Candidates Trump and Biden don’t agree on much, except that this is the most consequential election in modern US history.
Presidential elections are often declared the most important, but this one has a strong claim to the statement. And from the narrower perspective of financial markets it is undeniable that this is a massive event. Leaving aside the historic implications for the future of US democracy, the rule of law or America’s standing in the world, the 2020 election shoulders enormous implications for public health and economic activity, the very fundamentals that determine the value of stocks, bonds, real estate and a host of other assets.
We are therefore bewildered by the oft-heard advice to investors that they should unwaveringly carry on, ignore politics and focus on the long run. That’s plain wrong. This election will shape the long run and hence what matters for portfolios now and thereafter.
We are not pollsters. We don’t make guesses about the vote. Rather, our focus is on how markets are likely to respond to different possible outcomes. Specifically, there are three possible outcomes for investors: win, lose or draw. We define a ‘win’ as an election result where the investment outlook brightens, a ‘lose’ where it darkens and a ‘draw’ where ambiguity prevails.
A ‘win’ for equities and other risk assets is one where uncertainty falls and the prospects for the US and global growth improve. That’s not a partisan definition. The value of an asset rises if its future expected cash flows improve and are discounted more lightly.
In our view, the only unambiguous ‘win’ for risk assets is a ‘blue wave’, where Democrats convincingly win the White House and the Senate, producing a result that is uncontestable.
Here is why.
First, the key to restoring US growth, full employment and higher profitability is pandemic control. Based on the US experience, but also on those of countries such as Taiwan, South Korea or Germany, effective pandemic control requires mask-wearing, social distancing, effective testing & tracking policies. The odds that such a science- and evidence-based approach will work better than the 2020 Trump approach are very high.
Second, as the Federal Reserve, other central banks and the vast majority of economists have noted, economic recovery requires additional fiscal stimulus accompanied by aggressive monetary easing. With the House of Representatives certain to remain in a Democratic majority, only a ‘blue wave’ can align all of Capitol Hill and the White House behind the fiscal policies that will required over the next few years to lift the economy back towards full employment.
Third, markets globally will respond favorably to the decline in risk premiums associated with more predictable US economic, financial, trade and foreign policies under a Biden presidency.
What, in contrast, does ‘lose’ look like?
The worst case for markets is election uncertainty and strife, driven by a contested vote.
Unfortunately, that is a real possibility. For four years candidate and then President Trump has openly talked about election fraud. In the runup to this Tuesday’s vote, the Justice Department, the Trump campaign and other Republican party operatives have appealed to federal courts to restrict voting and the counting of ballots in nearly all fifty states. Candidate Trump has openly called on armed ‘militias’ to ‘observe’ polling sites.
Polls in key swing states, including Pennsylvania and Florida, indicate outcomes tightening, and perhaps too close to call. Final results and certification could come days or even weeks after voting ends. Note that ‘official’ outcomes depend on certification by elected or appointed officials, whose decisions will likely be seen as partisan. If the Electoral College outcome goes against candidate Trump, he will almost certainly contest the result in the courts, potentially culminating with a Supreme Court ruling. If a decision by the highest court is along political lines, investors will question whether Biden and significant parts of the population will concede and accept the result, in contrast to Bush vs. Gore in 2000. Concerns of long-lasting civil strife would undermine market confidence.
And what does a ‘draw’ look like?
To begin, a draw assumes the presidential election is uncontested and therefore implies a Trump victory, where Biden concedes. In a draw scenario, however, Trump’s victory is blunted by Democratic gains in the US Senate, the House of Representatives and in various state elections, undermining the mandate of the second-term president.
A ‘draw’ is not unambiguously bad for markets—gridlock would prevent the imposition of higher corporate taxes desired by Democrats. It might also curb erratic domestic policies by a Trump Administration. But a draw would still leave open deeply unsettling questions about how the US will effectively contain the Covid-19 pandemic and how divided government could support the economy. Both are big potential negatives for financial markets.
Lastly, there is a final outcome with the re-election of President Trump, supported by a Republican majority in the Senate and offset by a Democratic majority in the House of Representatives.
In other words, more of the same. This would be a bad outcome for markets. Risk premiums would not abate. Fiscal policy would remain uncertain and stimulus smaller than required. And the pandemic would rage. This outcome should be considered in the ‘lose’ bucket as well.
On Wednesday, we will publish a follow up Market Compass on the election outcome, or at least based on what is known after the polls close.
In the meantime, if you are a US citizen, please vote. This is, indeed, the most consequential election in modern US history.