August 18, 2020
Frances Donald, Chief Economist
As we get closer to November, investors are likely to become increasingly preoccupied with a new source of uncertainty: the U.S. presidential election. The coming months represent a period in which opinion polls could have an outsize influence on market sentiment, making it even more important for investors to focus on the bigger picture and the key issues that matter.
We’re roughly three months away from the U.S. presidential election, which is both near enough to merit careful monitoring, but also awkwardly far out enough to make it impossible to have any meaningful visibility into likely outcomes. The fact that it’s taking place amid an unprecedented health crisis introduces even more uncertainty into the financial markets. That said, we’ve identified three themes that we believe investors should consider.
There’s no shortage of financial news analysis—such as article in the New York Times—suggesting that markets are focused on one particular election outcome: a Biden win and Democratic control of both the House and the Senate also known as a Democratic sweep. While the popular perception is that a Democratic sweep would be broadly market negative, we’d caution that we believe such fears are likely exaggerated.
A quick analysis of how different asset classes have responded to the change in opinion polls, which had been moving in Mr. Biden’s favor in the past month,2 shows that a positive correlation exists between the S&P 500 Index, the U.S. dollar, and the prospect of a Biden win and a Democratic sweep.
Congress plays an important role in the policymaking process in the United States, and this is an important reason why it isn’t always easy for newly elected presidents to fulfill the policy pledges that they’ve made while on the campaign trail. While political pundits will highlight that there's a path for the Democrats to gain a simple majority in the Senate, from a mathematical perspective, it’s unlikely that the Democrats can reach a 60-seat majority that will allow it to end debates on proposed bills and prevent minority parties from mounting filibusters that could block the passage of legislation. In other words, even in the event of a Democratic sweep, without a 60-seat majority, barriers to passing major legislation will remain—and this will apply to many of Mr. Biden’s proposed policies, including his plan to raise corporate tax.
In our view, 2021 will be an exceptionally challenging year for the economy as it faces elevated levels of unemployment, rising inflationary pressures, and an ongoing health crisis. It isn’t likely to be an environment that can plausibly absorb higher tax rates on either the corporate or individual level. Rather, it will be an environment that necessitates large-scale, continuous stimulus, such as the extension of various relief measures in the CARES Act.
In our view, should the probability of a Democratic sweep continue to rise and investors begin to take a more considered view of the challenges that could face the new administration, they’ll likely:
From an economic/academic perspective, there can be no doubt that the COVID-19 outbreak has made it rather difficult to make historical comparisons with the current economic environment—we’re certainly in uncharted territory here; however, we believe it’s important for investors to note that Democratic sweeps don’t, on average, lead to market losses. Historically, the Dow Jones Industrial Average has risen twice as much when a Democrat was elected president than when a Republican was elected president.3
We certainly aren’t suggesting that markets will perform better under certain types of government—the real world is much more complex than that—but it’s useful to note that the often-cited view that Democrats may be market negative isn’t historically accurate.
Mr. Biden’s proposal to reverse some of the Tax Cut and Jobs Act and gradually raise the U.S. corporate tax rate from 21% to 28%4 has attracted a lot of interest—and caused concern—among market watchers. Certainly, when taken in isolation, higher corporate taxes will be tough on risk assets, but, as mentioned earlier, we think the probability of this being a near-term policy priority is low.
Instead, we think investors should focus on policies associated with a change of government that have so far received less attention—three issues in particular, in our view, have important implications:
To have a fuller picture of the market environment we’re likely to be in after November’s election, investors shouldn’t focus only on factors that could change—it’s just as important to pay attention to macro issues and developments that are likely to continue to shape future policies regardless of election outcomes.
|U.S.-China decoupling continues
|Large-scale infrastructure spending
Pressure on corporate share buybacks
Note that this is a starting place for discussion as we attempt to map out how financial markets are likely to respond to the upcoming election. The markets’ perspective on the election will likely evolve in the coming three months as new events occur and existing developments play out. Other dynamics that investors should consider could include how the election is contributing to a weaker US dollar, the implications of a continued decoupling of the US and Chinese economies, and what a second term for the Trump administration could mean for investors. Given the known unknowns, it’s too early to make any form of definitive judgment.
1 Bloomberg, as of July 21, 2020.
2 RealClear Politics, as of July 21, 2020.
3 Ned Davis Research, Manulife Investment Management, as of July 21, 2020.
4 “Biden tells donors: I’m going to get rid of most of Trump’s tax cuts and 'a lot of you may not like that',” cnbc.com, June 29, 2020.
5 “The Biden plan for strengthening worker organizing, collective bargaining, and unions,” joebiden.com, as of July 21, 2020.
6 “I think Amazon should start paying taxes, Joe Biden says,” cnbc.com, May 22, 2020.
7 “Biden calls for revoking key online legal protection,” thehill.com, January 17, 2020.
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