D.A. Davidson’s View on Elections and the Markets
The 2020 U.S. general election season is now in the home stretch, and we expect elevated volatility over the next few months. The challenges created by the COVID-19 pandemic have led to stark differences between 2020 and previous election cycles. Both the Democratic and Republican national conventions were held digitally, many traditional campaign events were cancelled, media interviews are mostly conducted remotely, and the upcoming debates are expected to follow strict social distancing guidelines. In addition, the number of mail-in voters nationally will increase dramatically, potentially creating litigation and expected challenges to deliver timely results. However, similar to 2016, in 2020 both the presidential and congressional races remain highly uncertain and carry implications for investors. Although there are large policy differences between the candidates, it is uncertain exactly how this will impact the economy and financial markets, especially given the likelihood that no matter the election results, both fiscal stimulus to support the post-COVID economic recovery, and accommodative monetary policy from the Federal Reserve Bank will continue. Both political parties will need to address post-recession economic growth and employment, ongoing COVID-19 risks, and high Federal debt levels. Major legislative changes will require support from the executive and legislative branches so investor sentiment will consider both the presidential and congressional races.
Change in the balance of political power has not been a significant determinant of long-term equity returns, in our view, as companies and businesses are adept at optimizing results in reaction to policy changes. Thus, we don’t believe investors should make significant portfolio changes due to election probabilities or the election outcome. However, there could be market reaction due to potential tax changes or perceived winners and losers on a business sector basis. We have summarized some of our thoughts below.
What do the polls say? As of early September, Democratic presidential candidate Joe Biden holds sizable leads in polling and betting markets, placing him as the favorite to become the 46th President of the United States. Polling on which party will control Congress, especially the Senate, is much closer, however. According to Real Clear Politics, Mr. Biden holds a lead of 7.5 points over President Trump, a lead that has held within a couple of points throughout the summer. In addition, polling aggregator FiveThirtyEight views the odds of a Joe Biden victory at 75%. Betting odds compiled by FiveThirtyEight also show Mr. Biden up 53% vs. 46% as of 9/9/20, but as recently as 8/31/20 it was a dead heat. Most believe that Democrats will hold their House of Representatives majority, with the current composition of 232 Democrats vs. 198 Republicans – with 218 required for a majority Republicans, they need to flip 20 seats. The race for control of the Senate is expected to be close. Republicans currently hold a 53 vs. 47 seat majority, and there are 35 seats (23 Republican held and 12 Democrat held) contested in this election. Real Clear Politics’ compilation of national polls shows an estimated 46 seats for each party as secure, with eight toss-up seats, suggesting that the outcome is uncertain and too close to call. We remember that the polls got it wrong in 2016, as candidate Trump was trailing in the polls, and Democrat control of the Senate was thought to be secure, only to see Donald Trump win the Electoral College and the Republicans sweep the House and Senate. Beyond the polls, recessions during election years have led to defeats for the incumbent political parties in 2008, 1980, 1960, and 1948 (not good news for the Republicans in 2020). The S&P 500 index performance over three months prior to the election (August, September, and October) has also been a reliable indicator of incumbent party success. According to Strategas, in 20 of 23 (87%) elections, the incumbent party has won when market performance is positive over that period, and lost when performance is negative. Time will tell, but from the beginning of August through 9/10/20, the S&P 500 gained 2.1%.
What does the market expect? We believe that equity markets are expecting a Biden presidential victory, with a split Congress comprised of Republicans keeping the Senate and Democrats keeping the House. But this is a tenuous expectation in our view, as markets have not ruled out the potential outcomes of either a Trump victory, and/or Democrat takeover of the Senate. The only result widely expected in our view is Democrats retain the House. The range of expected outcomes could cause elevated volatility in stock prices, which has been the case in early September. The CBOE Market Volatility Index (VIX) has moved above 30 after trading in the low 20s throughout July and August, and the S&P 500 index made daily moves of at least 0.8% in all seven trading days in September, compared to only four such days in all of August. We assess three potential outcomes for the November election: 1) Biden wins with Democrat sweep of Congress, 2) Biden win with split Congress, and 3) Trump win with Democrats keeping the House. Major policy changes are more likely in outcomes where one party controls the Presidency, the House and Senate, which would be the case in outcome #1 above. Due to a polarizing political environment that is expected to continue, major legislation is unlikely to pass in a bipartisan fashion (outcomes #2 and #3). In addition, given the COVID-19 recession and ongoing recovery, some policy changes, either through legislation or executive order, will meet popular resistance if deemed to restrict growth.
- Joe Biden President, Democrats sweep Congress. This outcome creates the most implications for investors as a Democrat sweep increases the likelihood of policy changes and legislation. The Biden platform includes investment in alternative energy and infrastructure, expansion of the Affordable Care Act (ACA), a Federal minimum wage increase, increased regulation for fossil fuels and banks, and higher taxes for corporations and high income earners. Legislation could be positive for green energy companies, engineering and construction, and equipment manufacturers. The expansion of a public healthcare option is mixed for healthcare providers insurers, as the number of participants would rise but reimbursement rates could fall (note: Biden has not supported a single- payer system). Congress would address drug price legislation, but could also fund drug research. A minimum wage increase to $15 could hurt restaurant and hospitality companies at a time when business remains compromised, and increased regulation could lead to underperformance of value sectors including Energy and Financials. The Biden platform also promises to raise the U.S. corporate tax rate to 28% from 21%, set a minimum tax for large companies, and raise individual taxes (higher top tax bracket and higher capital gains, dividend, and social security taxes) on high income earners. Offsetting this would be a proposal to removethe $10,000 State and Local Tax deduction limit, a benefit to high income earners in high tax states. In our view tax increases, even on high earners, could face opposition in a post-recession environment, as lower tax is the normal post-recession playbook. An increase in corporate taxes will hurt earnings growth in year one and could pressure valuation multiples. Fears of a higher capital gains rate could lead high earners to sell appreciated stocks this year (post-election) to lock in a lower tax rate, creating market pressure. And the prospect of higher tax rates on dividends in 2021 and beyond could lead to an increase in companies paying special dividends in 2020.
