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Current US election polls have a Joe Biden win and a Democratic Party sweep of both houses of Congress at roughly a 50 per cent probability, a Biden win with a split Congress at 10 per cent and a Donald Trump win with a divided Congress (i.e.- the status quo) at 40 per cent. Each of these election results has different near- and long-term implications for market outcomes. Of course, polls and projections don’t always hold (as we learned once again in the 2016 presidential contest), and with less than three months to go until Nov. 3, anything can happen. But for investors, attempting to analyse the potential trajectories for the US in each of the above scenarios can help to position for the range of potential outcomes.
For guidance as to how things might play out, we can draw lessons from the last presidential election cycle. Trump’s 2016 win over the Democratic establishment candidate Hillary Clinton, who had been the clear favourite in the polls in the runup to the ballot, effectively sent the Democrats into the political wilderness. Trump had ridden a wave of populism by targeting those who were ‘left behind’ in the US rebound from the 2008 financial crisis, especially in landlocked and rural regions.
Biden, who was vice president under Barack Obama from 2009-2017, along with the Democrats, have learned an important lesson in economic policy from Clinton’s defeat: in the wake of a crisis, if the party in power is perceived to neglect the economic well-being of key parts of the electorate (as measured through employment and wages), it will soon find itself out of power.
Source: Fidelity International, US Bureau of Labor Statistics, Yahoo Finance, August 2020
In the context of the current crisis, if the Democrats take the White House and both houses of Congress in November as the polls suggest, we expect they are likely to act as quickly as possible to push unemployment back down below 5 per cent. This would be achieved through massive fiscal stimulus, which would ease through Congress due to consolidated control of both the legislative and executive branches of government. Below we offer a more detailed analysis of each of the three scenarios:
Scenario 1: A Dem sweep (50 per cent probability)
Biden’s spending proposals are currently close to $5 trillion and growing. To date, he has announced:
- $2trn for healthcare reform and expansion;
- $2trn for a green jobs program (Plan for Climate Change and Environmental Justice);
- $775bn on child and elderly care
In terms of funding, we would expect the government to look the other way on deficits for several years, until unemployment returns to pre-Covid-19 levels. If Biden’s policies proved successful, the combination of expansionary fiscal and monetary policy would effectively reflate the real economy. We would expect inflation to appear in a meaningful way in late 2022/2023. And we think a Biden-led government would hold off on a significant tax hike on corporates until the economy and unemployment stabilised, potentially until halfway through his term, in 2022.
While markets may initially baulk at a Democratic sweep due to the party’s association with higher taxes and more regulation, we think investors would eventually start to price-in the effects of a combination of greater fiscal largess and monetary expansion, which should ultimately lead to higher consumer confidence and support for risk assets.
Scenario 2: Biden wins and Congress remains divided (10 per cent probability)
A Biden White House with Republicans holding the Senate is the lowest probability scenario, given current polling and the tendency for voters to stick with one party all the way down the ballot. There is a 75-85 per cent probability the Senate will flip to Democratic control, should Biden win the Presidential race. As a result the chances of a Trump re-election are higher than Biden winning the White House without bringing the Senate along.
We would view this outcome as a partial mandate for the Democrats, e.g. a repudiation of the Trump Administration but not necessarily of the Republican establishment. With Senator Mitch McConnell remaining the majority Senate leader and Representative Nancy Pelosi in control of the House, legislative outcomes would rely on compromise and reflect Democratic fiscal stimulus combined with Republican fiscal conservatism. The end product would be closer to a “skinny New Deal.”
The impact of such policy on the real economy and financial markets would probably resemble the last 6 years of Barack Obama’s administration, in which he presided over a divided Congress: gradual (slow) repair in unemployment and wages and strong returns in the financial markets, with the latter supported by low interest rates and limited ability for Democrats to push through tax hikes – or more bluntly: a positive outcome for Wall Street but less beneficial for Main Street.
Scenario 3: Status quo: Trump wins and Congress remains divided (40 per cent probability)
Polls and betting markets are assigning a roughly 40 per cent probability that Trump is elected to a second term. The most likely outcome for Congress in this case is for the Senate and House to remain in Republican and Democratic control, respectively, with McConnell and Pelosi continuing as majority leaders.
Given Congressional gridlock, economic policy would be similar to scenario 2; however, we see added downside risk from growing civil unrest, political instability and potential for continued poor management of the Covid crisis, which increases the risks of a double-dip recession in the US. The risk of an erosion of confidence in US assets also increases most in this scenario.
The suspense will continue
It is increasingly likely the results of the election won’t be known for days or weeks after Election Day, Nov. 3. The main reason is the expected heavy reliance on voting-by-mail and absentee voting (through post, fax or email) due to the Covid social distancing measures. Many states will not finish counting ballots on election night. It could take weeks, or longer. Additionally, questions raised by President Trump over the legitimacy of results and by Democrats over voter suppression could further draw out a resolution. We could see a repeat of the 2000 Presidential race (Bush vs. Gore), in which the result was decided ultimately by the Supreme Court on Jan. 6, 2001 - two months after the election.
With the Covid crisis driving US policy to extremes not seen in generations, the 2020 election will be closely watched. Understanding the long-term drivers of policy, and the ability of different agents within the US government to set economic strategy, will play a key role in asset allocation decisions.