Given the radical positions and policies enacted by the Trump administration since 2016 on issues including tax, healthcare, trade and international relations, the US election of 3 November 2020 has real potential to further engrain this shift or to radically reverse it. The ramifications for the economy, markets and the international world order could be enormous.
Biden leads, but Trump is unpredictable
Democratic party candidate Joe Biden has a significant lead in the opinion polls, at 49% relative to 43% for Donald Trump - see the chart below. Even more important are the regional polls in the ‘Swing States’. This is the group of a dozen or so States which will effectively determine the outcome of the election, as the remainder already heavily lean Democrat or Republican. Of these 12 Swing States, ten voted for Trump in 2016, with an average winning margin of 3.8 percentage points. According to the latest polls, this time Joe Biden leads in nine of these Swing States, with an average poll lead of 4.6 percentage points.
The table below shows the top dozen ‘Swing States’, listed according to their number of electoral college votes and showing the outcome of the 2016 election and the current state of the polls. A candidate needs 270 electoral college votes to become President. Counting those states highly likely to vote Democrat or Republican takes Biden to 213 votes versus Trump at 126. If Biden were to win in those swing states where the current opinion poll gap is greater than 5%, this would take the number of electoral college votes to 250. Winning just Michigan and Pennsylvania, where Biden is ahead by 4-5%, would then be enough for Biden to claim the Presidency.
The polls appear convincing but note all these barometers have shifted significantly over the past year and the experience of 2016 suggests nothing should be taken for granted - even the outcome could be contested - see the chart on page 5. In the current volatile political climate, plenty can change ahead of and even after 3 November 2020.
There’s a lot at stake
From a market perspective, there are five key areas of difference in the policies proposed by the two candidates:
While Trump intends to preserve the lower corporate tax regime introduced since 2016, Biden has pledged to increase the corporate tax rate from 21% to 28%. He also pledged to introduce a minimum tax rate for large firms of 15% of reported earnings and target corporate tax avoidance by doubling the global intangible low tax income rate (GILTI). Personal tax rates on higher income earners would also be raised under Biden’s plans.
Trade tensions with China will not end under a Biden Presidency but it is likely that his administration would employ a less combative strategy. While Trump would continue to push for increased tariffs as part of his trade strategy, Biden will likely try to rebuild some of the relationships with multi-lateral agencies such as the WTO and use those to address disputes such as the ongoing one with China.
Both candidates are making infrastructure spending a key plank of their campaign pledges. In Biden’s case, he has promised a $2trn accelerated investment programme that includes investment in public transport and public housing as well as retrofit programmes for the existing housing stock. Trump has recently set out plans for a $1trn programme of investment in roads, bridges and broadband infrastructure.
A highly divisive policy topic once again. Trump will continue to deconstruct the polices implemented by Obamacare. Biden, on the other hand, would push for wider availability of public health care and introduce a system that would have the potential to cap drugs prices.
This is a policy area that the two candidates are probably most apart on. Biden has made tackling climate change a centrepiece of his campaign, pledging a massive green jobs programme and greatly increasing alternative energy adoption. He plans to rejoin the Paris Climate Change Agreement, while Trump plans to follow-through on his commitment to pull out of the Agreement at the earliest opportunity, just after the election.
Congress will determine the President’s power to implement policy
The Presidential outcome will set the tone for policy particularly in international relations, but whether the President can truly wield power and execute their domestic manifesto will depend critically on the balance of power in Congress. Trump has stretched Presidential powers to the limit over the past four years, but the majority of policies still also require the support of the House of Representatives and the Senate in particular.
Republicans are currently in control of the 100-seat Senate with 53 seats. There are 35 seats up for grabs, 23 of which are currently in Republican control. Four states are seen as a toss-up for November’s election. If Biden wins the election, the Democrats need to gain three Senate seats to take control, with the casting vote being given to the incumbent Vice-President. It really is too close to call this particular race, but its outcome will have important implications for the shape of policy over the coming four years.
Implications for financial markets
The high degree of electoral uncertainty and the scale of potential policy divergence on the outcome suggests investors should be in a relatively defensive mode into November and possibly December. Longer-term, fiscal policy is likely to have the most impact, with a clean sweep victory for either party across the President, House and Senate, likely to exacerbate the potential market reaction.
Both candidates have proposals that will deliver extra fiscal stimulus and larger deficits, so no matter who wins the bond market is facing higher issuance. But the Biden plan does entail larger deficits, so a victory for him would be slightly more negative for bond markets. However, given the Fed’s commitment to unlimited QE the short- and even medium-term impact for bonds could be quite small.
