Dear Advisers and Investors
The US presidential election to take place on Tuesday 3 November is shaping up to be one of the most contentious and consequential in modern history, making its potential policy and market implications front of mind for investors.
Already more than 3 million ballots have been cast by American votes1 in a campaign taking place against a tragic backdrop of more than 200,000 COVID-19 related deaths, and white-hot polarisation between the Republican and Democratic parties.
In this note, I’ll touch on policy differences between President Trump and his Democratic challenger former Vice President Biden, and round out my remarks by summarising how we’re positioning client portfolios in the run up to election day.
Foreign and trade policy continuity ahead rather than change
It almost goes without saying that the candidates’ worldviews are far apart, and this is evident in their policy agendas.
That said, while the tone of US trade and foreign policy would be expected to change in the event of a Biden victory, substantively, there may be more continuity than people outside the US might imagine. That’s because notions of American exceptionalism did not start with Trump; almost every US president has pursued it in some form.
US policy towards China would probably be fairly similar under both administrations, with a hawkish approach on issues including Hong Kong and Taiwan, the South China Sea, human rights, and technology and trade.
The single biggest foreign policy difference between Trump and Biden would be on Europe, where substantially more alignment between the US and its European allies would occur under a Biden administration.
Trump tax cuts versus active fiscal policy with Biden
The sharpest differences are in domestic policy where some close observers of US politics believe that a Biden win, alongside a Democratic sweep of Congress, could herald the largest shift in US domestic policy in decades.
Given that he’s the incumbent and a known quantity with a four-year track record, a Trump re-election would likely mean more of the same on the domestic policy front.
The Trump administration’s first-term economic agenda was dominated by business and personal tax cuts, and the same is anticipated in a second term.
A returned Trump White House’s top priority would be extending the expiring provisions of the Tax Cuts and Jobs Act (TCJA), which came into effect at the beginning of 2018. Also expected is another tax proposal that would include additional middle class tax cuts.
President Trump made some attempt to put forward a large infrastructure spending plan in his first term, but gave up after a lack of support from his Republican Party colleagues in the Senate and House of Representatives. Nevertheless, his economic advisers have publicly stated that Mr Trump is prepared to consider a US$2 trillion infrastructure package in his second term.2
Contrast that with what might occur should Vice President Biden win. Senior advisers have made plain that getting the COVID-19 pandemic under control would be the first economic priority of a Biden administration.
His plan to achieve this involves a much more significant role for the federal government in organising governors and other state authorities to administer testing, tracing, quarantining, as well as preparing for vaccine distribution.
Changes can also be expected to the tax regime with Mr Biden proposing higher taxes on those earning above US$400K in income, and some of them, like taxing realised capital gains as regular income, would kick in on adjusted gross incomes over US$1 million.
The corporate tax rate would rise from 21 to 28%.3 The idea is to recycle the revenue raised back into the economy through everything from tax credits for small businesses as well as middle-lower income earners, to funding a US$2 trillion clean energy and infrastructure fund.
Of course, both the Trump and Biden proposals are just that, proposals. The composition of Congress will heavily influence what and how much of either leader’s agenda gets passed. Currently, the Democratic Party control the House of Representatives while the Republican Party has a Senate majority.
Recent polls point to reasonable chances of Democrats taking the Senate.
Historically, divided government — where the president is from one party and Congress dominated by the opposing political party — has worked surprisingly well as it has resulted in sensible compromises, which is something America’s founders had in mind when they created a constitutional system of dispersed power, and strong checks and balances.
However, today’s heated political atmosphere, and deep social and cultural divisions laid bare by the campaign implies more deadlock and confrontation, should the election result in divided government.
Potential stock market impacts
All elections cause investment professionals to engage in crystal ball gazing and opine on which industries and companies may do well, and those that might run into headwinds.
Depending on the outcome, market participants believe the election could increase the likelihood of a market rotation away from companies expected to have strong earnings growth. These growth companies, especially technology companies, have performed strongly in recent years, but interest may shift toward companies in more cyclical industries that rely heavily on economic activity.
The thinking behind the argument for a possible switch in the composition of US share market leadership is that the spending proposed by the Biden campaign would likely boost economic activity and inflation expectations, which could reduce both the earnings and valuation premiums carried by growth stocks.
A reason for the strong performance of growth stocks in 2020 and recent years has been the scarcity of economic growth, which has made the growth prospects of stocks able to generate earnings particularly attractive. The kind of spending expansion proposed that increases economic activity would reduce growth stocks’ scarcity premium and improve the earnings outlooks for cyclical stocks levered to economic growth.
…and the winner is….
Of course, there must be an election result and a newly elected Congress in place before any of this conjecture comes to pass. Right now, there’s anxiety in the US and elsewhere that rather than a clear-cut outcome, we could be in for political mayhem.
There are a few reasons why a tense, even alarming, post-election situation could arise.
