states. So the swing states are Arizona, Georgia, Michigan, Nevada, North Carolina, Pennsylvania, and of course Wisconsin as well. So yeah, it’s really going to depend on those key swing states. And I think looking at this right now, again, we’re two months out from the election. A lot of things have changed. A lot of things will change. There’s very thin margins right now and the election’s really going to be determined by a handful of states and in particular a handful of counties. So it’s going to be a close race.
Host: So Jeff, you know, when it’s all said and done, how much impact does the US president and congressional composition have on the capital markets?
Jeff Schulze: Well, different president and congressional configuration will dictate how much can be passed and ultimately how much effect you will have on the markets and the economy. For example, when you have a sweep scenario, whether it’s Republican or Democratic, that’s really where you can see drastic increases or decreases in tax authority and then also spending as well. So, for example, when you had a Republican sweep in 2016, that’s when the Tax Cuts and Jobs Act came out under President Trump. You saw a lot of legislation come out after the 2020 elections when you had a Democratic sweep during that timeframe. So those examples are going to be the ones where you’re going to see major policies that will drive the markets and the economy. But there’s other areas that are impactful at the margin. If you have a divided government, that’s really where regulation and trade policy is going to come into play, because those are the areas where the president can act unilaterally, and you don’t necessarily need Congress in order to exact changes. So, you know, it does have an impact on the market. I don’t want to downplay that, but I do want to say that, generally speaking, the economy and the trajectory of it is really the most important driver for markets over the long haul, even though you know the presidential and congressional composition can have some smaller effects on the markets as you get through election day.
Host: Jeff, let’s dive into the four areas where the election can impact equity markets and the economy. I’d like to start with the potential tax changes.
Jeff Schulze: Now I feel like I’m talking out of both sides of my mouth, because I just said that, generally speaking, tax and spending changes only happen during a sweep scenario. But we actually have a unique situation coming up in November, and more specifically next year, because legislation will need to pass even in a mixed government as major elements of the Tax Cuts and Jobs Act, the TCJA, or the Trump tax cuts are going to sunset next year. And if nothing is done, you’re going to see almost every taxpayer see an increase of their average tax rate. So nobody wants that to happen. There’s going to be incentive from both sides of the aisle to talk and negotiate and to extend some of these expiring provisions.
Now to put some numbers around it, the Tax Cuts and Jobs Act had a pretty material impact in equities back in late 2017 and early 2018. In fact, forward earnings for large- and small-cap stocks increased by 10% to 12% respectively during that timeframe. So it’s important that a lot of this legislation remains intact.
But let’s look more specifically on Harris’s view on taxes. She recently released a tax proposal, and she’s proposed to increase dramatically the tax rates on corporations and high-income households while leaving most Americans’ taxes unchanged. She’s promised to protect households making under $400,000, and that’s really going to be key to extend the expiring provisions from the Tax Cuts and Jobs Act. In order to fund that though, you’re going to see the top marginal tax rate reach the highest level that we’ve seen since 1986, 44.6%.
Now, just today she released an update on capital gains. Capital gains taxes, 23.8% currently and it was expected to move up closer to 45%. But Harris mentioned today that the top tax rate there is going to be 35% for high-income individuals, which still is going to be the highest level of tax on cap gains that you’ve seen since 1978. But, ultimately, you’re going to see higher taxes on corporations. Corporate tax rates, if she wins in a sweep scenario, would go from 21% to 28%. The 21% minimum tax would be there instead of the current 15%. And also corporations would pay higher taxes on foreign profits. But there are going to be areas of opportunity. She does want to revive the expanded child tax credit that was in place back in 2021, which gives most households a $3,000 tax credit for children over the age of six, $3,600 tax credit for children from the ages one to six and a new tier for newborns that would be a tax credit worth $6,000.So that would be something that would be a boost to low-income consumption. So that’s Harris’s views, at least major views on the tax landscape, higher taxes for corporations, wealthy individuals, and then also a lot of tax credits for lower-income individuals. But a promise not to increase taxes on households making less than $400,000.
Now in talking about Trump, Trump would likely prioritize again the extension of his legislation in 2018. He’s probably likely going to extend individual provisions as well, and he is likely going to reinstate some of the depreciation allowances from businesses that you saw back in the early part of the TCJA, which allowed immediate expensing for equipment, property and research. Trump on the campaign trail has advocated to reduce the corporate tax rate even further to 20%, and his VP nominee, J.D. Vance, has also called for an extension of the child tax credit to $5,000.
