Investors see higher taxes, delayed results but election winner by Dec. 8, Goldman says

Published Fri, Sep 18 20201:40 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Key Points

Investors in the options market are pricing for extended volatility after the election in part due to concerns there will be no clear winner immediately, but it appears investors expect an outcome by Dec. 8, according to Goldman Sachs strategists
The strategists also calculated that the market is pricing in 53% odds of an increase in corporate taxes, about the same level of odds prediction markets are giving to a Democratic sweep of the White House and Congress.
"The election matters for equities, and the outcome is highly uncertain," the strategists wrote.

Investors have been positioning for an extended period of volatility for days and months after the election and also the potential for a corporate tax hike next year that could hit tech, communications services and health care companies the hardest. according to Goldman Sachs strategists. The stock market appears to be pricing a 53% chance for corporate tax hikes, nearly the same odds the prediction markets give a Democratic sweep of the White House and Congress, according to the strategists. The options markets appears to expect a resolution to the Nov. election by Dec. 8, Goldman Sachs strategists wrote in a sweeping note on the markets and election. Goldman's chief U.S. equities strategist David Kostin was among the authors. "Complications involved in tallying mail-in votes may lead to an extended period of counting following Election Day, but the market appears to expect the presidential race will be known by December 8," they wrote. The strategists looked at positioning in S & P 500 options. Dec. 8 is the "safe harbor" deadline for states with contested elections to file their results. In 2000, the deadline coincided with the Supreme Court ruling in that contested election between ultimate victor George W. Bush and former Vice President Al Gore, they noted. The market had been pricing higher volatility around and after the election, but the strategists say there's been a shift in positioning for risk later in November and beyond. For instance, the options-implied one-day move on Nov. 4, the day after the election, had been at 3.2% in late August, and is now at 2.8% "The term structure remains elevated well into early 2021. This term structure likely reflects the potential for election results to be finalized with a delay, the possibility of an extended equity market reaction to what is currently a competitive race, and the prospect of vaccine news around the same time," the strategists wrote. "The level of implied volatility sends a clear message: The election matters for equities, and the outcome is highly uncertain." Looking for higher taxes The Goldman strategists said their clients are focused on the potential for corporate tax increases. The predictions market has a 54% chance of a Democratic sweep, and that if former Vice President Joe Biden's tax plan is implemented, it would shave 9% off of S & P 500 earnings next year. Democrats would need to control both houses of Congress to legislate tax changes. When the tax rate was cut in 2017, stocks with the highest effective rates outperformed, but the strategists said this year that trade has partially unwound. In 2017, the tax rate was cut to 21% from 35%. Those cuts boosted earnings by 10%. Biden proposes a 28% corporate tax rate, but the strategists said other proposals and base broadening would push the rate back towards its previous level. Goldman said the stocks that would be impacted most by higher taxes would be those of technology, communications services and health care companies. They calculated expectations for corporate tax hikes by looking at the relative performance of stocks of high and low tax companies. They said they estimated the market-implied probability of tax reform by adjusting the relative performance of high and low tax stocks by sector, revenues and other factors. They then compared the recent performance of the stocks to their post tax-cut performance, to see how much of the benefit of the 2017 tax cuts the market expects to see unwound. If Democrats win, the possibility of a capital gains tax rate hike also increases. That would also be a risk to stock market momentum, the strategists said. Stocks in the technology, consumer discretionary and communications services sectors generated the most capital gains over the past 10 years. "Past capital gains tax hikes have been associated with short-term reductions in US household allocation to equities as well as the underperformance of high-momentum 'winners' that had delivered the largest gains to investors ahead of the rate hike, although these dynamics were generally short-lived and reversed following the tax change," they wrote.

Voters cast their ballots for the 2020 election at an early, in-person voting location in Arlington, Virginia, on September 18, 2020.

Andrew Caballero-Reynolds | AFP | Getty Images

The stock market appears to be pricing a 53% chance for corporate tax hikes, nearly the same odds the prediction markets give a Democratic sweep of the White House and Congress, according to the strategists.