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Looming Election Volatility: Scenario Analysis

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The forward-looking stock market begins to look beyond the medically induced economic coma that continues to plague financial systems across the world. Now analysts and investors are starting to look towards the November election as the (virtual) Democratic convention kicks off this week. I'm going to look at the economic and market driving implications of each candidates' position and what the stock market may look like under each regime.

Current Conditions

Market volatility has a track record of rising during election season, and I anticipate this contentious election will be no exception.

The bulls & bears are duking it out at crucial market levels with the S&P 500 fighting its way past its pre-COVID highs, trading less than 1% below. The innovation-driven Nasdaq 100 has surged beyond its all-time highs and is coming up towards a critical Fibonacci level at around 11,600 or about $282 if you are trading QQQ (QQQ - Free Report) .

Both levels will likely represent robust resistance levels that the markets may struggle to breakthrough.

These next two weeks of party conventions could shape this election's fate and the market reaction to follow. Below I will take a look at what each candidate and their potential impact on stocks.

A Biden Win

As of now, Biden is up in the polls, but these polls have a tendency to be less than reliable because of the small sample sizes and typically biased contributers (which we saw in the last presidental election). According to a WSJ & NBC, Biden holds on to 50% of voters compared to Trump's 41%.

A Biden win could bring some initial headwinds into the public equity markets.

A new president means uncertainty. Despite Biden's more politically centered stances, compared to cohorts like Elizabeth Warren or Bernie Sanders, it is not out of the question that his policies might turn more progressive when he gets in office and feels party pressure.

In recent years, there has been a Democratic push to redistribute wealth evenly across America, which would mean higher taxes for the corporation and the wealthy. This would be bad news for corporate America, which was just given a massive tax cut by the Trump administration.

A tax on the wealthy could also have negative implications on the market, in the long and short-term. Biden has discussed increasing capital gains taxes, which could lead to a big sell-off before this tax change is implemented, as shareholders pull profits at the lower tax rate. If taxes are sizably increased for the higher tax brackets, it would also decrease the amount of money that the wealthy could invest.

Overall, I think that a Biden win could shock the stock market, which has seen such massive gains not only in the past few months but in the past few years. The "valuation foam" that has been building up in equities could be blown off if Biden were to take office.

Another Trump Win

Many believe that another win by Trump would be neutral to positive for the stock market.

Trump has lost ground in recent polls because of how he responded to the Pandemic. The public has felt that Trump's attitude towards this virus was too cavalier and lacked empathy as well as the proper swift response. 

Despite what you might think about President Trump and his controversial comments & tweets, the economic actions he has taken have been beneficial to the markets.

The Tax Cuts and Jobs Act of 2017 reduced the corporate tax rate from 35% to 21% while allowing a one-time repatriation tax reduction on foreign profits and cash. These actions brought both jobs, money, and capital investments back to the US.

The US stock market has been flourishing since Trump inauguration in January of 2017. The S&P 500 has expanded roughly 50% and the tech-driven Nasdaq 100 is up over 120%. This represents an annualized return of 17% and 36.4%, respectively. Despite the recession in which we currently find ourselves, the markets have been able to far outpace the S&P 500's century-long average annual return of 10%.

Whether you attribute these returns to Trump's actions or pure coincidence, investors will likely see another 4 years of the same presidential regime as a positive for their portfolio.

US-China Trade War

We can't discuss the upcoming election and the current political landscape without exploring the trade dispute between the US and China. This issue is beginning to take center stage…again. Trump has not held back his provoking opinions during this Pandemic, always calling it the "China Virus" and blaming the country for its global spread.

The Trump administration is now threatening to block one of the hottest new social media platforms out of China, Tik Tok, along with instant messaging application WeChat due to national security concerns about user data. The Trump administration has given the apps 45 days (earlier this month) to find American buyers before he claims he will ban them in the US.

Microsoft (MSFT - Free Report) is in talks with Tik Tok owner ByteDance to purchase this prolifically expanding social media platform. WeChat is unlikely to find an interested US buyer as its usage isn't significant in the US. This is an attempted power move by Trump to illustrate his political authority and instill fear in Xi's economic regime.

The aforementioned application bans would likely provoke an equal (if not greater) and opposite reaction from China, who could block US online giants like Facebook (FB - Free Report) , Google (GOOGL - Free Report) , Twitter (TWTR - Free Report) , and Snapchat (SNAP - Free Report) . This could cut sizable revenue from these US tech giants.

The handling of the reheating trade dispute is going to critical to the short-term outlook of these economic superpowers. Trump's approach may be strong and even seeming erratic at times, but I fear that Biden would be too affable in trade discussions with China and lose the ground that the Trump administration has worked so hard to gain. Still, Biden's approach in this vital dispute remains to be seen.

The Takeaway

Expect market volatility to rise as we close in on the November elections. The virtual party conventions over the next 2 weeks, could drive poll decisions.

If we end up with a divided government, where congress and the executive branch are controlled by different parties it could be a long two years with no fruitful progress.

With the equity market appearing to be overbought and tech-stocks' frothy valuations, I am very hesitant to purchase any equities at this point. I have been trading QQQ puts at varying expirations to protect my tech-heavy portfolio from a market correction. 

We have an enormous amount of uncertainty still to come in 2020, so don't get stuck in the mindset that "stocks only go up" because this strategy can turn against you fast at our current levels.

5 Stocks Set to Double

Each was hand-picked by a Zacks expert as the #1 favorite stock to gain +100% or more in 2020. Each comes from a different sector and has unique qualities and catalysts that could fuel exceptional growth.

Most of the stocks in this report are flying under Wall Street radar, which provides a great opportunity to get in on the ground floor.

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