Quiet markets in the run-up to the U.S. election belie the high political stakes.

Although it’s been all but impossible to escape the U.S. political circus over the past four years, with all the understandable focus on COVID-19 and its economic effects, electoral politics have taken a bit of a back seat as far as markets are concerned—despite the vote being just three months away.

The pandemic has severely disrupted the two parties’ national conventions, the traditional opening act for the fall election process. The Democrats’ event was supposed to take place three weeks ago. Now, both are slated for later this month, much reduced and largely virtual. And a virtual circus just isn’t as glitzy and raucous as the real thing.

We think it’s time to look more closely at the implications of November 3, however. This election comes with huge uncertainty as virus and economic data swing from one extreme to another and the candidates chase votes in the most polarized electorate in living memory.

Most important of all, there is a lot at stake.

Blue Wave

Three months is a long time in politics, but based on current polling data, if we had to call the election today we’d put Joe Biden in the White House and concede the likelihood of the Democrats taking the Senate.

History supports that outcome, too. The last incumbent president to be reelected after a recession had struck within two years of the vote was Calvin Coolidge in 1924. Since 1900, Richard Nixon and George H. W. Bush are the only first-term presidents who assumed office without their party controlling both houses of Congress.

A “blue wave” will likely have a number of important implications for the economy and markets. One notable observation that political science expert Dr. Sam Potolicchio made when I interviewed him recently is that Biden has spent his 36 years in the Senate right in the center of the Democratic Party regardless of how the party itself has shifted. Given current Democrats’ leftward tilt, he said, “Biden is going to end up making Obama look like a Republican.”

Biden’s platform includes significant corporate and personal tax increases and a series of policy proposals in health care, government regulation, the environment and infrastructure.

Tax increases are typically viewed with concern by markets. One important initiative of the Trump administration was reducing the U.S. corporate tax rate to levels more on par with other major countries. Analysts have estimated that this reduction boosted S&P 500 earnings per share by between 8% and 12%.

In our view, a return to higher levels would put pressure on the market: An industry rule of thumb is that every one-percentage-point increase in the corporate tax rate reduces S&P 500 earnings per share by approximately $1. (2019 S&P 500 EPS was approximately $165.)

The spending proposals are more complicated to assess. Thoughtful, targeted fiscal stimulus can be helpful to economic growth. However, history suggests that we should be skeptical of the efficiency of political “stimulus” (remember “Cash for Clunkers”?), as well as concerned about the budget deficit, which is already extraordinarily high.

Furthermore, fewer checks and balances exist when one party controls Congress. One traditional Senate measure, the “filibuster rule,” essentially requires 60 votes to approve a bill. While the Democrats may end up controlling the Senate, they are unlikely to win 60 seats—but they may choose to eliminate or change the filibuster rule, requiring only a majority, or 51 votes, to pass legislation. This raises the stakes for November 3.

Provocative

We also need to think about what the incumbent might do. The further behind he is in the polls, the more provocative his decision-making could become.

That could mean casting doubt on the veracity of the vote—or even, as Dr. Potolicchio suggested, pulling out of the race altogether. Even if the president doubles down on themes that appeal to both sides of the political spectrum, the results may not be business-friendly.

If there are two things that members of both the Democratic and Republican parties have recently supported in the current partisan climate, the first is beating up on China and the second, as we saw in recent Congressional hearings, is beating up on big tech.

Could the current administration use the fact that China isn’t buying all the U.S. goods it promised under phase one of their trade deal as an excuse to ditch the agreement altogether? Does the bizarre TikTok affair, which combines antipathy toward both China and big tech, indicate a growing willingness to strong-arm the sector?

Political Risk

As a wave of liquidity pushes the Nasdaq Index into uncharted territory and the S&P 500 back toward its all-time high, we’re asking ourselves how much of this is priced into markets. There may be early signs in the recent U.S. dollar weakness, but we believe markets should also look closely at sectors that are potentially exposed to political risk, such as energy, finance, big pharma, big tech and e-commerce. I know our teams are very focused on this.

So far, this year’s election has taken a back seat. But that’s unlikely to last. Investors should be calibrating the serious policy issues at stake now, ready for when the circus comes to town and the markets start to pay more attention.

In Case You Missed It

  • ISM Manufacturing Index: +1.6 to 54.2 in July
  • ISM Non-Manufacturing Index: +1.0 to 58.1 in July
  • U.S. Initial Jobless Claims: +1.19 million for the week ending August 1
  • U.S. Employment Report: Nonfarm payrolls increased 1.8 million and the unemployment rate decreased to 10.2% in July

What to Watch For

  • Tuesday 8/11:
    • U.S. Producer Price Index
  • Wednesday 8/12:
    • U.S. Consumer Price Index
  • Thursday 8/13:
    • U.S. Initial Jobless Claims: +1.43 million for the week ending July 25
  • Friday 8/14
    • Eurozone 2Q 2020 GDP (Second Estimate)
    • U.S. Retail Sales

Statistics on the Current State of the Market – as of August 07, 2020

Market Index WTD MTD YTD
Equity      
S&P 500 Index 2.5% 2.5% 4.9%
Russell 1000 Index 2.4% 2.4% 5.4%
Russell 1000 Growth Index 2.1% 2.1% 20.8%
Russell 1000 Value Index 2.7% 2.7% -10.6%
Russell 2000 Index 6.0% 6.0% -5.2%
MSCI World Index 2.2% 2.2% 1.3%
MSCI EAFE Index 2.0% 2.0% -7.2%
MSCI Emerging Markets Index 1.0% 1.0% -0.5%
STOXX Europe 600 1.8% 1.8% -6.7%
FTSE 100 Index 2.4% 2.4% -18.4%
TOPIX 3.4% 3.4% -8.9%
CSI 300 Index 0.3% 0.3% 17.0%
Fixed Income & Currency      
Citigroup 2-Year Treasury Index 0.0% 0.0% 3.0%
Citigroup 10-Year Treasury Index -0.2% -0.2% 13.5%
Bloomberg Barclays Municipal Bond Index 0.5% 0.5% 4.3%
Bloomberg Barclays US Aggregate Bond Index 0.1% 0.1% 7.8%
Bloomberg Barclays Global Aggregate Index -0.1% -0.1% 6.2%
S&P/LSTA U.S. Leveraged Loan 100 Index 0.4% 0.4% -1.4%
ICE BofAML U.S. High Yield Index 0.6% 0.6% 0.4%
ICE BofAML Global High Yield Index 0.6% 0.6% 1.0%
JP Morgan EMBI Global Diversified Index 1.3% 1.3% 2.2%
JP Morgan GBI-EM Global Diversified Index -0.9% -0.9% -4.9%
U.S. Dollar per British Pounds -0.6% -0.6% -1.5%
U.S. Dollar per Euro -0.3% -0.3% 5.0%
U.S. Dollar per Japanese Yen -0.1% -0.1% 2.6%
Real & Alternative Assets      
Alerian MLP Index 6.0% 6.0% -34.3%
FTSE EPRA/NAREIT North America Index 1.6% 1.6% -16.9%
FTSE EPRA/NAREIT Global Index 1.3% 1.3% -17.7%
Bloomberg Commodity Index 2.6% 2.6% -12.6%
Gold (NYM $/ozt) Continuous Future 2.1% 2.1% 33.1%
Crude Oil WTI (NYM $/bbl) Continuous Future 2.4% 2.4% -32.5%

Source: FactSet, Neuberger Berman.