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While investors have spent much of this year grappling with all of the unique challenges represented by the global pandemic, coming into the year, the 2020 U.S. elections were expected to be the greatest source of potential disruption. Economic data had slowed modestly into the end of 2019, but the Phase One trade deal with China was expected to kick start the manufacturing recovery through the first half of 2020, putting President Donald Trump in a position to move into election season with a positive economic backdrop and well supported by a Republican Senate.
Covid-19 created a different path to the elections, and the push and pull of fiscal stimulus negotiations between the White House, Speaker of the House Nancy Pelosi, and Senate Majority Leader Mitch McConnell culminated in the failure of the U.S. government to deliver another stimulus package before November 4th, following the expiration of many of the CARES Act provisions at the end of July. Unemployment remains above its pre-pandemic levels, and the recovery has slowed modestly into early November. Voters heeded the call to vote early, and many voted by mail-in ballot, a change which has proven difficult for pollsters and prognosticators alike over the last several days.
With all that said, and with the increasingly polarized political landscape in the United States, it is not surprising that we sit two days out from Election Day without a clear decision. The prevailing view coming into Tuesday was that there was a strong likelihood of a blue wave, with the Democrats in control of the White House and both branches of Congress. Talk of a massive fiscal stimulus package, support for alternative energy, further regulation of technology and oil & gas companies, and higher taxes for individuals dominated the narrative. Health care stocks came under pressure in anticipation of changes to the Affordable Care Act. Industrials and materials companies gained steam on expectations of stronger economic growth and meaningful infrastructure spend; financials rose as a steeper yield curve would support earnings for these companies.
Now, it would appear that it will prove challenging for the Democrats to take the Senate, although not impossible based on the races that are still outstanding. In order to take control of the Senate, the Democrats need to take 4 seats - or 3, if former Vice President Joe Biden picks up the White House, as his Vice President Kamala Harris would act as the tie-breaking vote in the chamber. However, going into the election, the Senate seats in Maine and Iowa appeared vulnerable, and neither of those seats flipped. Right now, all eyes are focused on the races in Arizona and Georgia, which offer the Democrats their last shot to gain ground.
It is this shift in the Democrats' Senate hopes that turned the path of the markets in yesterday's trading, not necessarily the improvement in Biden's vote counts. As mentioned in our comments leading up to the election, equity markets have historically enjoyed positive gains during periods of legislative inaction, and with Biden in the White House, McConnell in the Senate, and Pelosi in the House, the first two years of a Biden term would look a lot different than what was expected in the blue wave scenario outlined above. A much smaller Covid-19 stimulus package would likely come with compromises, and would not create the same level of yield curve steepening as an unfettered Democratic bill would have. Infrastructure is likely still on the table, but will be focused primarily on traditional forms of infrastructure, like roads, bridges, ports, and airports, rather than on projects designed to lessen the carbon footprint. The tax increases on individuals as proposed during the Biden campaign are not likely to be enacted in the same form, if at all, and any attempt to raise the corporate tax rate will be met with sharp Senate opposition. De-regulation may not occur at the same clip as during the Trump Administration, but regulation in general is not likely to dominate the narrative in the first two years at least. There will be little to no appetite to meaningfully expand the Affordable Care Act, which keeps health care in a holding pattern; the change in the Supreme Court could even yield a decision that deems the ACA unconstitutional.
What it also does is shift the focus away from fiscal stimulus as panacea back to the need for greater flexibility from the Fed. Fed Chairman Jerome Powell along with several other governors have been very vocal about the need for Congress to act in order to insulate against significant economic disruption that could result from localized social distancing mandates resulting from the second major wave of U.S. Covid-19 cases. This has major implications for the bond market, and in turn for retirees, savers, and those living off the income generated from their portfolios, as it implies that real yields from fixed income and cash will remain pressured for the foreseeable future.
The takeaway today is that a Biden White House and split Congress, along with a Fed that needs to be as accommodative as possible in the near term, creates a tailwind for stocks, and specifically the sectors that have outperformed in the low rate, low growth environment which dominated that last several years - namely, technology and communication services. Health care, too, could face some pressure from drug price controls, but the rest of the sector represents an opportunity. A rotation to cyclicals could still come next year, as economic growth accelerates, but any meaningful move in sector leadership is probably on hold in the near term. Success in curbing the spread of Covid-19 through a combination of economically thoughtful prevention policy, therapeutics, and a vaccine for high-risk candidates could bring new flows into equities from bonds and cash, which could start the cycle of strength for cyclicals, but again, that is more likely a 2021 story.
The caveat is that all of this is conjecture, and the path to 270 for either candidate is not yet assured. Nor is the Senate decided, with four outstanding seats waiting to be declared. After the elections are finally behind us, though, it is important to remember that the U.S. economy still faces meaningful challenges, many of them related to Covid-19, and these issues will require coordination effort across the Federal, state, and local governments, as well as the firm and steady hand of the Fed to navigate the American economy through these extraordinary times.
As your trusted advisor, our priority is helping our clients to navigate these difficult times. We understand that your attention is likely on the health and safety of your family, friends, and community, and as such, it is a critical time for us to remain diligent and disciplined in the care of your wealth. Please reach out to your SVB Private representative with any questions or concerns you may have.
