As the US presidential election looms, we explore potential scenarios – from a Democratic “blue sweep” to a Trump re-election to a divided government – and assess the implications for investors.

2020 has thrown even more curveballs than usual

Elections are by their very nature unpredictable – just ask Hillary Clinton or Al Gore. But 2020 has thrown even more curveballs than usual. Uncertainty surrounds the future course of the COVID-19 pandemic and its impact on the economy. Meanwhile, President Donald Trump has cast doubt on the validity of the vote before it even takes place.

Figure 1: The electoral process timeline
The electoral process timeline
Source: ‘How Will Markets React to the 2020 U.S. Election?’, J.P. Morgan, October 7, 2020

Trump’s opponent, former Vice President Joe Biden, has a comfortable lead in both national and state polls. FiveThirtyEight, an organization that specialises in opinion poll analysis, estimated Biden had an 87 per cent chance of winning the presidency as of October 23.

The ability of each candidate to enact his agenda rests in large measure on which party controls the Senate

With the election just around the corner, we set out the potential scenarios and their investment implications. While we don’t seek to make predictions, we do believe it is wise to gauge how portfolios might be positioned to take advantage of the opportunities each situation presents.

These scenarios focus on the presidential contest but also pay attention to the US Senate. The ability of each candidate to enact his agenda rests in large measure on which party controls the Senate, assuming the US House of Representatives stays in Democratic hands. FiveThirtyEight polling analysis suggests there is only a four per cent chance that the Republicans will take control of the House.

Scenario 1

“Blue sweep”: Biden wins the presidency; Democrats take the Senate

We would expect markets to respond positively on the prospects of an economic rebound in 2021

Markets crave certainty. A decisive victory for Biden would quell investor worries – at least in the short term. In this scenario, we would expect markets to respond positively on the prospects of an economic rebound in 2021, since a generous fiscal stimulus package would be more likely. Over the longer term, however, the impact of tighter regulation under a Democratic administration may act as a headwind.

Equities

  • Regulation: Deregulation has been a hallmark of the Trump administration. Biden would likely reinstate many of those regulations; for example, we expect Biden to introduce clean fuel and net emissions standards and to repeal tax incentives for traditional energy projects. These measures would boost renewable energy stocks and potentially harm fossil fuel companies. Financial companies, too, could see new oversight.
  • Climate change: Biden has vowed to quickly rejoin the Paris Agreement on climate change, from which Trump withdrew the US in 2017. This would prompt stricter emissions standards. A “blue wave” would also allow Biden to enact legislation to expand green energy infrastructure.
  • Technology: Social media firms would continue to face scrutiny under Biden. Democrats have argued the protections offered to technology companies under Section 230 of the Communications Decency Act should be curbed in order to make them more accountable for disinformation and illegal content on their platforms. Tech, like other industries, would face risks from Biden’s proposals to raise the corporate income tax rate from 21 per cent to 28 per cent, as well as his proposal to increase taxes on offshore income.
  • Healthcare: Democrats want to expand healthcare coverage to more Americans, potentially giving the stocks of some healthcare providers a boost, though pharmaceutical companies might come under pressure as a Democratic administration is likely to seek to negotiate lower drug prices.

Fixed income

  • Interest rates: Jerome Powell will remain Federal Reserve chair until at least 2022, when the next president will be able to re-appoint him for another four-year term or appoint a new chair. The dovish Fed framework announced in September makes it likely that interest rates will remain low through 2025. Coupled with a large fiscal boost expected under a Biden administration, this could ultimately lead to higher inflation and steeper yield curves.
  • Deficit spending: Biden will inherit the largest budget deficit in decades: it exceeds 17 per cent of GDP. Formerly a deficit hawk, Biden looks poised to increase the deficit with economic relief programmes to deal with COVID-19. This could create some upward pressure on government bond yields.
Figure 2: Federal debt is on the rise
Federal debt is on the rise
Source: ‘The Budget and Economic Outlook: 2020 to 2030’, Congressional Budget Office, January 2020

Scenario 2

Divided government: Biden wins; Republicans hold the Senate

Fearing a Trump defeat, more and more Republican candidates are touting themselves as a check on a Biden presidency in their pitch to voters. A Republican Senate would try to block Biden’s most sweeping policy priorities, such as an aggressive economic stimulus package, Medicaid expansion and higher corporate taxes.

In this scenario, Biden might have to expend significant political capital to nudge even modest proposals over the finish line

In this scenario, Biden might have to expend significant political capital to nudge even modest proposals over the finish line. If a COVID-19 relief package is not reached before the election, a Republican-held Senate is unlikely to pass a generous version in 2021, potentially spelling trouble for companies counting on increased consumer spending to get back on more solid economic footing. On the other hand, a divided government could have the opposite effect: perhaps it would push both parties to the negotiating table to iron out key pieces of legislation.

Equities

  • Healthcare: After more than ten years and hundreds of legal challenges, Obamacare continues to enjoy support among voters. Despite initial opposition, some Republicans endorse the programme’s most-popular provisions, such as protections for people with preexisting conditions and the stipulation that young adults can stay on their parents’ health insurance plans until age 26. With Obamacare looking solid, we anticipate healthcare stocks will benefit.
  • Financial services: With Republicans in charge of the upper chamber, financial services companies would probably escape additional oversight. One exception is the Security and Exchange Commission’s (SEC) Regulation Best Interest (Reg BI). Reg BI went into effect in June 2019, but critics say it doesn’t go far enough in eliminating brokers’ conflicts of interest. A Biden-appointed SEC commissioner might replace Reg BI with a stricter fiduciary rule.
  • Technology: Both Democrats and Republicans believe Big Tech has monopoly power. Yet they disagree about how to regulate those firms, and that could prevent the introduction of any meaningful tech regulation.

