Biden’s Stock Markets Are Starting Off With 3 Major Headwinds

The stock markets have performed well under President Trump with the S&P 500 increasing 57.5% between the day he was elected in 2016 until November 3, 2020, when he lost to President-elect Joe Biden. The increase has been driven by a combination of higher earnings and higher valuations assigned to them.

For the stock markets to see another four years of strong growth there are at least three major headwinds to overcome. These include earnings growth, the Fed not just continuing to increase its balance sheet but materially add to it and stocks being at high valuation levels.

Earnings were materially helped by tax cuts

Trump and the Republicans were able to pass a tax bill that cut the corporate tax rate from 35% to 21%. This materially helped earnings as can be seen in the chart below when they jumped from 2017 to 2018, the first year they went into effect. Over the four years Trump was in office earnings have increased by 27.1% over four years.

  • 2017 earnings: $133.61
  • 2021 earnings: $169.83, up 27.1%

Earnings growth should continue to grow during the Biden Administration but they won’t get the huge help from a tax cut. From a financial perspective the best outcome is the rate to stay the same and there is a possibility it could increase as Biden is talking about going to a 28% corporate tax rate.

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The Fed has pumped up the markets

The Federal Reserve has pumped over $3 trillion into the economy, and in reality the financial markets, in just four months from February to June this year. This is the same playbook it used during the Great Recession.

Think of it this way. The Fed buys bonds, which means the holders of those bonds now have cash. The holders, or investors, want or need to reinvest the cash. Since interest rates are so low (because the Fed has a huge demand for bonds, which drives up their prices and lowers the interest rates the bonds pay) the bulk of the cash investors have received ($3 trillion) goes into stocks.

During the Great Recession the Fed increased its balance sheet by about $1.4 trillion in three months. While it fell by half a trillion dollars in two months, it reversed course and essentially brought it back up to its higher level a few months later.

  • September 2008: $900 billion 
  • December 2008: $2.3 trillion
  • February 2009: $1.8 trillion
  • May 2009: $2.2 trillion

Over the next five years to July 2014 the Fed doubled the size of its balance sheet to $4.4 trillion and essentially kept it at that level for almost four years to March 2018. The Fed then tried to lower it some and got it down to $3.8 trillion by August 2019.

  • July 2014 to March 2018: $4.4 trillion   
  • August 2019: $3.8 trillion

However, it reversed course again increasing it to what was then a small degree or $400 billion by February 2020. When the economy started to be negatively impacted by the coronavirus and essentially shut down, the Fed jumped in and bought $3 trillion in assets during the spring.

  • February 2020: $4.2 trillion  
  • June 2020: $7.2 trillion 
  • July 2020: $6.9 trillion
  • December 2020: $7.4 trillion 

Hopefully the Fed will be able to moderate its purchases but if it is successful in this endeavor it removes a major accelerant to the stock markets. If you wanted to look for the main reason that stocks have moved higher in 2020 it is due to the Fed’s asset purchases.

Stocks have risen faster than earnings

During the four years from December 31, 2016, to December 31, 2020, the S&P 500 rose by 67.8%. However, earnings have only grown by 27.1%. With the upward move in the stock markets being greater than earnings growth the S&P 500’s PE multiple has increased from 16.5x when Trump was elected to 22.1x currently.

With stocks trading at higher valuation levels it could be hard for stocks under Biden’s time in office to outperform Trump, even though in the first two months since Biden was elected the stock market has done better than when Trump was first elected.