MARKET COMMENTARY

A Potential Blue Wave Amidst a Second Wave

10.29.2020 - Carin L. Pai, CFA

As the US election nears, investors have been tracking the polls to see who the next leader of the world’s most powerful country will be. Democratic candidate Joe Biden appears to be ahead, with an increasing possibility of Republicans losing their Senate majority and Democrats keeping the House of Representatives. This result would create the so-called “Blue Wave”. 

That said, based on the 2016 presidential election, we know that polls can be flawed. Outcomes may surprise even the best election analysts.

Investors Have Made Two Bets

Although many believe a Biden win would end many of Trump’s pro-business policies, we don’t think that’s necessarily true. Whoever wins will likely have to tackle the most significant issue facing markets—the economic recovery from COVID. Based on recent equity market strength and despite an increase in virus cases globally, investors seem to be making two bets:

  • First, they think another fiscal package to support the economy is likely.
  • Second, they believe a Blue Wave could release a tidal wave of government spending to keep the economy afloat.

Chart: Infrastructure tops Biden’s planned spending list



Surprise! Democrats and Republicans Agree on These Issues

Our team believes an infrastructure bill will be a priority for any administration in 2021 since the pandemic has crimped corporate profits as well as personal income for lower- to middle-class consumers. We think there will be efforts to upgrade airports, bridges and roads. These areas are more likely to find bipartisan support than green energy projects. The plan would probably include funding to improve technology infrastructure in the US. This would include broadband access and 5G wireless technology. We think tech will be at the forefront of many potential post-election policy changes.

On trade policy, there is bipartisan support to protect intellectual property. Despite a perception that Biden might take a softer approach, we believe he would pressure China on technology issues. We do expect overall trade tensions to thaw out if a new administration steps in.

Trump’s “America First” stance is certainly supportive of reshoring efforts. However, we see both sides wanting to bring manufacturing back home. The pandemic has exposed many weaknesses in global supply chains, particularly in health care. In addition, our team expects sectors such as industrials and manufacturing to move closer to consumers. We anticipate bipartisan support under either administration because this trend can help job growth.

A Split Congress Could Be Favorable for Equities

While a Blue Wave has gotten the most attention, we believe there is a good chance for a divided government. Our team thinks a Biden presidency with a split US Congress could be favorable for equities. Historically, equities have performed best under a Democratic President and a split Congress.[1] This is likely due to less policy changes under this scenario.

However, we think meaningful legislation can be passed even if there is a split Congress with either candidate as president. We expect incremental policy shifts from a new administration. We also see bipartisan agreement on policies related to fiscal support, infrastructure and trade, although with some differences between the two parties. 

A Blue Wave May Offer a Bumpy Ride

Despite these areas of bipartisanship, and the likelihood of more fiscal stimulus from Democrats, the prospect of a Blue Wave warrants some caution for equities. Many investors worry that it could lead to higher taxes for wealthy individuals and corporations and a sharp shift in regulation for businesses.  

  • Higher individual taxes could lead to a short-term selloff
    • Although Biden has stated that he will not increase taxes for individuals earning less than $400,000, his proposal calls for increases for top-tier earners from 37% to 39.6%. For those with incomes over $1 million, he has proposed raising taxes on dividends and capital gains from 20% to 39.6%.  If enacted, this policy change may induce some short-term selling pressure on equity markets, given that the wealthiest 1% of Americans own over 50% of the stock market.
  • Higher corporate taxes may weigh on company earnings
    • Biden’s plan has been projected to raise between $3 to $4 trillion in revenue over the next 10 years.[2] This new tax policy could weigh on 2022 earnings, especially for US companies that benefitted from the Tax Cut and Jobs Act. That may slow corporate share repurchases.  Buyback programs helped drive US equities over the last few years. Limiting their use may impact stock valuations. 
  • Increased regulation could affect operating margins in some sectors
    • More government regulation could occur. For US banks, a reform-minded Treasury secretary might be seen as a negative.  Biden has also stressed the need for diversity at the Federal Reserve. He could appoint someone who believes in tighter oversight. Also, health care providers and drug prices would likely be under pressure if Democrats pursue a “Medicare for All” policy.  However, the status of the public option[3] remains unclear. This would likely weigh on drug and managed-care stocks as it could pressure their operating margins.

However, Biden’s final tax policy would likely be dependent upon how COVID progresses. Many economists now believe that his tax bill may not be as aggressive and may be lower in priority given the challenges of the economy. 

Our Four Themes for These Uncertain Waters

Markets do not like uncertainty and today, there are more questions than answers. We expect more near-term volatility, especially as investors consider selling equities with profits ahead of any potential increases to capital gains taxes (see the recent article by our colleague Craig Richards). 

While some investors may hope to surf on the Blue Wave of fiscal stimulus, we think it may be unwise to be on a surfboard in a sea of uncertainty.  We continue to favor these investment themes: US over international, large-cap over small-cap stocks, high quality over low quality, and liquidity over leverage. 

[1] Source: Bloomberg. Time period begins in 1976 with Carter administration. Methodology is based on rebalancing every two years or every election cycle, thus incorporating any changes to Congress resulting from the mid-term elections. 

[2] Source: Tax Policy Center, 3/5/20, Penn Wharton, as of 9/25/2020; Tax Foundation, as of 9/29/2020.

[3] The public option is a proposal to create a government-run health insurance agency that would compete with other private health insurance companies within the US.

 


The information provided is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy, or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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