Now both Trump and Harris have vowed to eliminate taxes on tips for services and hospitality workers. And you kind of put this all together, given the expiration of a lot of the elements of the TCJA, gridlock from a tax perspective is probably a market negative, because there’s not going to be as many concessions that are going to be made in that environment. So risks are skewed to the downside. If you have a Republican sweep, that’s probably the most market-friendly outcome from a tax perspective. You’re going to have favorable tax treatment. It’s going to build on some of the elements that expired, including individual provisions and full expensing of R&D, which will benefit areas of the market like technology, like industrials, like manufacturing that are Capex- [capital expenditure} heavy industries. A Democratic sweep would probably be a headwind to the market because the corporate tax rate is going to likely move back up to 28%. You’re going to see higher international taxes, but it is going to have a positive knock-on effect for credits for low-income consumers and some social spending as well.
But overall, even though that will benefit some areas of the market, the headwind coming from corporate profits and higher taxes for multinationals would probably create a retracement of the market of anywhere from four to 6%, because there’s going to be less profitability, lower profit margins at the end of the day. So, from a tax perspective, key takeaway, we’re likely going to get something even with a gridlock scenario because of the expiring provisions from the TCJA. But if you have a full Trump sweep, probably a market positive. If you have a Democratic sweep, probably going to be a minor headwind to the market because you’re going to have higher taxes there.
Host: Let me just ask you one quick question before I move to my next question. Can you just define for our listeners “TCJA”?
Jeff Schulze: Yeah, the Tax Cuts and Jobs Act is the TCJA, better known as the Trump tax cuts, that were introduced in 2017 but went into effect in early 2018. So that was his signature tax package that was passed about eight years ago.
Host: Perfect, thank you. Okay, how about the regulatory environment, Jeff?
Jeff Schulze: So this is an area that you don’t need a sweep scenario. The president can act on regulation and don’t need anything from Congress. And when you look at Harris, she’s focused her regulatory aim on prescription drugs, housing (more affordable housing, that is), higher minimum wage, grocery costs, and she likely will come out in favor of clean energy relative to fossil fuels. From a housing perspective, likely going to push for more relaxed local zoning housing rules, probably going to deter larger investors from moving into the single-family space, which could boost multi-family units. Ultimately, bringing on more housing supply, and housing affordability is key to her campaign. She’s also talked about accelerating Medicare negotiations on more drugs and cracking down on pharmacy benefit managers, which likely will be a headwind to health care and pharmacy benefit managers as well. But overall, Harris is probably going to have a more firm regulatory touch than Trump.
Now, when you look at Trump, he significantly dialed back regulation in his first term. To put some numbers around it, according to the American Action Forum, Obama had about $111 billion of net regulatory costs per year during his tenure. Trump was around $10 billion. So that was a pretty big difference. And we think most of Trump’s efforts on the deregulation front are likely going to be continued as we look to a potential second term. Going to be focused on labor, education, the environment and health care. Probably going to see a reduction of the transition towards electric vehicles. You’re going to probably see more energy production, embracing cryptocurrencies. Enhancing school choice has been talked about on the campaign trail as well. Potential negative, at least from a labor market perspective, is the potential for deportation or less aggressive immigration in the US, which could hurt labor-intensive companies.
So, when you talk about the impact of the two candidates, Harris from a pure regulatory standpoint would be viewed as maybe a net negative for equities at the margin. You’re going to have increased regulatory burden, probably more uncertainty from a business perspective, but there are going to be winners and losers there. A second Trump administration would be an incremental positive benefiting energy and pharma again, but you could see some headwinds from a labor supply perspective. But taking a step back really quickly, the outcome that you think would happen from the election is usually very different than the reality that actually happens. The reason why I say that is if you look at Trump’s first term, solidly pro-energy president, everybody thought that energy would do well under the Trump administration, and it was one of the worst-performing sectors in his four years. If you think about Obama, health care was expected to be a tough sector when Obama was passing a lot of the health care initiatives from his administration—and health care did actually pretty well on a relative basis. So it’s important not to read too much into higher regulation and what the impacts are going to be for these sectors. As I mentioned earlier, the underlying economic backdrop is going to be more of a driver at the end of the day.
Host: Okay, Jeff, the other area where the US president can act unilaterally without congressional support is trade policy. What’s your sense on trade?