Firstly, unlike most democracies, there is no independent national election authority in the United States, so there is no agency or person who declares the winner. Instead media organisations are the ones who declare which candidate has won based on everything from exit polls to their own election models.
In the absence of an independent national election authority, controversies over presidential elections are generally resolved at the state level. Each state has procedures for recounts, the validation of absentee ballots to address potential disputes. In an extreme case in which the entire integrity of a state’s election is disputed, the state legislature has the right to directly appoint electors to the “Electoral College.”
American voters do not, technically, directly elect the president. They choose “electors”, who are pledged to one or another candidate. This “Electoral College” was established as a compromise between a congressional and popular vote. The Electoral College consists of 538 electors. A majority of 270 electoral votes is required to elect the President.
Each state has a certain number of electors to the college, based on the size of its population.
President Trump’s 2016 success came off the back of winning “battle ground states” including Michigan, Ohio, Wisconsin, and Pennsylvania by a total of less than 100,000 votes against Mrs Clinton. This translated to him winning the Electoral College by 306 to 232 votes.
The aim of a US presidential campaign is the race to the magical 270 electoral college figure, not winning the most popular votes. As the previous race showed, it’s possible to win the presidency with fewer votes.
Most recent national polls show Biden ahead but Trump’s 2016 victory, despite finishing more than 2 million votes behind Mrs Clinton,4 is making pundits cautious.
Both sides have already hired armies of lawyers ready for a post-election legal battle. President Trump has essentially said that he won’t accept defeat and instead will look to the courts, all the way to the Supreme Court, to potentially overturn a negative election outcome.
Investors hate uncertainty and so share markets will be an important barometer of psychology should the upcoming election be disputed. The Florida recount during the 2000 presidential battle between Democrat Al Gore and Republican George W. Bush offers a hint of what may happen if this election turns out to be messy.
That election wasn’t fully decided until a Supreme Court decision declared George W. Bush the winner five weeks after, during which the US S&P 500 Index fell nearly 10% by the end of November 2000.5 Considering today’s acrimony, investors might be wise to prepare for many possibilities.
How we’re positioning client portfolios
Given the very murky outlook, now is not the time for daring investment calls. From an investment perspective, diversification is the best response to uncertainty.
Diversification across many dimensions is an MLC investment bedrock. Diversification means that the fate of our clients’ portfolios is not dependent on the success of a single investment thematic.
In fact, as I remarked in my previous note to you, we’ve been developing new and innovative way of achieving diversification including the use of derivatives.
Through derivatives we can access entire markets, as well as individual securities in cost-effective and efficient ways. Derivatives also enable us to participate in investment markets with protection. Moreover, thanks to derivatives, it’s also possible to be paid even if markets fall.
This kind of dexterity will be needed in the lead up to 3 November and, likely, beyond.
Chief Investment Officer, MLC Asset Management
1More than 3 million general election ballots cast so far in November election. Adam Levy, Ethan Cohen and Liz Stark, CNN, October 6, 2020. https://edition.cnn.com/2020/10/06/politics/ballot-returns-early-voting-2020-election/index.html, accessed 8 October 2020.
2Remarks on President Trump’s domestic policy agenda draw from an interview with Kevin Hassett, former Chairman of the Council of Economic Advisers in the Trump administration in Beyond 2020, post-election policies, Goldman Sachs Global Macro Research, Issue 93, October 1, 2020.
3Remarks on Vice President Biden’s domestic policy priorities draw from an interview with Jared Bernstein, Economic Adviser to former Vice President Joe Biden, in the previously named publication.
4Presidential Election Results: Donald J. Trump Wins. The New York Times, August 9, 2017. https://www.nytimes.com/elections/2016/results/president, accessed 8 October 2020.
5Here’s Why Delayed Election Results Might Not Lead To A Market Sell-Off Like In 2000. Sergei Klebnikov, September 2016, 2020 https://www.forbes.com/sites/sergeiklebnikov/2020/09/16/heres-why-delayed-election-results-might-not-lead-to-a-market-sell-off-like-in-2000/#40114c0a4243, accessed 16 October 2020.
This information is provided by MLC Investments Limited, ABN 30 002 641 661 AFSL 230705 and NULIS Nominees (Australia) Limited (ABN 80 008 515 633, AFSL 236465), together “MLC” or “we”. We are members of the group of companies comprised National Australia Bank Limited, its related companies, associated entities and any officer, employee, agent, adviser or contractor (“NAB Group”). An investment in any product or service offered by a member company of the NAB Group does not represent a deposit with or a liability of the NAB or any NAB Group member. NAB does not guarantee or otherwise accept any liability in respect of any financial product referred to in this communication.
This information included in this communication is general in nature. It has been prepared without taking account of an investor’s objectives, financial situation or needs and because of that an investor should, before acting on the advice, consider the appropriateness of the advice having regard to their personal objectives, financial situation and needs.
Any opinions expressed in this presentation constitute our judgement at the time of issue and are subject to change. We believe that the information contained in this presentation is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made at the time of compilation. However, no warranty.