inancial markets have been under pressure for the past week as COVID-19 cases rise and hopes for a pre-election stimulus package fade. The apparent failure of stimulus negotiations means financial markets will have to ride out the election results without assured fiscal and monetary support.Without that support, election results could produce another wave of financial market volatility.
This volatility could be exacerbated by the potential for electoral surprises. Early voting numbers are shattering all previous records, suggesting that this election could see the highest voter turnout in 100 years.
The three biggest pools of new potential voters (white Americans without college degrees, ethnic minorities, citizens under 30) have different voting patterns. Election results could depend upon the exact turnout from each of these three groups. Polling models based on previous elections may not accurately capture this unprecedented wave of new voters.
In this unpredictable environment, we believe investors should prepare for four potential election scenarios:
This is the scenario that could cause the most short-term pain for investors. Both candidates have indicated that they will not concede a close election, with President Trump ready to challenge absentee vote counts and Vice President Biden waiting until every ballot has been counted.
The political uncertainty and rancor of a disputed election would likely push hopes for a new stimulus package into 2021.The S&P 500 could fall to 3000 (the red line in the chart below), a 10%correction from current levels. Such a pullback should eventually represent a buying opportunity, in our opinion, as the dispute is peacefully resolved and one of the other three scenarios unfolds.
This is the election outcome with the biggest immediate upside for financial markets, in our opinion. According to polling data, independent voters like Vice President Biden personally but worry about his proposed tax increases. These voters may bridge this divide by voting for Biden but also supporting a Republican for the Senate.
A Republican Senate will likely block Biden’s planned tax increases on corporate America, creating more upside for corporate earnings. With over 40 million Americans facing potential eviction, the political implications of mass evictions should force SenateLeader McConnell to allow a vote on stimulus legislation. A handful ofRepublican Senators will undoubtedly vote no, but stimulus legislation should pass thanks to overwhelming Democratic support.
Equity markets could soar under the combined good news of continued low taxes, more stimulus spending, and another big injection of printed money.
Equity markets could remain volatile until clarity is provided regarding the economic recovery strategy for a second Trump term. We believe that if President Trump is reelected, he is likely to have a RepublicanSenate but has little chance of retaking the House.
A status quo election means continued low corporate taxes and a light regulatory touch, all good news for corporate earnings. However, a substantial bloc of Senate Republicans fiercely opposes another big COVID-19 stimulus package. President Trump’s most loyal supporters tend to be similarly skeptical of big government spending programs.
President Trump has been vague about his plans for a second term. He might oppose any stimulus bill acceptable to Democrats in the House. Without short term support from fiscal and monetary policy, equity markets could struggle until investors gain confidence in whatever alternative economic recovery policy is adopted.
Markets could be caught in a tug of war between short term enthusiasm regarding stimulus efforts and long term concerns about tax policy. If Democrats take control of all three branches of government, we believe a $2-$3 trillion stimulus package would quickly be enacted.
The power of such combined fiscal and monetary stimulus would likely push markets to all-time highs. However, the sustainability of this rally could depend upon the tax policies the new Democratic government puts in place. The last two wave elections saw both the Democrats (2008) and Republicans (2016) shutting out opposition voices and legislating as if their party would control government forever.Voters used the very next elections to take the House of Representatives away from the party in power.
If Biden heeds the lesson from these last two wave elections, then he will moderate some of his tax policies to reflect Republican concerns. Markets could continue to move higher. If he does not, then markets may struggle and a 2020 Blue wave, like the 2008 and 2016 waves that preceded it, could be short lived.
Americans have endured a year of uncertainty and stress in2020. The COVID-19 pandemic and its economic consequences have overshadowed nearly every aspect of our lives. We are concluding the year with an election filled with still more uncertainty and deep divisions across our nation.Throughout the stresses of 2020, one bright spot has been our consistent confidence that the policy combination of deep deficits funded by printed money would drive equity and housing markets higher.
We believe that the best way to understand the investment implications of this election is to focus on the prospects for bigger deficits and more printed money. The long term consequences of this Modern Monetary Theory (MMT) policy combination are worrying. The short term effect of MMT has been to push equity and housing markets higher despite collapsing corporate earnings and a global recession. An election outcome that assures more stimulus is on the way will eventually overcome any other concerns, in our opinion. Markets should move higher as a result.
By contrast, a contested election or a status quo outcome could result in stimulus being delayed or outright denied. Millions ofAmericans could lose their homes and their businesses over the next few months.Opponents of stimulus argue that this short term pain will prove less costly than the long term consequences of out of control deficits and endless money printing. They may be right. However, equity markets could be volatile until their new economic policies prove as positive for equity prices as MMT was in2020.