Fixed income

  • Boost to corporates: Continued economic pressure could force the Fed to ramp up its Treasury buying programme to keep credit markets running smoothly. Downward pressure on Treasury yields makes high-yield corporate bonds and mortgage bonds more attractive and we would expect fixed-income investors to turn their attention to these assets.
  • High yield: Record high-yield issuance would likely continue as issuers take advantage of record-low interest rates. But spreads won’t tighten until the economic effects of COVID-19 are successfully dealt with. This is less likely under a divided government.
Figure 3: US High Yield monthly bond issuance 2019-2020
US High Yield monthly bond issuance 2019-2020
Source: SIFMA, September 2020

Scenario 3

More of the same: Trump wins; Senate stays Republican

Trump’s major domestic priorities in a second term are unclear; the Republican Party did not unveil a new policy platform at its convention in August. In any case, markets may not be looking for ambitious legislation from the Republicans: the priority is economic relief from the impact of COVID-19.

If Trump wins re-election, he is likely to continue to impose tariffs on Chinese imports

In this scenario we don’t anticipate a sweeping stimulus plan because there aren’t enough Republican votes to push it over the finish line. On the other hand, Trump and a Republican Senate would likely seek to make permanent the temporary tax cuts introduced in the Tax Cuts and Jobs Act of 2017. Many of the provisions that lowered taxes on middle-income earners are set to expire in 2025.

If Trump wins re-election, he is likely to continue to impose tariffs on Chinese imports, especially given the deterioration of the US-China relationship over the last few months. While it is difficult to predict just how big the next round of tariffs would be, it is not unreasonable to assume it would be roughly the same size as the $70 billion in tariffs currently in place.

Figure 4: US/China trade deficit
US/China trade deficit
Source: ‘Trade in Goods with China’, U.S. Census Bureau, 2020

Equities

  • Industrials: Manufacturers were already scrambling to diversify their supply chains outside China after Trump’s initial tariffs. New tariffs would disrupt global supply chains further. While retail companies were able to pass along higher costs to their customers, industrial manufacturers have and will continue to struggle with pressure on margins and to absorb the costs of tariffs. Agricultural products like wheat and soy could also see a collapse in demand.
  • Fossil fuels: Trump would likely loosen environmental protections further in a second term. But it is unclear if the benefits to oil and gas producers would be sufficient to offset the global slump in demand due to COVID-19.
  • Banks: Under a second Trump term, it is unlikely that banks would face any new regulation. Yet banks and other financials rely on a healthy economy to drive loan growth and earnings. The drag on the economy from the pandemic will persist until a vaccine emerges.

Fixed income

  • Interest rates: Trump is adamant about keeping interest rates low for the foreseeable future. And while he may be able to get some tax cuts through Congress, the size of those tax cuts may limit upward pressure on yields.
  • High yield: Until COVID-19 is under control, the economy will continue to stutter, which could harm high-yield credit, the most economically sensitive corner of fixed income. In particular, we are watching acute care hospitals, which might experience disruption.

Scenario 4

Another form of gridlock: Trump wins; Senate turns Democratic

Even if the Democrats take the Senate, it is unlikely the party will secure a veto-proof majority and any ambitious Congressional legislation would be unlikely to receive a presidential sign-off. A Democratic Congress may focus instead on fresh impeachment proceedings.

Foreign policy is one area where presidents have significant leeway and don’t need legislative approval

Foreign policy is one area where presidents have significant leeway and don’t need legislative approval. As in our third scenario, Trump may seek to flex his muscle on the international front through additional tariffs on China and new sanctions on Iran.

Equities

  • Carmakers: When Trump reversed Obama-era emissions standards on cars and light trucks, few automobile companies took advantage of the new rules, fearing that a Democratic administration would undo those changes. Under a second Trump term, automobile makers may be interested in loosening environmental controls. On the other hand, additional Trump tariffs could harm this group of companies since many of their inputs come from China.
  • Pharmaceuticals: Despite the headlines, we believe Obamacare will remain in place in more or less its current form under most election scenarios. But don’t expect a second Trump administration to negotiate lower drug prices.
  • Infrastructure: One area where Trump might find a warm reception from a Democratic Senate is infrastructure. Though the former real estate developer has touted infrastructure spending throughout his administration, no infrastructure plan has emerged. Democrats are keen to improve roads, bridges and transportation and could find rare common ground with Trump on this issue. We would look to building materials, utilities, transportation and 5G technology as beneficiaries in such a scenario.

Fixed income

  • Monetary support: Trump has made clear he wants an accommodative Fed that will keep interest rates low and provide credit markets with ample liquidity no matter the economic headwinds. For now, the Fed seems to hold the same view and we expect that to continue.
  • High yield: Continued pressure on yields would compel some fixed-income investors to stretch for yield. However, without a robust fiscal stimulus package, which seems unlikely in the event of a divided government, consumer spending would probably fall, hurting issuers in economically sensitive industries.

Scenario 5

50/50 split in the Senate

While not a likely outcome, an evenly split Senate would give both parties leverage, increasing the potential for gridlock. Whoever wins the presidency would have a tough time enacting his full agenda.

We would expect far less sweeping spending, regulation or tax cuts, which would help to rein in the federal deficit

Senate rules say the party holding the presidency in this scenario also controls the upper chamber, with the Vice President casting the deciding vote in the event of tie. If Trump wins, the Senate would stay Republican; a Biden victory would turn the Senate Democratic.

Should this happen, we would expect far less sweeping spending, regulation or tax cuts, which would help to rein in the federal deficit. By the same token, it’s unlikely that large scale COVID-19 relief legislation will pass either, potentially stalling the economic recovery. Interest rates and inflation should remain steady.

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