A Blue Wave: Will Investors be Swept Away?

January 07, 2021 | Richard So


Share

How should investors surf the 'Blue Wave'?

The New Year kicked off with another highly anticipated political event, the Georgia Senate Election. This election decided whether Americans would bring upon a political “blue wave”, where Democrats sweep control of the White House and Congress (House & Senate). The prevalent narrative was that markets would prefer a divided congress through a Republican-controlled Senate as that should maintain political gridlock and produce less surprising policy changes. Many investors understood that a Democratic-controlled congress could spell disaster for the markets as it could allow for an easier path towards raising taxes. At the time of this writing, it appears that the Democrats may indeed secure the sweep.

Three Things to Remember about Politics

Before diving into the potential market implications, I want to make three points clear. First, in my professional experience, I have yet to meet any money manager who has ever tethered their asset mix decisions based on Senate elections. Hence, investors should remind themselves to not extrapolate any knee-jerk reactions of the markets into the distant future. Second, as discussed in previous blogs, history has shown that different combinations of government have never permanently derailed the upwards trajectory of the major indexes. In fact, since 1933, the S&P500 has risen an average of 9% in a Democratic Sweep scenario. Finally, as often is the case for elections, it is the “uncertainty” of the election that is arguably the bigger overhang on markets than the actual outcome. Hence, once results are known, markets can be quick to recalibrate and refocus on fundamentals and earnings.

Democratic Sweep Implications

Now, let’s discuss the potential implications of a democratic sweep. Indeed, this will increase the party’s ability to move forward with the “Democratic Agenda”. However, investors have to question whether this will materially impact the macro landscape. Even with the two added Senate seats in Georgia, an element of gridlock should persist in DC. Much of the Democrat’s success within the Senate can be attributed to the idea that some of the leftmost wing of the party had subsided, with many candidates campaigning from a more centrist position. For example, Jacky Rosen of Nevada and Kyrsten Sinema of Arizona are now in the Senate and in 2018 both had voted in the House to make tax cuts permanent. One could say their ability to unseat Republican incumbents was due to their centrist affiliation. Given this, with such a narrow majority of the vote (Vice President Kamala Harris serving as a tie-breaker), it will still be difficult to get enough votes to pass a significant anti-growth tax policy.

A more centrist Democratic party could struggle to support broad-based tax increases or an extreme fiscal agenda. However, they will be inclined to support some of the “low hanging fruit” that could have some very positive short term economic implications. For example, under a blue wave, it is expected that additional and bigger stimulus checks will be passed. We could also see tax increases for higher-income individuals ($400,000+), however, tax cuts for lower-income individuals could be maintained and receive bi-partisan support to make them permanent.

A significant tax increase for corporations is also difficult to imagine as it would run counter to Biden’s agenda to create jobs and keep businesses domiciled in America with a competitive tax rate. Moreover, the Trump corporate tax cut did not actually lead to a significant decline in tax revenues even though the effective tax rate fell by nearly a quarter from 22.2% (2016) to 16.5% (2019). The National Income and Products Accounts (NIPA) as reported by the U.S. Bureau of Economic Analysis (BEA) showed corporate income taxes fell from $262 billion (2016) to $212 billion (2019). Ultimately, this is only $50 billion, which is quite small in the grand scheme of things. Hence, the Democrats may be deterred from momentous changes to the corporate rate as it does not significantly improve the country’s fiscal position, however, it would have a large impact on business competitiveness.

Rebalancing

Rather than fearing a Democratic sweep, we would be inclined to view any pullback related to a sweep as an opportunity to add equities for those who are underinvested. The fundamental expectations of a post-covid economic recovery, continued global stimulus, and depressingly low-interest rates remain favorable for investors. One should also expect that a democratic sweep would bring more spending and therefore larger deficits and more treasury supply. Hence, this should push the 10-year Treasury yield higher which could be favorable for the underperforming banking sector. Larger stimulus checks could also be fruitful for retail and consumer discretionary sectors. Biden’s aims to boost infrastructure spending towards more green energy should also get investor’s attention. Finally, increased fiscal spending could further weaken the dollar, which could bode well for commodities and emerging market assets. In all, we find this political event to serve as another reminder for investors to rebalance and to strive for a more diversified portfolio.

Categories

Economy Investing