For equity markets President Trump’s fiscal plans carry less risk, taxation as you are and the chance of higher spending. The Biden plan would include yet more spending and thus be more growth friendly, good for equities, but has the offsetting sting of higher taxation for corporates and individuals. Full implementation of the Biden corporate tax proposals would reduce S&P 500 earnings by 6%. This is arguably the factor determining that a Biden/Democrat victory could be less bullish for stocks than a Trump/Republican victory, but the overall fiscal bias is still likely to be supportive.
Even with a divided or Republican Congress, we are still likely to see increased spending. Employment levels are unlikely to have fully recovered by the end of the year and thus there should be a more receptive environment for spending proposals. This should help some of the cyclical industries and could more than offset some of the negative tax implications.
The potential increase in personal taxation under Biden is viewed as relatively benign, based on the lower propensity to consume of the higher earners, but this still could be of concern for Consumer stocks, if it came to pass.
Businesses would prefer an easing in trade tensions
A Biden victory would most likely lead to some improvement in international relations. One should not expect much improvement in US China tensions - that particular genie is out of the bottle - but a change in negotiating tactics under Biden may give the perception of calmer relations. A more important development could be the US re-engaging with international bodies with some ammunition to make them more effective and more balanced. It would be a positive development for the EU as both blocs have many common aims. A Trump victory would continue the process towards unilateralism which would favour the US but leave open the potential for rolling confrontation. Business always does better in times of peace. A reduction in international tensions would thus be good for the valuation of all assets in our view. Similarly, a Biden win would likely favour international stocks post-election, while a Trump victory may favour the US.
Regulation a secondary issue
The common perception is that a Biden victory means more interference through increased regulations while a Trump victory leads to further loosening via executive orders. This is probably a fair assumption but the implications of it may be overstated. Trump’s arrival in 2017 heralded a roll back in regulation which would benefit Financials, Energy and small and mid-caps in particular. Looking at the performance of these groups since the Trump election shows that there are bigger issues that will drive their performance. One should expect the same again. Healthcare regulation, especially on pricing has been widely discussed as a potential issue, but there does not seem to be the political will to do anything major about this. With COVID-19 in the background the will may be even less. History does show the Pharma sector underperforming going into the elections and then out-performing after the election, regardless of the outcome.
What’s the best and worst market outcome?
For financial markets overall, a Biden Presidency and a split Congress is probably the best outcome. A split Congress means it will be difficult to get any substantive changes in policy, in particular tax increases. The Republicans will be very sensitive to taxing corporates and the higher earners. Meanwhile international tensions should ease and we should have a more consistent policy message which should reduce policy uncertainty and allow valuations to rise.
The least favoured outcome would be a return of President Trump and a split Congress. That would mean a watered-down fiscal package and continued policy uncertainty.
For the US dollar, Fed policy and actions by central banks elsewhere in the world are probably bigger issues but a Democratic sweep would leave it more vulnerable as we get looser fiscal policy combined with the Fed continuing to pump liquidity into the system until inflation starts moving upwards.
The risks of an inconclusive result
Tight election results are a common occurrence in the United States, but the risks of such an outcome have been heightened by the very real risk that one of the candidates refuses to accept the result. Such a situation may come about by Trump questioning the legitimacy of postal votes for instance given his frequent utterings on this topic. The number of postal votes is likely to be higher this time out due to the impact of fears among the general public about the health risks involved in physically attending a polling station.
Currently, candidates can request recounts in 43 states if the result lies within a certain margin. As such, it could potentially take several weeks for a result to be known. A key date to look for is 8 December, known as ‘safe harbour’, which is the deadline for when states must resolve any controversies related to the appointment of their electors to the Electoral College.
We have some precedent for such uncertainty in the 2000 election battle between George W. Bush and Al Gore in the state of Florida. Bush was adjudged to have won the state by just 537 votes, but this was challenged by the Gore side. 36 days after the election, the Supreme Court ruled that the original Florida result would stand, handing the keys of the White House to George Bush.
What happened in markets in those five weeks? Volatility increased immediately, with the VIX index rising by 20% to a peak of 30. The NASDAQ by 25% over the period of uncertainty, although this coincided with the long bear market in technology stocks. The S&P also fell over the period. While Gore accepted the Supreme Court decision, it is very possible that it could be different if a similar situation were to evolve in this election, especially in the context of the death of Supreme Court Justice Ginsburg and the current battle to replace her. A prolonged period of uncertainty about who the next President may be could result.
Report authors Chief Economist Dermot O’Leary, Global Strategic Advisor Joe Prendergast and Chief Investment Officer Bernard Swords will host a 30 minute webinar including Q&A on Tuesday, 6 October at 9.30am to share the key takeaways from the report as well as latest views following the first presidential debate.
Register for this event here: https://goodbody.zoom.us/webinar/register/WN_N9Tcz6qgT1-RB159ZaqCiA