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Blog Posts — October 7, 2020

Presidential Election Stress Test Part II: Biden’s Tax Plan Could Take a Bite Out of the FAANGs—and More

On Monday October 1, 2020, the Wall Street Journal published an article headlined “The Stock Market’s Leaders Appear Most Vulnerable to Biden’s Tax Plan”, citing estimates from BofA Global Research about the impact of the candidate’s proposed tax plan on corporate earnings. According to the article, the plan includes “raising the corporate tax rate to 28% from 21%, imposing a new minimum tax on U.S. companies and increasing taxes on foreign income of many U.S.-based multinationals”. The BofA report cited in the article concludes that these proposals would “reduce expected earnings among companies in the S&P 500 by 9.2%“ and “would produce estimated double-digit percentage declines in profits in the information-technology, communication-services and consumer-discretionary sectors”, home of the FAANGs (Facebook, Apple, Amazon, Netflix, and Google).

If the above-mentioned analysis is correct, how much of this potential impact has been priced in by investors, given that most polls point to both a Biden win and a Democratic Senate post-election? We used the Axioma Risk platform to conduct a transitive stress test simulating a 20% drop in each of the five FAANG stocks, calibrating the correlation between them and the other stocks in the STOXX USA 500 using data for the past three months, and estimating the impact on the index portfolio for this scenario.

The table below shows the results of our stress test broken down by GICS Sectors. The STOXX USA 500 would fall by 8.9%, more than erasing the 3.6% YTD gains it has accumulated over the prior nine months. Not surprisingly the three sectors of information technology, consumer discretionary, and communication services would contribute most (74%) of the losses with -4.1%, -1.5%, and -1.1%, respectively. On a standalone basis (column: “Sectors (SA)”), these three sectors would drop by 13.6%, 11.6%, and 11.7%, respectively.

The issue for investors is that these are precisely the sectors—and even the five individual stocks—that have powered most of the market’s rallies thus far. They are the biggest beneficiaries of the pandemic, as the global economy shifted online. Their YTD performance, and the polls indicating a sweeping Democrat victory in November—now a mere month away—seem contradictory. Could it be that this scenario has not yet been priced into the market?

We ran the same scenario on the Stoxx Global 1800 index portfolio to estimate the impact this would have on global investors. The table below summarizes our results. The global index would fall by an even bigger 9.1%. The US sub-portfolio (63% of the index weight) would drive the bulk of the losses with a 7.6% contribution. Interestingly, at the sector level, although information technology would be the biggest driver of loss at -2.5%, consumer discretionary (-1.1%) and communication services (-0.8%) come in at 4th and 5th place, with financials (-1.2%) and health care (-1.1%) coming in at 2nd and 3rd place. Note that on a standalone basis, Energy would get hit the most as it is the most volatile sector by far (40% versus an average of 20% across all other sectors).

There will of course be many offsetting positives to a Biden tax plan, including the expectation of a bigger fiscal stimulus package to fight the economic impact of the pandemic than under a Republican administration and Senate. Timing will also be non-congruent (i.e. stimulus first, higher taxes later). In other words, the taxman giveth and the taxman taketh away.  The key for investors is to have a robust and transparent process to simulate the impact of these ‘gives-and-takes’ to make informed investment decisions.  Unexpected losses are easier to avoid when you know where they may be coming from.