Jeff Schulze: I think from a Harris perspective on trade, it’s going to be pretty much status quo from what we saw from Biden. You’re going to have some tinkering, but it’s going to be much more of a surgical approach rather than the shotgun approach that Trump has talked about. And Harris is likely going to remain firm on China. Obviously, that’s something that’s embraced by the Democratic party. Going to protect industries like solar and semis. And also retain a lot of the tariffs that are already in place from the first Trump administration.
From a Trump perspective, this is going to be a repeat of what we saw under his first term, right? He’s talked about imposing two different types of tariffs. The first is a 10% across-the-board tariff on all imported goods to the US. The second is increasing Chinese tariffs to 60%. And if you look at the Tax Foundation, they did an analysis, they suggest that a 10% tariff across the board and the retaliation from our trading partners would create a US economy that’s 1% less large if that was fully put into place.
And then also, if you see higher prices from Chinese goods, ultimately it’s inflationary at first, but it’s deflationary as you look out on a longer-term basis, because consumers are spending more of their income on these new goods, which means less of their income on potentially other goods as well. And you see this time and time and time again throughout history. So overall, if you think about it from a pure trade perspective, equities probably have a little bit more to lose than gain under a Trump trade policy—even if some of this is a negotiation tactic by Trump, which I do think that that is the case. Harris is going to be pretty close to the current trade regime. So you’re going to have a lot less uncertainty and downside, because it’s going to be more status quo.
Host: Jeff, let’s touch on federal spending. Will deficits be coming down with either candidate?
Jeff Schulze: I would say maybe the most bipartisan thing that you have in America right now is that government spending will keep growing. Neither candidate wants to really rein in spending. You’re going to have deficits in the six, 7% of GDP range for the foreseeable future and potentially even higher if, again, you have a sweep scenario where much more legislation comes and gets passed. But in looking at each candidate from a spending perspective, Harris is going to prioritize spending on things like health care, housing, childcare, clean energy, infrastructure. You’re going to have a lot of support for housing. And there’s been some mention of a $40 billion innovation fund to boost the efforts of local governments to make housing easier. And also a $25,000 down payment aid for first time home buyers. Also, Harris has proposed canceling medical debt for millions of individuals as well. So those are the areas that Harris has prioritized on the campaign trail.
Trump, in his first term, a lot of his spending was focused on defense and infrastructure. I think that that’s likely going to be something that’s repeated as we look out over the next four years if Trump is to win the election. But I think the key takeaway here is that neither candidate is really looking to have a lot of fiscal restraint. The fiscal thrust, if you will, from a Republican candidacy, really will come in the form of tax cuts. The Democrats will likely lead with more spending, but they’re both two sides of the same coin. That’s going to be a boost to the economy in either scenario. But, given what we talked about with potential taxes and tax credits, a Democratic setup would favor higher discretionary spending for low-income individuals, which could have some opportunities in companies that cater to low-income individuals and consumer staples and consumer discretionary. If the Republicans take office, probably going to favor heavy industry a little bit more. But I think in either case you’re going to see military spending inflect higher. So, overall, if you have a mixed government, it’s probably the most bearish outcome for spending because it raises the odds of gridlock and not all of those provisions that are sunsetting from the Tax Cuts and Jobs Act being able to move forward. From a spending perspective, probably the best-case scenario is actually a sweep scenario from either of the two parties.
Host: You’ve covered a lot of ground here today. Given your perspective on taxes, trade regulation and spending, how do you see the overall reaction from market participants to a Trump presidency? And maybe you can touch on areas of the market that we will see headwinds in and tailwinds in.
Jeff Schulze: A second Trump presidency is probably a net positive for equities. You’re going to have a favorable tax regime from a corporate standpoint, less regulatory burden, and both of those should boost corporate profits at the end of the day. You do have risk though. You have the potential for increased tariffs and retaliation from our trade partners. You also have some risks on the supply of labor from an immigration standpoint, which could weigh on some industries that are pretty labor intensive. And then also companies that have a lot of foreign revenue could be exposed because of higher tariff policy. So domestic stocks are probably best placed if Trump ends up winning. A couple of other winners could be banks and capital markets from less of a regulatory touch.
