The first Presidential debate occurs tonight and it kicks off the final stretch towards Election Day, November 3rd, so I wanted to provide what could be considered an initial “Election Preview” that details three possible scenarios: Trump Presidency with a Divided Congress, Biden Presidency with Democratic Congress (democratic sweep) and No Clear Winner.

 

In order to hopefully keep your attention, I’m breaking this into two parts. The first, included today, will detail a typical election scenario, where we know the winner in relatively short order following Election Day. 

 

Part 2 of the Election Preview (tomorrow) will cover the possibility of a contested election, and the subsequent market fallout.

From a broad market consensus standpoint, the market views a Trump Presidency as the “Good” scenario, a Biden win/democratic sweep as a “Bad” scenario, and No Clear Winner as an “Ugly” scenario. 

 

Those market opinions are broadly driven by two stated Biden policies: Raising the corporate tax rate to 28% from the current 21%, and raising the national minimum wage to $15/hour (from the current $7.25). Both of these policies would reduce corporate earnings, as increased taxes would directly reduce corporate earnings, while an increase in minimum wage would compress margins for companies in specific sectors (especially hospitality). Both of these policies also have social benefits... I’m just identifying that stock prices are a reflection of future earnings. If future earnings will definitely go down (because of higher taxes or lower margins) then stock prices will go down, at least initially. Over the longer term, markets have performed well during Democratic administrations, but in the near term, the market will worry about higher taxes and lower margins, and that’s why the market broadly views a Trump win as “Good” and a Biden win as “Bad,” for the near term. 

 

The “Good”: Trump Wins and There’s a Divided Congress. There’s virtually zero change that Republicans re-take the House so even if Trump defies the polls again and wins, he’s almost certainly going to be working with a divided Congress. 

 

Likely Policy Implications: Not much. Think of the last two years of the Obama administration, and the last two years of the Trump administration. Large policy initiatives are virtually impossible to pass in today’s partisan environment with a divided Congress, so essentially this outcome would be ensuring the “status quo” for the next two years, from a domestic policy standpoint. From an international standpoint, this means more trade war noise. With no looming re-election, we should expect the trade war with China (and other regions) to heat up substantially, and so we should prepare for more intermittent volatility regarding tariffs and trade war rhetoric.

 

Likely Market Reaction: Knee jerk rally, based on the relief of no tax increase or minimum wage increase.

 

The “Bad”: Biden Wins and Democratic Congress (Democratic sweep). Based on the polls, this is now the most likely outcome of the election, although given the polls were wrong in 2016 they are being viewed with currently more skepticism than usual. 

 

Likely Policy Implications: Significant. We would expect: 1) A corporate tax increase, 2) A minimum wage increase, 3) Increased regulation across industries 4) Expansion of Obamacare.

 

Likely Market Reaction: Knee jerk declines, again based on expected tax increases and minimum wage hikes.

 

Bottom Line: Importantly, I do not see either immediate election outcome (Trump win or Biden win) as a bearish game changer, regardless of who controls Congress. That said, Democratic sweep will likely create more short term volatility which might impact market returns for 2020, but the reality is that even when one party is in control Congress and the Presidency, meaningful change is hard to effect. Case in point, it took nearly two years for Democrats to pass the Affordable Care Act, and they had strong majorities in Congress and the Presidency. Similarly, Republicans failed to repeal Obamacare despite controlling Congress and the Presidency, and it took two full years to pass the Tax Cuts and Jobs Act. 

 

Beyond policy, the bigger medium term drivers of market performance will be Fed policy and stimulus. Yes, policy decisions from the government will impact the markets over time, but we’ll cross those bridges as we come to them. Bottom line, neither outcome is a bearish game-changer for anyone with a time horizon stretching into early 2021 and beyond (but again acknowledge we could see volatility into year-end).