Special market commentary | Election 2020: What we know
It appears increasingly likely that a definitive outcome may still not be imminent, as the Trump campaign has already commenced litigation in multiple states with additional lawsuits still possible. It’s more than a little reminiscent of the 2000 election, which culminated in the Bush v. Gore case being decided by the U.S. Supreme Court on December 12 — a full five weeks after the November 5 election — in time for the electoral college to fulfill its duty. This year, the electoral college is scheduled to vote on December 14. The experience of the 2000 presidential election outcome may provide a reasonable “worst-case scenario” timeline for resolving the election, although it’s certainly possible that the matter could be resolved before then.
At this point, it’s too soon to say how this will play out. As of midday Thursday, former Vice President Biden holds the lead in the electoral vote count, and is closing in on the 270 votes needed to be declared the winner. There’s still a path to victory for President Trump, although he needs to virtually run the table in states where the final vote totals haven’t been announced. Either way, it’s unlikely that the outcome will be definitively concluded in the near term. It could still take several weeks for the process of recounts and litigation to play out.
While most eyes remain on developments in the presidential race, votes are still being counted in a considerable number of races in the U.S. House of Representatives. Despite that, it appears that Republicans will gain seats, but Democrats will narrowly retain control of the lower house of Congress.
In the Senate, where 35 seats were up for grabs, Republicans defended 23 seats to the 12 for Democrats. Votes in a few races are still being counted, which are too close to be called. Of particular note are the two races in Georgia, which may end up in a January 5 runoff election. In one, no candidate was able to secure a majority of the votes; in the second, a similar outcome looks increasingly likely. It appears that Republicans will have a slight edge and will be poised to narrowly maintain control of the Senate, although the outcome may be in doubt until after January 5.
If that’s in fact the case, it will have a significant impact on the outlook for policy, regardless of whether Biden or Trump ultimately wins the presidency. A split government effectively limits the ability of either party to go all-in on their policy initiatives, creating an automatic check on power and reducing policy uncertainty for investors.
If we’re to assume that neither party will have unified control of both houses of Congress and the White House, the implications from a policy perspective are meaningful.
Tax policy – Candidate Biden’s tax plan called for higher individual income and capital gain taxes, higher corporate income taxes, and increased estate taxes. If Republicans do maintain control of the Senate, the likelihood of major tax hikes decreases at least until after the 2022 midterm election.
Fiscal stimulus – Heading into the election, both parties had concluded in concept that additional fiscal stimulus was needed, although they remained far apart on the details. It seems likely that policymakers will be able to find a deal, but expectations are already being reined in. A divided government will require compromise, which could extend the process of passing a bill, and also reduce its size and scope.
Finally, a divided government means that any legislative agenda put forward by either a Trump or Biden administration will be more measured. There still appears to be bipartisan support on matters related to trade relations with China, the need for infrastructure investment, and potential regulatory considerations related to privacy matters related to big tech.
A Trump win and Democrat-controlled House of Representatives would largely reflect the status quo. A Biden win coupled with the GOP retaining the Senate would similarly limit his ability to push forward some aspects of his agenda; the likelihood of sweeping healthcare reform or massive regulatory action against big tech, energy, or financial sectors would be significantly diminished. And while it wouldn’t signal a 180-degree turn on China relations, it could result in a different approach that’s less dependent on the use of tariffs as a form of leverage.
The bottom line is that a divided government scenario delivers gridlock, with neither party in a position to aggressively push forward their full agenda.
As already noted, additional policy support is expected and would provide a near-term boost to the economy but is likely to be less robust if Republicans hold the Senate. A more measured stimulus bill would lower expectations for near-term growth and inflation.
That was apparent in terms of market reaction to the undecided (although clearly not “blue wave”) election results on Wednesday, as the yield on the 10-year treasury fell from 0.9% to 0.78% — an outsized single-day move. That reflects changing expectations for lower inflation and less robust growth as a result of lowered expectations for fiscal support for the expansion.
On the flip side, markets have already been pricing in zero expectation for the Fed to raise rates for the next few years. Clearly, recent events did nothing to change that view.
The question is whether or not the Fed would step in and provide additional monetary support in the absence of a more aggressive fiscal response? Fed Chair Jay Powell has been beating the drum for greater fiscal stimulus in recent months. If Congress and the administration don’t deliver, the Fed may need to do more at the margins to support the economy. That would more likely come in the form of continued bond-buying, a reiteration of the central bank’s willingness to let inflation run high for some period, and perhaps more clarity on its willingness to institute even more aggressive measures to control rates along the curve.
The baseline forecast remains largely unchanged, calling for growth to moderate but remain above long-term trend in the coming quarters. The two predominant risks to that forecast are the uncertainty around the COVID-19 pandemic, the timeline for a vaccine and mass distribution thereof, and insufficient policy support to bridge the gap until the primary health risk is in the rearview mirror.
Put all the pieces together and what does it mean for investors? Market activity on Wednesday illustrated the recalibration of expectations that’s underway. Long-term treasury-bond yields came in moderately, while equities posted solid gains on the back of positive returns on election day — a surge that was extended by solid gains again on Thursday.
Even so, the market is still sorting out what it all means. Trading on Wednesday heavily favored large caps and the technology, communication, consumer discretionary, and healthcare sectors; cyclically sensitive sectors lagged. That changed on Thursday, with materials, industrials, and financials leading the way along with small caps and value-oriented stocks more broadly. Certainly, any change in leadership in Washington D.C. opens up the potential for a refocusing of tax, fiscal, and regulatory policies that can also act as a catalyst for changes in market leadership. It seems likely that is what the market has been trying to sort out in the past few days. What will this mean for healthcare reform, the regulatory outlook for big tech, or the potential stimulative tailwind for cyclicals? As the outcomes of both the presidential and congressional elections become clearer, investors should expect equity market leadership to also remain fluid.
What does this tell us? The market certainly doesn’t hate what it’s seeing. Historically, investors have been comfortable with divided government — one in which business can still get done while reducing the ability for either end of the political divide to exert too much power over the agenda that’s advanced. As we shared last month, equity markets have typically performed well when Congress is divided.
As we’ve also warned in recent weeks, the potential for a long, drawn-out process of recounts and litigation could be a catalyst for near-term volatility. We wouldn’t view that as a reason to deviate from your investment policy, though it could create the need and opportunity to rebalance. As always, maintaining adequate cash reserves to meet near-term needs should allow investors to look through periodic volatility and maintain their long-term focus.
We may be speaking to you today as your financial advisor, but we’re watching the events unfold across the country with the same eyes that you are: as Americans. We may disagree at times on specific matters of policy or party affiliation, but our hope is for a definitive and fair resolution to the election that can be reached as quickly as possible while most importantly maintaining the integrity of the process.
As your advisor, our goal is to set any personal political views aside and take a pragmatic, analytical approach to translating what it means for the economy, for policy, and for you as an investor. We will continue to make that our focus in the days and weeks ahead.
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