One stock market signal suggests the US presidential race is tightening, Goldman Sachs says

• The trading activity of certain stocks is sending a signal to investors that the upcoming Presidential election this November is going to be close — and is getting closer, Goldman Sachs said on Friday.
• The relative outperformance of high-tax stocks relative to their low-tax counterparts signals a recent preference for stocks expected to benefit from a Republican victory.
• It specifically suggests a 53% probability of corporate tax reform, according to Goldman. The firm says this is only likely happen if Democrats pull off a sweep in November.
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Judging by the trading activity of certain stocks, the presidential election in November is getting tighter — although it still favors a Democratic sweep, Goldman Sachs said in a note on Friday.

Specifically, the recent outperformance of a basket of stocks with high corporate tax rates relative to its low-tax counterpart signals a recent preference for companies expected to benefit from a Republican victory. Further, the direct probability of Joe Biden's proposed tax hike has declined in recent weeks, although it remains the more likely outcome, Goldman data show.

Both dynamics are reflected in the charts below:

Specifically, the high-tax basket's outsized returns currently imply a 53% probability of corporate tax reform, the note said. Reversing President Donald Trump's signature 2017 tax legislation is a Biden policy initiative that could likely only be pulled off if Democrats controlled both Congress and the White House.

The 53% probability of corporate tax reform is in line with prediction market's 54% probability of a Democratic sweep this November, Goldman highlighted.

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Despite the declining implied probability of a Democratic victory, there are still signs that investors are preparing for a full sweep.

"Education and clean energy stocks have moved in directions consistent with a rising probability of Democratic sweep," Goldman said.

Clean energy stocks have outperformed the S&P 500 by 55 percentage points year-to-date, while for-profit education stocks have lagged the broader market in recent months.

If Democrats do pull off a sweep in November, Goldman says to expect a period of heightened market volatility as investors grapple assessing the impact of Biden policy initiatives amid a global pandemic and sharp economic decline.

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While corporate and tax hikes from the Biden administration would reduce 2021 S&P 500 earnings by 9% and likely hurt stocks, large fiscal expansion initiatives and less uncertainty with trade policy could be a tailwind for stocks, Goldman said.

Biden's plan includes $7 trillion in gross fiscal spending on infrastructure, education, clean energy, and healthcare, Goldman noted.

Finally, investors should brace for a period of extended and heightened volatility based on current implied moves in option pricing "as investors assess the potential for it to take longer than usual to reach definitive election results," the note said.

"The market now shows an extended period of high volatility well beyond Election Day. This likely reflects the potential for election results to be finalized with a delay," Goldman said.

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