Aerospace and defense is likely going to benefit. Software, biopharma will benefit as well. And of course energy equipment and services because of a pro-energy approach from Trump. Some areas that could see some headwinds are restaurants and leisure due to the less availability of labor; EVs and autos; and then also clean energy producers. And then if we take a bigger step back, what countries are poised to benefit and not benefit from a Trump presidency? China obviously is probably going to be a net loser in a Trump presidency, but there are going to be countries that are going to benefit because more imports are going to come from them at the expense of China. And from what we saw back during the last trade war in 2018 and ‘19, that’s likely going to be Vietnam, Mexico, India, and Italy—and the last one was Cambodia—were the five largest beneficiaries. So I would see those five countries benefiting yet again.
Host: Okay, Jeff, how about the same thing, a summary with a Harris win?
Jeff Schulze: So, a Harris win would probably be a net negative for equities due to higher taxes on corporations and high-income individuals and greater regulatory burden. So again, I don’t think the headwind’s going to be more than mid-single digit as we talked about earlier, but it would be a headwind at the end of the day. But there are some areas that are going to benefit. Again, tax credits for low-income individuals are going to provide an offset, create a little bit of an economic boost and create opportunities in some of the segments that cater to those individuals. Again, from a tighter regulatory standpoint, that’s going to weigh on biopharma, banks, capital markets, energy, and then mega-cap tech. But as I talked about earlier, slippery slope trying to position your portfolio strictly on the regulatory environment. But thinking about areas to be bullish or bearish, potentially would be bullish on restaurants and leisure, again, because of the benefit that you’re going to see for the low-income consumer. You’re also likely going to see a benefit to home building as Harris has pledged to bring on more housing supply. Managed care and building products as well will do well in this environment along with household products. Some areas that may, you know, see a bit of a headwind are going to be banks and capital markets from greater regulation; biopharma due to lower drug prices; software; and then also of course energy producers as well.
Host: Jeff, any closing thoughts for our listeners to consider?
Jeff Schulze: We’ve covered a lot of ground. I think the key takeaway here is markets have gone up under Republican presidents. Markets have gone up under Democratic presidents. Markets generally go up regardless of who’s in the Oval Office, because companies just don’t sit back because you have somebody new in the Oval Office. They’re looking to maximize their profits. And again, the economic momentum that you have is generally speaking, going to be a bigger driver of equities. And if you go back 125 years, drawdowns are similar under both types of presidents. Returns are very similar on both types of presidents. So it’s important not to get too concerned depending on what type of president wins and then obviously what’s the composition of Congress. And we are expecting though maybe some volatility as we look into the election day. Usually, the VIX [CBOE Market Volatility Index] picks up dramatically in September and October as election uncertainty starts to be heightened.
But the key takeaway is after election day, regardless of who wins, whether it’s the opposition party or the incumbent party, you generally speaking have a relief rally. And in election years, going back to 1960, average drawdown has been 14%. If you had bought at the lows of all of those election year selloffs, the one-year forward returns have been 24%. So, if we do see some higher volatility as we look out over the next couple of months, especially election-related volatility, we would be advocating for long-term investors to buy the dip. But at the end of the day, the Anatomy of Recession program, which we talk about a lot on this podcast, we still very much believe that a soft landing is intact and that the Fed cutting cycle is going to create a re-acceleration of economic momentum next year, which ultimately will drive equities higher over the course of the next couple of years.
Host: Thank you, Jeff, for your terrific insight today as we continue to navigate the landscape here in 2024. To our listeners, thank you for spending your valuable time with us for today’s update. If you’d like to hear more Talking Markets with Franklin Templeton, please visit our archive of previous episodes and subscribe on Apple Podcasts, Google Podcasts, Spotify, or any other major podcast provider.
This material reflects the analysis and opinions of the speakers as of September 5, 2024, and may differ from the opinions of portfolio managers, investment teams or platforms at Franklin Templeton. It is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the speakers and the comments, opinions and analyses are rendered as of the date of this podcast and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, security or strategy. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks. Equity securities are subject to price fluctuation and possible loss of principal. Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Treasuries, if held to maturity, offer a fixed rate of return and fixed principal value; their interest payments and principal are guaranteed.
There is no assurance that any estimate, forecast or projection will be realized.
Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. Past performance does not guarantee future results.
Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.
Issued in the U.S. by Franklin Templeton, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com. Investments are not FDIC insured; may lose value; and are not bank guaranteed.
Issued by Franklin Templeton outside of the US.
Please visit www.franklinresources.com to be directed to your local Franklin Templeton website.
Copyright © 2024 Franklin Templeton. All rights reserved.
