For the first time ever, could raising taxes be a winning campaign strategy in 2020? Earnings coming in as expected with few surprises

As we get closer to the election, the political landscape is heating up. President Trump is defending his administration's handling of Covid-19 and focusing on how strong the economy was pre-COVID-19 as well as how it's recovering post-COVID-19. Joe Biden is sharing his plans for sweeping reforms in Energy, Healthcare, and Education. In order for Biden to implement the changes he is outlining, he will have to raise taxes across the board.

Given the state of the economy, it's interesting to be so committed to raising taxes now. The world is in the middle of the worst pandemic since the Spanish flu in 1917-18. Because continuing to return to "normal" is so dependent on what happens with Covid-19, now is a period of increased uncertainty. Most economists, market analysts, and portfolio managers would argue that raising taxes during a period of as much uncertainty as we now face would not be ideal. As a matter of fact, many political analysts believe one of the main reasons President George H.W. Bush (41) lost his re-election was because he raised taxes after he said he would not.

Looking at the past few years of data, one would have to concede the Tax Cuts and Jobs Act of 2017 delivered on economic growth. Prior to Covid-19, the United States was experiencing the lowest unemployment rate it had seen in decades. It was also experiencing some of the best wage growth it had seen in decades. It wasn't perfect, but it was improving nicely. It will be interesting to see how news of the proposed tax increases is received.

Chart 1 below shows how various tax rates will change under Vice President Biden’s proposed economic plan. V.P. Biden will need these tax increases to deliver the rest of his platform to fundamentally change the country's Energy, Health care and Education policies. Biden would likely only be able to implement these tax increases under a democratic sweep scenario. Some of his more dramatic changes to taxes would include:

  • raising the corporate tax rate from 21 to 28%
  • lifting the top income tax rate from 37 to 39.6% and adding a 12.4% payroll tax on incomes over $400k
  • removing the 20% small business tax deduction and raising the top income tax rate
  • equalizing the capital gains and dividend tax rate with ordinary income tax rates plus adding the 3.8% Obamacare tax on investment income
  • assets that transfer from an estate would no longer get the step up in basis with the transfer. Capital gains tax will need to be paid when the heir sells the assets.

Chart 1:

Chart 2:

Back to the data, stocks rose for a third straight week as the S&P 500 gained 1.27% after the first wave of corporate earnings were reported. Cautious optimism surrounds earnings season as companies try to look beyond the effects of the shutdown and into the future. The market responded in step on a sector basis with Industrials and Materials stocks leading the S&P 500 last week while Consumer Discretionary and Information Technology holdings waded into negative territory.

Netflix reported less than stellar results on Friday and gave disappointing guidance to user growth for the third quarter. The tech giant had been trending higher into earnings season and analysts did not waiver in their optimism while raising price targets on the shares despite company guidance. States around the country have also begun to lay out their plans for various stages of reopening. On Friday, California ordered its hardest hit counties to only offer online learning with no option for on-campus instruction. This move comes after Governor Gavin Newsom ordered a reversal of opening restaurants, bars, gyms, and hair salons earlier this month.

On the relief front, Treasury Secretary Steven Mnuchin told the House Small Business Committee the government should consider forgiving small business loans under the Paycheck Protection Program (PPP), although he did not specify which business would qualify for loan forgiveness. The PPP has approved over 4.9 million loans totaling $518.1 billion dollars. Earnings will be in focus next week as well as 88 companies in the S&P 500 are set to report quarterly results.

Last week witnessed new record low yields in mortgages. According to Freddie Mac, the average rate on a 30-year fixed mortgage fell to 2.98% as mortgage rates continue to plumb new lows amid expansive Federal Reserve policy. Concurrently, next week’s existing home sales report is expected to climb but remains substantially off its pre-COVID pace. Treasury’s traded in a relatively narrow band last week amid light volumes and prices sagged into the weekend. Last week’s economic news highlights included US consumer prices popping up the most since 2012, with gas prices accounting for over half of the 0.6% month-over-month gain.

If the COVID-19 plagued second quarter of 2020 has felt miserable, Wednesday’s Industrial Production report corroborated the feeling reporting Q2 down at a 42.6% annualized rate! Importantly, the report showed a 5.4% increase in June and an increase in capacity utilization. Thursday’s June retail sales report saw a 7.5% lift led by a surge in clothing & accessory stores, autos, and restaurants & bars. This follows May’s 18.2% gain. Wrapping up last week’s economic news was June housing starts which recorded a 17.3% rise.
Source: First Trust, Strategas

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments


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