Linda Duessel: Hello, and welcome again to the Hear and Now Podcast from Federated Hermes. I'm Linda Duessel, Senior Equity Strategist, and today I'm joined via phone by Phil Orlando, Chief Equity Market Strategist, and RJ Gallo, Senior Fixed Income Portfolio Manager. So let's start with you, Phil. So you've said that the 2020 election could be the most consequential of our lifetime. Can you explain, please.
Phil Orlando: Yeah, thank you. That's not hyperbole. Ordinarily, the election of a president is sort of a big enough deal, and we have that in spades this election, but I think there are five levers of government that are on ballot this election, other than the president. So you've additionally got control of both houses of Congress, the House of Representatives and the Senate, the Senate very much in play, and depending upon what happens there may or may not have a legislative check and balance, which means that the likelihood of initiatives may not be down the center of the fairway and we may get a movement potentially to the progressive left, which might have a potentially deleterious impact on economic growth, corporate earnings growth, and ultimately share prices.
Phil: I think the fourth lever is the Supreme Court. The untimely passing of Justice Ginsburg has really shown its light on what's going on in the Court in terms of a progressive, liberal, reliable vote, Justice Ginsburg, possibly moving over to the conservative side in the form of Judge Amy Coney Barrett for the next 25 years. Democrats are obviously upset with that, particularly in light of the Merrick Garland situation four years ago, and so there's speculation that Vice President Biden, should he get elected and should there be a blue wave, might introduce things like term limits or increasing the size of the Court to retake that liberal balance.
Phil: And then finally, the Federal Reserve. Jay Powell, the chairman of the Fed, I think has done a pretty good job cutting rates to zero back in March, telling us he'll keep rates at zero, at least until the end of calendar '23, but his term as the chairman of the Federal Reserve expires in January of '22, and the next president will either reappoint Chair Powell or select another chair, and Vice President Biden has talked about increasing the Federal Reserve's mandate. Historically, they would look at sort of the Phillips curve trade off between stable inflation and full employment. Vice President Biden's talking about introducing a third racial diversity mandate to the Fed's purview. So all of those things are on the ballot. So it's not just selecting a president. So all in, I do believe it's the most consequential election of our lifetime.
Linda: And I hear you saying that Phil, but the things that you're pointing to are very, very important for the long-term for our country and seem to be very much more socially directed. I've seen discussions that said it doesn't matter who wins as far as economic policy is concerned. We're all populous now. Regardless of who wins. Look for trillions of dollars of spending. As far as the markets are concerned, is it as consequential, really?
Phil: I think it is, because the risk of a blue wave is that legislative initiatives get out of that middle of the fairway kind of road. One of the things you just mentioned was very interesting, Linda, that historically it doesn't really matter whether the president is Republican or Democrat, whether the control of the Senate and control the Houses is Democrats or Republicans. They've all sort of shared those responsibilities, with by and large great success over the last 90 years or so, and there hasn't been much deviation for the market, except there've been a couple of instances where the results of the stock market have been substantially less on an annualized basis, and in those instances it's been when there has been a democratic takeover in Congress, that you've had both houses in Democratic control, and in those instances, legislative initiatives have been less economic friendly, less business friendly, less stock market friendly.
Phil: And that's been reflected in weaker share price performance. So from the perspective of investors, they're hoping for split government. Split government, divided government works, and so that's one of the concerns here. Do we sort of share government and everyone gets to put their initiatives on the table? Or do we get this so called blue wave and everything sort of shifts to the progressive left and is there an impact on economic world corporate earnings growth and ultimately share prices that we as investors need to concern ourselves with?
Linda: It's really crazy too, that the election is getting tighter and tighter, even as we say it's the most consequential. So how's this going to work out? I'd like to bring you into the discussion, RJ now, and the election will obviously affect policies across the board, but what are the policies in which the candidates differ most and how do you think those policies impact the economy and the market?
RJ Gallo: Well I think I would echo Phil, that all elections have consequences. This one does seem particularly consequential, but they all have consequences. That's a phrase that we've heard now from both sides of the aisle when the majority party or the party in power does something that the minority party opposes. In terms of their greatest contrasts in terms of policy areas that matter most to the economy markets, it's a pretty short list that's worth emphasizing; taxes, health policy, energy and the environment, and labor and education. President Trump and Vice President Biden are pretty much diametrically opposed across each of those big issue areas. On taxes, The Wall Street Journal recently made a comment that the unifying aspect of GOP ideology is low taxes, and President Trump has fit the bill with respect to that with the 2017 Trump tax cuts. Meanwhile, Democrats unite around the idea that high income earners and corporations should pay more in taxes.