- Joe Biden President, split Congress. Divided government makes sweeping policy changes less likely and a Republican-controlled Senate would limit the passing of Biden-supported legislation. This could lead to a wide range of executive orders addressing new regulations on manufacturers, energy companies, and financial institutions. In addition, executive orders could be used to drive immigration policy and workers’ rights. Congress would focus on bipartisan issues including additional COVID-19 relief, and incentives for more manufacturing and blue collar jobs. There might also be support for technology industry privacy and anti-trust regulation, although that is likely a longer-term concern, and Mr. Biden is generally friendly with the technology industry. We would expect bipartisan efforts to pass an infrastructure bill, drug price reform, and plans to provide expanded health coverage for uninsured individuals. Trade relations would likely improve, especially with the European Union, but it is uncertain how Mr. Biden would treat existing tariffs on China goods. In general this would be positive for U.S. exporters and multinational corporations (industrials, consumer goods, manufacturers). We believe cyclical sectors would rally if economic growth continues to rebound from lows.
- Donald Trump President, Democrats win the House. We believe a Trump victory would result in a divided government, as Democrats are likely to hold control of the House, and could win the Senate as well. But even with Democrat control of Congress, a stalemate condition would persist as legislation requires approval from the President. This would prevent President Trump from passing additional tax cuts (which he supports) and immigration reform, but we would expect him to continue with executive orders to reduce regulation and increase energy independence. This could help domestic-focused financials, energy producers, manufacturers and other U.S. industrials. Much like a Biden/split Congress result, legislation would likely be tied to COVID-19 relief, infrastructure spending, and U.S. manufacturing incentives. We think health care could rally due to a status quo scenario with less uncertainty, although President Trump supports drug price controls. Trump has also indicated ongoing willingness to use tariffs as part of trade policy, negatively impacting U.S. exporters and foreign exposed industrials. Elevated China tension could disrupt large technology companies with operational and revenue exposure in that region. We believe cyclical sectors would rally if economic growth continues to rebound from lows.
- How have the U.S. equity markets performed under different party leadership? We analyzed party leadership since 1945, a span of 75 years and 13 presidents. Through 2019, the U.S. was led by a Democratic President for 36 years and a Republican for 39 years. The S&P 500 index price return has averaged 11.1% annually under Democratic presidents, and 6.9% annually under Republicans. However, the numbers change somewhat when overlaying congressional party affiliation. When Republicans hold all three offices (President, House, and Senate), the S&P 500 has gained 10.1% annually; when Democrats hold all three the market has gained 9.8%. This suggests that one party control has been good for equity markets overall. The best annual market performance has come from a Democratic president and Republican control of the House and Senate. But over time, the dominant party has been less correlated with higher returns, as annual returns when Democrats control two or three of the offices averaged 9.0%, vs. 8.8% when Republicans have control. The numbers can be analyzed in several different ways, but we conclude that historically U.S. equities have produced solid annual gains over time with either Democrat or Republican leadership. The S&P 500 has performed better with a Democrat President, although the best returns have come when Republicans control both the House and Senate, regardless of which party holds the Presidency. Please see the summary chart below.
James D. Ragan
CFA Director of WM Research
Important Disclosure: The information contained herein has been obtained by sources we consider reliable, but is not guaranteed and we are not soliciting any action based upon it. Any opinions expressed are based on our interpretation of data available to us at the time of the original publication of the report. Assumptions, opinions, and estimates constitute our judgment as of the date of this report and are subject to change without notice. Investors must bear in mind that inherent in investments are the risks of fluctuating prices and the uncertainties of dividends, rates of return and yield, as well as broader market and macroeconomic fluctuations and unforeseen changes in the fundamentals or business trends affecting the securities referred to in this report. Investors should also remember that past performance is not indicative of future performance and D.A. Davidson & Co. makes no guarantee, express or implied, as to future performance. The information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us, or an offer, or the solicitation of an offer, to sell or buy any security. Further, a security described in a report may not be eligible for solicitation in the states in which a client resides. D.A. Davidson & Co. does not provide tax advice and investors should consult with their tax professional before investing. Further information and elaboration is available upon request.
Market Indices: The information on indices is presented for illustrative purposes only and is not intended to imply the potential performance of any fund or investment. Indices provide a general source of information on how various market segments and types of investments have performed in the past. Index performance assumes the reinvestment of all distributions, but does not assume any transaction costs, taxes, management fees, or other expenses. You may not invest directly in an index. Past performance is not an indicator of future results. The Russell 2000® Index is a market cap weighted index that measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The S&P 400 Index is a market cap weighted index comprised of U.S. stocks in the middle capitalization range, generally considered to be between
$200 million and $5 billion in market value. The S&P 500 Index is a market cap weighted index that is designed to measure the US large-cap equity performance. The index is composed of the 500 leading publically traded US companies based on size, liquidity, industry, and profitability criteria. The Dow Jones Industrial Average is a price weighted index that tracks 30 large, publicly-owned companies trading on the New York Stock Exchange (NYSE) and the NASDAQ. The MSCI EAFE® Index (Europe, Austral, Asia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the US and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.