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A democratic sweep won’t be that dangerous for shares if it creates a much bigger incentive, say some merchants

U.S. House of Representatives Speaker Nancy Pelosi (D-CA) and Senate Minority Chairman Chuck Schumer (D-NY) speak with Treasury Secretary Steven Mnuchin and White House Chief of Staff Mark after their negotiations on coronavirus aid Meadows, at the U.S. Capitol in Washington, United States, with reporters August 7, 2020.

Jonathan Ernst | Reuters

The trading community is actively debating the impact of more fiscal incentives on the economy and markets, but sometimes they seem to be talking about two different types of incentives.

There is one that would emerge from the ongoing negotiations between House Speaker Nancy Pelosi and Treasury Secretary Steven Mnuchin.

But there is another incentive that is being discussed – the incentive that could come if Democrats sweep both the presidency and the US Senate.

This second type of stimulus has been largely rejected by the trading community, but now that the elections are near and polls show Biden has a small head start, it has become the subject of some debate and part of the trading "stew" in the markets.

"Even if there is a business cycle agreement now, it could be a small down payment for what would happen if the Democrats came to power," said Marc Chandler, chief market strategist at Bannockburn Global Forex, noting that Democrats added Another general economic stimulus plan would also likely seek to boost infrastructure and health care.

Chandler goes further, saying that if the Presidency and Senate remain in Republican hands, there is a chance that Republicans will also get their own boost in the form of spending increases and even permanent tax cuts.

"Trump now wants major infrastructure spending," said Chandler. "One way or another, we're likely to get extra momentum. That's why the stock market is so resilient."

All of this is hotly debated among traders, and many still reject a democratic sweep as a positive for stocks, regardless of the level of incentives promised. "If the Democrats raise capital gains tax and the corporate income tax rate, that's negative – people will sell," said Matt Maley, chief marketing strategist at Miller Tobacco.

Maley also believes the Republicans will push back hard, as some have already said: "Once the Democrats gain power, you will see Republicans go back to their roots and be much more fiscally accountable. It will be." It is very difficult to run another massive stimulus plan if the economy is not completely crater-like. "

To see how far the debate has moved, take a look at taxes. The trading community has long viewed Biden's proposed higher corporate tax and capital gains tax as severely negative for stocks, but David Kostin, chief equity strategist at Goldman Sachs, suggests that the "mix" of proposals that Biden is proposing may not be as damaging for earnings is, "Our analysis suggests that the combined effects of higher corporate tax rates, higher household spending and lower tariffs would likely result in a similar medium-term S&P 500 profit as our baseline forecast, which does not require significant policy changes," said Kostin in a current note to customers.

"A sharp increase in household spending, partly financed by higher tax revenues, would spur economic growth and help offset the headwinds in profits from high tax rates," wrote Kostin.

Regardless of the outcome, traders seem to agree that solving a highly uncertain choice will reduce equity risk – assuming we get a clear outcome. That leaves the status of the vaccine as well as the Federal Reserve's policy as the main stock maker.

While the elections will attract everyone's attention in the short term, those in the longer term know that ultimately other factors – including a capitalist society and a judicial system that enforces treaties – are far more important than the president.

"History shows that the market tends to rise regardless of who is in office," said Maley.

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