US Elections: framing the market debate

WHAT YOU NEED TO KNOW    

• While market participants tend to focus on whether the next US president is going to be Trump or Biden, we think the key debate is whether the elections will deliver a divided or a single-party, unified government. The former tends to bring about extended legislative gridlocks. The latter raises the possibility of significant policy change.
• A unified Trump government would seek to boost US growth via tax cuts and, depending on the extent of its majority, perhaps further deregulate the financial and energy sectors. The US dollar could hold its value or strengthen eventually. The yield curve is likely to steepen in relative terms, providing some support to banks. But, with monetary policy capping interest rates, any rise is bond yields is likely to be quite small.
• A unified Biden government would boost spending. Infrastructure and managed healthcare should benefit. However, corporate taxes would increase – a direct hit to corporate earnings. As with a unified Trump government, Fed action is likely to moderate any rate rise, so any curve steepening (and any benefit for the banks) is likely to be limited. Reform and regulation may negatively affect pharmaceuticals, the tech sector and financials.
• Polls put Biden ahead of Trump, with a possibility of the Democrats retaking the Senate – albeit with a slim majority. Cooperation among moderates is likely to be required. And, while corporate tax hikes are a negative from an earnings perspective, there are also positives from demand-boosting fiscal policies. China scepticism is a rare non-bipartisan issue.                

All 435 seats in the House of Representatives, 34 of the 100 seats in the Senate and the White House will be contested. Political cycles generate plenty of headlines everywhere. But the important issue for investors is whether there’s a divided or unified government, as this determines the likely extent of legislative gridlock versus significant policy change.

While the policy platforms aren’t fully specified, these are the four possible outcomes, which we think will have different implications for the economy and financial markets:

1. Divided Red (R President, R Senate, D House): This is the status-quo scenario, which could happen if the economy rebounds from the pandemic more quickly than expected, boosting President Trump’s re-election chances. We would only see moderate near-term policy changes, perhaps including an extension of expiring tax cuts if the economy was to underperform. Fiscal policy would probably stay expansionary in a reactive fashion, US interest rates would remain range- bound and the dollar should continue to weaken gradually.
2. Divided Blue (D President, R Senate, D House): With most voters believing that Biden would be more effective at managing the ongoing crisis, based on current opinions on the response to Covid-19, the Democrats take the White House Voter demand for change results in increased regulation and oversight, but not to a large extent. At the margin, this may pressure financial, energy, internet and pharmaceutical companies. US rates are unlikely to swing significantly and the dollar could depreciate modestly.
3. Unified Red (R President, Senate and House): A V-shaped recovery leads Trump to a second term and the Republicans take back the House. Trade tensions with China rise further. Tax cuts become a cornerstone of federal policy once again. US GDP growth accelerates, the dollar may take some time to adjust but eventually strengthens and, given the growing deficit, bond yields rise – but only slightly, as the Fed manages to keep them at historically low levels. Sector-wise, financials and energy benefit from continued deregulation.
4. Unified Blue (D President, Senate and House): Given high unemployment, voters turn to Biden and the Democrats. Spending rises and benefits infrastructure projects. Corporate taxes rise too, impacting earnings. Deficit-spending boosts economic growth and leads to an increase in bond yields – a positive for banks – but only to a slight extent, as monetary policy keeps them low. Healthcare reform is a positive for managed care organisations, but puts pressure on pharmaceuticals. Increased regulation impacts the tech sector and financials.

WHAT DO THE POLLS SAY?

Trump’s victory in 2016 came after 20 consecutive quarters of falling unemployment. Before the virus outbreak, he appeared to have a good chance of winning a second term, thanks to a rapidly growing economy. But with unemployment rife and the virus outbreak spreading again, the situation is different this time. While the evidence is far from conclusive and there are a few exceptions since 1900, no incumbent president has ever managed to win in a recession or bear-market year over the past seven decades or so.

Before Covid-19, The Economist’s election model made Trump a narrow favourite. But it now has Biden ahead. The Financial Times makes a similar prediction. Biden is now leading in the polls, seems to be doing well in battleground states like Florida, Michigan and Wisconsin, and stands a chance in Republican states such as Arizona, Georgia and Texas. He has strong support among older voters and is performing better than expected among white voters who did not go to college.

Apart from the path and pace of the virus, there are several events over the summer that could have an impact on voter intentions and swing things one way or the other.

The most important ones are Biden’s choice of running mate, which could come before the end of the month or in early August, the Democratic Convention on 17-20 August and the Republican Convention on 24-27 August.

All re-election bids are to a large extent referendums on the incumbent – this one is no exception. History reminds us that predictions are often unreliable. There is a long time to go until November and the past decade, if anything, has shown that unlikely events happen more frequently than one would have thought a priori. If the virus recedes and the economy rebounds, then Trump’s chances may improve. If it’s still rampant and states have not organised themselves for voting by mail, a low turnout could deliver a surprising result.

Importantly, in order to put in place lasting change through the federal government, the Democrats would need a majority in the Senate as well as the presidency and control of the House of Representatives. That requires them to win three or more of the 23 Republican-held Senate seats being contested. A few months ago that looked like a long shot. Today’s polls make it look more plausible. That opens up the chances of a more productive presidency. But the odds aren’t that much better than fifty-fifty.

COVID-19 WATCH

Globally confirmed cases of Covid-19 now exceed 14.3 million, up from approximately 12.7 million seven days previously.

With cases in the US surpassing 3.7 million and deaths, unfortunately, climbing beyond 140,000, we take a deeper look into the US hospitalisation data to identify the states most likely to trigger further significant economically damaging lockdowns.

Using data compiled by Goldman Sachs, and derived from a number of public sources, we analyse two measures. First, we consider each state’s ability to control the spread of Covid-19. Rather than use the effective reproduction number (R number), we take into account imperfect testing and therefore utilise the percentage of positive results. Across the US, the proportion of Covid- 19 tests yielding a positive result is 8.8%, up 0.8 percentage points from two weeks prior. We reason that states with a high percentage of positive results may be testing too few individuals and are therefore failing to adequately track, monitor and contain Covid-19. This could lead to more infections and increase public and political pressure to (re)implement lockdowns.

Second, we consider each state’s healthcare resources to respond to known cases of Covid-19, which we proxy with the available capacity in hospitals’ intensive care units (ICU). Across the US, available capacity averages 35%. We suggest that in states where available healthcare resources are limited, standards of care may drop, leading to an increase in public and political pressure to (re)implement lockdowns.

To identify at-risk states, we compare these two measures with a bubble chart, with the size of each bubble representing each state’s contribution to US GDP, using the official figures from the US Department of Commerce.

States in the bottom-right quadrant are in the unenviable position of having lower than US average capacity available in their ICUs and also are witnessing a higher than US average positive test rate.