RJ: So they're really on opposite sides of the spectrum here. President Trump would look to reduce the top capital gains rate to 15 from 20, and he would likely look to extend the expiring components of the Trump 2017 tax cuts. So more tax cutting from him should he be reelected. Should Vice President Biden end up being in the White House, he wants to raise the top marginal rate for individuals back to 39.6, that's where it was prior to 2017, for everybody making 400,000 per year or more. And he also wants to tax all investment income at that same rate for anybody who makes more than a million in income. And lastly, and this is pretty important I think to the markets, to the point that Phil was making earlier, Biden wants to raise the tax rate back to 28. Currently it's 21. It had been 35 before the Trump tax cuts in 2017. So that would reduce the tax return to capital, obviously, by raising the corporate tax rate to 28. So they're pretty big differences on the tax front.
RJ: Now on health policy, President Trump remains committed to dismantling and replacing the ACA. Vice President Biden wants to expand on energy and the environment. President Trump has been committed to expanding domestic fossil fuel production, which has helped get the US to energy independence, which is a pretty good thing in the near term. That said, President Biden, should he be elected, believes that we rely too much on fossil fuels and natural gas is okay for now, but it's a transition fuel, and ultimately he wants to put the US on a path to zero carbon emissions by 2050. President Trump pulled us out of the Paris Climate Accord. President Biden wants to put us back into the Paris Climate Accord. So vastly different, and when you think about the cost implications of a heavy focus on renewable energy versus fossil fuels, you can see how that would have big impacts on the market from consumers to businesses.
Linda: Yes. Excellent points there, RJ. The one that I keep seeing come up is the idea that Biden may give the largest tax hike since 1968, but how curious is it that with him as the front runner, and I think the last I saw, best odds to the democratic suite, but the stock market seems to have been good with it. I don't know, what do you think, Phil? Why is it the stock market doesn't seem to care about the odds of a tax hike, which earnings wouldn't like?
Phil: So I actually think those talking heads on the business networks, you were telling us that the market's up because they like perspective Vice President Biden's tax hikes are just talking their political book. I think if we were to study the math on this, it would be a very different story. I don't think the market is up because of those tax hikes. You look at the stock market over the last four years, since Trump was elected, the stock market's up 70%, in part because of the lower tax regime. I thought that RJ did a brilliant job of outlining the differences between the two camps, and as I sort of heard him kicking down the list, higher corporate tax rates. I'm thinking, well, that's going to introduce the inversion problem again. Double the capital gains tax rate. I'm saying well, that's going to introduce tax gain harvesting later this year to lock in our gains at a 20% rate instead of a 40% rate. Higher estate taxes, uncapping social security taxes, doubling the minimum wage, therefore increasing inflation.
Phil: I mean as we sit down and study the economics of these predicted proposals, they're not good in terms of economic growth, corporate earnings growth. I think the markets rally for a different reason, and that reason may be that somehow they think that president Trump is going to get reelected based upon narrowing polls and some key swing states. I don't think they're rubber stamping his tax proposal and saying that yeah, let's raise all these taxes. It's going to be great for growth rate, for corporate earnings, stock prices are going to go up. I just don't see that. So maybe I'm missing something here, but that's not the conclusion I come to when I look at Vice President Biden's series of proposals on raising taxes.
Linda: Yeah, it's interesting, even as taxes were very high for corporations before the big tax cut took it down to 21%, the biggest corporations I've seen have very, very busy tax markets and the effective rate most recently was at 15%. So perhaps the market's thinking ... I don't know, maybe the market's thinking if he comes in, Biden certainly wouldn't do it next year because the economy is suffering, fits and starts trying to get back to business, or maybe corporations will do better. Maybe CapEx will start to come back into play as a tax shield. All things possibly to consider. The stock market is resilient to be sure.
Phil: To some degree, the market may be looking through and saying that maybe the infrastructure package or the fiscal stimulus package that we expect Vice President Biden to get with a consolidated Democratic Congress might outweigh some of the fiscal policy negatives on tax increases, and maybe that'll wash itself out.
Linda: What, 2-3 trillion more? Yeah, that might actually trump the taxes, if we can use the word in this context. Well thank you very much, Phil and RJ, and thank you to our listeners. We look forward to you joining us again on the Federated Hermes Hear and Now Podcast. If you enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Hear and Now episode, plus our other series, Amplified and Fundamentals for a global perspective on the issues, challenges, and trends shaping the investment landscape.
Disclosure: Views are as of October 20, 2020 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Past performance is no guarantee of future results. Federated Advisory Services Company 20-40495 (10/20)