A Democratic sweep could hit market initially, but effect likely to be short-lived, Goldman says

Published Tue, Sep 29 20208:43 AM EDTUpdated Tue, Sep 29 20209:01 AM EDT

(This story is for CNBC Pro subscribers only.) With Election Day only about a month away, talk of a possible Democratic sweep upending markets is intensifying, but Goldman Sachs believes this fear is overblown. President Donald Trump and Joe Biden will square off Tuesday night in the first presidential debate with the Democratic former vice president leading the polls. Many equity investors fear that Biden's policies — a tax-cut reversal, higher capital gains taxes and tighter regulations — could lead to lower profits, less economic growth and hence lower stock prices. However, Goldman said the market would only see a short-lived impact, even in a blue-wave scenario. "From an earnings perspective, a Democratic sweep would likely have only a modest net impact on the trajectory of S & P 500 profits," David Kostin, Goldman's head of U.S. equity strategy, said in a note. "The combined effects of higher corporate tax rates, more fiscal spending, and lower tariffs would likely result in a similar level of medium-term S & P 500 profits as our baseline forecast that assumes no major policy changes." The biggest threat to the market is considered to be increased taxes. Biden has proposed raising the top tax rate for capital gains for the highest earners to 39.6% from 23.8% , and he would boost the corporate tax rate from 21% to 28%. Goldman estimated that as proposed, Biden's tax reform could reduce S & P 500 earnings by roughly 9%. However, Biden's proposed fiscal expansion, which could total $5.4 trillion in new spending over the next 10 years, is likely to offset the negative impact from higher taxes, Goldman said. "A large increase in fiscal spending, funded in part by increased tax revenue, would boost economic growth and help offset the earnings headwind from high tax rates," Kostin said. Goldman said Biden's expansionary fiscal polices would translate into a large increase in the output gap, which could further support the economy as it recovers from the pandemic-induced recession. Additionally, Goldman's political economists believe only a "pared-down version" of Biden's tax plan would eventually become law in the event of a Democratic victory, and that it would be phased in starting in 2022. "Rather than a tax rate of 28%, they expect the rate would be lifted to 25%, and that the social security payroll tax proposed by the Biden campaign would not be implemented," Kostin noted. "We estimate this pared-down reform by itself would reduce S & P 500 EPS by approximately 5%." Meanwhile, easing global trade tensions could give corporate profits a further boost. Goldman economists expect that a potential Biden administration would reverse the tariffs Trump imposed on China and abstain from implementing any new broad tariffs. The bank estimated that a partial unwind of tariffs in 2021 and a full reversal in 2022 could add approximately 4% to S & P 500 earnings compared to no changes to the current punitive duties. Goldman maintained its year-end S & P 500 target at 3,600, a roughly 7% gain from Monday's close of 3351.60. The broad equity benchmark has bounced more than 50% from its March bottom. Don't miss CNBC and Institutional Investor's Delivering Alpha conference on Sept. 30, featuring Treasury Secretary Steven Mnuchin, Sen. Elizabeth Warren, Alibaba's Joseph Tsai, Vista Equity Partners' Robert Smith, J.P. Morgan's Mary Callahan Erdoes, Inclusive Capital's Jeff Ubben and more.

Democratic U.S. presidential nominee Joe Biden speaks to attendees at an outdoor "Black Economic Summit" while campaigning for president in Charlotte, North Carolina, September 23, 2020.

Kevin Lamarque | Reuters

(This story is for CNBC Pro subscribers only.)

With Election Day only about a month away, talk of a possible Democratic sweep upending markets is intensifying, but Goldman Sachs believes this fear is overblown.

President Donald Trump and Joe Biden will square off Tuesday night in the first presidential debate with the Democratic former vice president leading the polls. Many equity investors fear that Biden's policies — a tax-cut reversal, higher capital gains taxes and tighter regulations — could lead to lower profits, less economic growth and hence lower stock prices. However, Goldman said the market would only see a short-lived impact, even in a blue-wave scenario.