By Thomas J. Raymond Jr., CFA

When Lewis Carroll’s Alice sat down for tea with the Mad Hatter and March Hare in Wonderland, her journey was firmly in the surreal as she was beset with riddles and no answers. As she was traversed this curious land, Alice reacted as most of us might, with increasing frustration. It’s a similar sentiment to what most investors have had for months if not years. The outcome of the November presidential election was clear, but a state of paralysis as confusion was introduced.

The disjunction effect in choice under uncertainty, which was analyzed by acclaimed researchers Amos Tversky and Eldar Shafir in 1992, may have had a grip on many investors for several months after the election – maybe even some right now. There may have been an urge to do something, anything, to protect against the various consequences, but it’s a very binary event. What if I make changes based on A, but B happens? So, most do nothing to avoid the risk of misjudging the situation. Nonetheless, there are steps that can be taken now, even if all the scenarios still haven’t been made clear.

Tax Policy

Tax policy may or may not change as a result of Joe Biden’s presidential win and control of the U.S. Senate going to the Democratic Party. But regardless of what happens at the federal level, budgets at the state and local levels are going to be a challenge. There are serious fiscal issues that both political parties will face, and there is precedent of increasing rates in conservative regimes too. Remember, Ronald Reagan extended a telephone excise tax and accelerated payroll tax increases among other revenue raising techniques for the federal budget.¹ The proper mindset regarding taxes is not “if” they will go up, but “how” and “when.”

Consider proactive steps that can be taken today to navigate a higher tax reality of tomorrow. One step might be to realize capital gains in 2020 at a presumed lower tax rate. There are other tactics, including building capital loss reserves and transitioning out of tax inefficient mutual funds into more efficient exchange traded funds.

Zooming Out

Our instincts are to zoom in on issues to make sense of the uncertainty and perplexing matters. Sometimes, though, we can get a clearer image when we zoom out. The pandemic-fueled contraction was punishing, but it also means future economic and profit growth numbers will come off a much lower base. For instance, there are the lofty earnings estimates for the S&P 500, which exceed 27% growth next year.² The Biden administration will have some effect on the future, but it won’t stop this coming growth in its tracks. It’s an important consideration, and something that can anchor decision-making during a period of unknowns. You just need to zoom out to see it.

The world right now sometimes seems like a work of fiction, with riddles and complexities warping the backdrop we had all been accustomed to once upon a time. As with Alice, it can be frustrating and overwhelming, but we cannot let this create a state of paralysis. Rather, there are some clear views on the direction of the economy and tax policy. We don’t have the specifics, but we have enough information to combat the disjunction effect facing many. Importantly, several of these steps can be implemented now and with sound logic.

Yes, there are still effective ways to navigate an unclear future.

¹ “The Mostly Forgotten Tax Increases of 1982-1993,” Bloomberg (Dec. 15, 2017).
² Yardeni Research Inc. and I/B/E/S data by Refinitiv (Sept. 16, 2020).

Thomas J. Raymond Jr., CFA, is a senior portfolio manager for Abbot Downing in Philadelphia. He can be reached at traymondjr@gmail.com.

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