Last Week: Vaccine hopes (production and distribution aside) have many market participants looking past the projected nightmare that many in the medical and scientific community say is coming in late ...
It is now 15 days ‘till the general election! We see four apparent electoral scenarios (Democratic control of the House of Representatives does not appear to be contested):
Republicans hold the Senate and the White House
Republicans hold the Senate, but Democrats take the White House
Democrats take the Senate and the White House
Democrats take the Senate and Republicans hold the White House
We imagine there could be a fifth scenario—a contested Presidential election that throws everything off-kilter. However, it is our opinion that a scenario such as a seriously contested election has lessened quite a bit over the last few weeks. Perhaps it is because polls show Vice President Biden widening his lead nationally and in many swing-states. However, after 2016, we take the polls with a grain of salt. They should get it right a few times before we truly respect them again. We do, however, feel that despite a lot of hoopla, votes will be counted, and a legitimate election result will be confirmed. It may take a few days past Election Day, but not too long.
The first scenario means the continuation of the current status quo. It should be noted that, lately, the Senate Republicans have bucked President Trump on passing an additional large COVID-19 stimulus and relief bill. It appears from this that Senate leadership is beginning to discount a second term for President Trump by not honoring his desire for a large deal. However, to be fair to both the Senate and President, the President has been all over the map lately with regard to a large spending bill. Other than a few tweets, has not made any political moves to bring Senate Majority Leader Mitch McConnell to heel. It is very possible that if the President wins re-election, his focus on the big spending bill diminishes. That, in turn, should take some pressure of the long end of the yield curve and bring on a significant bull flattening. Equities and other risk assets see the need for a big bill, so our knee-jerk election night call is that we could see a decent sell-off in stocks and risk assets. Stocks have defied just about everything that can be thrown at them (although the major indices are dominated by a relatively few huge names). Perhaps, in another few weeks, the COVID-19 vaccine picture will be clearer and stocks will begin pricing in a return to normalcy in 2021.
The second scenario where the Democrats take back the White House and the Republicans hold the Senate, we believe we will see a similar situation in long-term Treasury yields as we would see in first scenario—a major bull-flattening. A President Biden will want a large stimulus package, but Senator McConnell won’t give him one, especially if they see a COVID-19 vaccine coming in a matter of months. In this scenario, we can see the Federal Reserve try to make up for the loss of fiscal stimulus through stronger Quantitative Easing action. The Fed sees the big picture without the political filter on. Even if we see an answer for COVID-19, our economy and society has been at war on our own soil; there has and will continue to be economic devastation. We don’t know what the changes to people’s spending and saving habits will be. We don’t know if the banking system will take a good period of time to recover from what is beginning to happen now—balance sheet devastation. The consumer and commercial loan losses are coming, especially without another CARES Act type of bill. Regarding stock and risk assets, the election night reaction for stocks will be a selloff. Normally, the scenario of Republicans holding at least one chamber of Congress and a Democrat in the White House (or vice versa) would normally bring joy to stocks because there is such a lack of confidence in D.C. that gridlock has been viewed in recent history as a good thing, although a President Biden can undo many of President Trump’s executive orders with regard to roll backs of environmental and business regulation. However, if Senate Leader McConnell continues to oppose a big relief bill, then equities and risk assets start to see what the Fed sees—a long and uneven slog to a pre-COVID recovery.
The third scenario where the Democrats take back the Senate and President Trump wins a second term is by far the most interesting one. It may not be good for the country, but Fox News and MSNBC will cry hallelujah! This is the scenario with the most uncertainty. President Trump wants a big stimulus bill and so does Senator Schumer and Speaker Pelosi. Other than a “Blue Wave” on election night, this is the scenario that gets a big spending bill. The way Leader McConnell has acted toward the President in the last weeks leading up to the election reflects classic power politics. The Republican Senators, many of the same ones that shunned President Trump prior to his 2016 win, are beginning to back away again as he is behind in the polls. As Lyndon Johnson frequently said, “Power is where power goes.” The President is beginning to look weak to them, meaning they are factoring into their equation that he has a good chance of losing. As recently as two months ago, President Trump was the Republican Party. All Republican Senators danced to whatever tune he called because he was incredibly popular with Republican voters as well as Republican state governments and organizations. Now, the potential of losing has begun to drain that power. Therefore, if President Trump wins and Republicans lose the Senate, there very well could be a better chance for a big COVID-19 bill. Whether that calculus is apparent on election night will remain to be seen. However, we think in the following days it could happen, causing a big selloff in longer term Treasuries. Additionally, a split of power between Congress and the White House means no roll-back of the President’s first-term executive orders; it also means no new taxes. Stocks and risk assets could blast off higher in this scenario than in any other.
Finally, the “Blue Wave” scenario. The knee-jerk reaction to an across-the-board Democratic victory would be a big sell-off in long-dated Treasuries as a big relief bill is all but guaranteed. Additionally, this takes pressure off the Fed, which might be seen as a reduction in policy accommodation. While we don’t think that stocks will plummet on election night with this result, they will start taking into account higher taxes and greater regulation as a President Biden would immediately begin rescinding President Trump’s executive orders rolling back environmental and business regulations. We could also expect a return of legislation to regulate the financial sector and the reemergence of departments like the Consumer Finance Protection Bureau (CFPB).
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John Tuohy is CEO of SWBC Investment Services, LLC, a Broker/Dealer and SWBC Investment Company, an SEC Registered Investment Advisor (RIA). In his role, John is responsible for identifying, developing, and executing the division's strategic plan and all business development, sales, and marketing activities.