Trading the election and how both candidates hold risks for the stock market, according to Citi

Published Mon, Aug 24 20201:45 PM EDTUpdated Mon, Aug 24 20202:10 PM EDT

Though Joe Biden's victory could spell headaches for Wall Street in the form of higher taxes, President Donald Trump's reelection may also have an unexpected equity pitfall, according to one of Citi's top strategists. Tobias Levkovich, the bank's chief U.S. equity strategist, advised clients on a number of potential outcomes and what to watch for when trading in the months ahead. He first warned a Biden win could spark modest selling in the months after the election as investors lock in gains at a lower tax level. And based on recent polling, Citi feels like the election is "Biden's to lose." "We are placing a 60%-65% chance that he wins and a 30% probability of a Trump repeat," Levkovich wrote. And given a Biden victory, "we would guess that there is a better than 50% prospect that the Democrats take the Senate too." Investors assume a Biden White House would necessarily lead to higher taxes as the administration looks to fund spending in areas from infrastructure and clean energy to health care and education. Therefore, Wall Street may be tempted to take profits in the months before Congress can approve of the higher tax obligations. "A Biden win would likely translate into higher taxes for richer Americans and corporations, with the key issue being capital gains treatment," the strategist wrote. "A meaningful adjustment towards ordinary income tax levels (as a somewhat backdoor and constitutionally safer wealth tax) could be considered market-unfriendly in the near term, in our opinion, as investors lock in gains at a lower tax rate initially." Though Biden has yet to release a formal tax plan, the Democrat has nonetheless proposed changes and increases tied to his policy priorities. Most of those proposals center on raising taxes on high earners and businesses, according to the non-partisan Tax Foundation. Specifically, Biden has voiced support for repealing Trump's Tax Cuts and Jobs Act tax reduction for those earning over $400,000 and restoring the top marginal income tax rate to 39.6% from 37%, wrote Garrett Watson and Erica York of the Tax Foundation. He's also a proponent of taxing capital gains at the ordinary income tax rates — up from a top rate of 23.8% today — for those earning over $1 million, they wrote. That alone may prompt some traders to take profits following a win on Election Night for the former vice president. Investors may want to lock in capital profits before Biden and a Democratic Congress have a chance to enact the tax changes. But Trump's reelection, even with the hopes of a capital gains cut, may also lead to near-term market pressure, Levkovich wrote. If the president decides to cut the capital gains tax rate, investors will likely be tempted to take profits and take advantage of what could be just a temporary reduction in the levy. "A Trump re-election would defer any tax increases and, perversely, a proposed capital gains tax cut might also cause a selloff," the strategist wrote. "Energy would fare better under Trump as would the Banks and Defense stocks, but trade uncertainty would weigh on multinationals." Trump said as recently as two weeks ago that he was "very seriously" considering a capital gains tax cut, a move he opted against last year after determining that it wouldn't do enough to help the middle class. "We're looking at also considering a capital gains tax cut, which would create a lot more jobs," Trump said from the White House on Aug. 10. Though the president cannot singlehandedly cut the 20% long-term capital gains rate without congressional approval, some advisors have advised him he could try some backdoor methods like index capital gains to inflation.

President Donald Trump speaks during the first day of the Republican National Convention, in Charlotte, North Carolina, U.S., August 24, 2020.

Chris Carlson | Reuters

Tobias Levkovich, the bank's chief U.S. equity strategist, advised clients on a number of potential outcomes and what to watch for when trading in the months ahead.

He first warned a Biden win could spark modest selling in the months after the election as investors lock in gains at a lower tax level. And based on recent polling, Citi feels like the election is "Biden's to lose."

"We are placing a 60%-65% chance that he wins and a 30% probability of a Trump repeat," Levkovich wrote. And given a Biden victory, "we would guess that there is a better than 50% prospect that the Democrats take the Senate too."