Sen. Elizabeth Warren, D-Mass. Photo by Gage Skidmore.
Should Sen. Elizabeth Warren become our next president, she promises to reshape many parts of the government and, as a result, the country. But whether Warren’s proposed agenda would reshape the stock market is less clear.
First, it is important to note that there is no guarantee Warren will even be the Democratic nominee, much less the victor of the general election in 2020. In most polls as of this writing, she still trails former Vice President Joe Biden, and in some she trails Sen. Bernie Sanders as well. A lot can happen in the coming months. Even in a scenario where Warren does win the White House, there is no guarantee that Congress will oblige her with passing a wealth tax like the one she has described in her campaign (and recently revised to increase the rate on taxpayers with a net worth at or above $1 billion). In the end, no one has a crystal ball, and there are a lot of “ifs” standing between Warren’s tax plan and reality. But it is still worth considering what this outcome could do to the stock market, even as a hypothetical scenario.
If Warren wins, I believe the stock market will experience a dip, but it is not guaranteed to be a lasting one.
To understand why, consider the position of investors who are wealthy enough to trigger Warren’s proposed wealth tax. Facing the prospect of that tax, as well as the probability of higher income taxes, these investors will want to adjust their strategies accordingly. A wealth tax would make illiquid, hard-to-value assets more attractive than liquid investments like stocks. There is no argument about what a stock is worth at a given point in time for purposes of a wealth tax. On the other hand, valuing assets such as fine art, real estate or private equity is not always easy. By their nature, these assets build in ambiguity that gives taxpayers room to negotiate, especially if the Internal Revenue Service is scrambling to cope with an entirely new type of tax while stretched to its breaking point. If Elizabeth Warren wins the 2020 presidential election, investors could decide to sell off stocks after Election Day and redeploy their capital into more illiquid investments ahead of potential legislation.
In addition, many investors hold large, concentrated stock positions that have appreciated over time, largely due to the tax consequences a sale would trigger. In effect, they feel stuck because the prospect of a huge tax bill is so unappealing. A Warren presidency, especially one with Democratic control of Congress, would mean a likely increase in capital gains rates. Warren has proposed taxing all capital gains, whether short- or long-term, at ordinary income tax rates. In this scenario, it would make sense for investors to go ahead and realize gains in 2020 before such changes arrive, potentially as soon as 2021.
Some analysts have also suggested that a wealth tax, or the prospect of one, could lead to a sizable increase in charitable donations. Investors who hold appreciated assets can give those assets directly to tax-exempt organizations, avoiding capital gains tax – and any potential associated wealth tax – entirely. The prospect of a Warren presidency could encourage taxpayers to accelerate plans for this sort of gift. And because tax-exempt charities are not subject to short- or long-term capital gains taxes, organizations typically go ahead and sell the appreciated asset right away so they can access the cash value. This selling could also contribute to stock market volatility.
Even if all this happens exactly as I’ve described, investors should stay rational and avoid panic. Recent history has illustrated that a presidential election’s effect on the stock market is typically less than people expect, and not always in the same direction. The night of the 2016 election, stock futures crashed as global investors reacted to Donald Trump’s unexpected victory. Yet the next day, the market was up at opening, with the S&P 500 and the Nasdaq both up by more than 1%. Stocks have continued to rally under President Trump, despite many predictions of doom under his leadership. Similarly, many investors were anxious throughout the presidency of Barack Obama, even though stocks flourished under his presidency. In fact, which party wins the White House historically has not had much lasting effect on the stock market in either direction. Investors who sold in a panic due to incoming President Obama or President Trump ended up leaving huge amounts of money on the table.
Whether or not you agree with Elizabeth Warren’s proposals, a Warren presidency would likely create a short-term scramble in the stock market – not because of panic, but because investors are making strategic choices. Such a burst of selling pressure ought to be temporary. Barring other surprises, the situation should stabilize after investors adjust to the new normal. But stock market returns under different presidents have been notoriously difficult to predict, so other surprises aren’t out of the question. Investors should avoid making a rash decision after the next election, regardless of the outcome.