Note: This is the last post until Monday, 9 November 2020 since I need a couple of days off after this madness…
Republicans outperform again
As I write this commentary (8.00am GMT), it is too early to call the election results in the United States. Yet, there are some clear trends emerging by now that allow us to narrow the outcomes down to two to three main scenarios. Being mindful that everything remains in flux, I note the following major trends:
Just like four years ago, the Republican candidates up and down the ballot again outperform relative to the opinion polls published before the election.
The Presidential election is too close to call and will likely be so close that we have to expect days, if not weeks of uncertainty about the final outcome as litigation in individual states unfolds.
In my view, the three most likely outcomes in descending order of likelihood are currently:
Biden wins the Presidency, but Republicans hold on to the Senate while Democrats hold on to the House.
Trump wins the Presidency, Republicans hold on to the Senate and Democrats hold on to the House.
Biden wins the Presidency, Democrats win the Senate and hold on to the House.
At this point in time, my base case scenario is scenario 1, which would put Washington into continued gridlock and basically a return to the Obama years where the President has to rely mostly on executive orders to force change, but no major laws can be passed. At the end of this post, I will look into the implications for US growth, the US Dollar and stock markets, but first, I show why I think these three scenarios are the most likely outcomes.
Presidential race: Biden likely to win
Before the election, the FiveThirtyEight forecast gave Biden an 89% chance of winning the election. As of the time of writing, including all states and districts that have been called by at least one media outlet, FiveThirtyEight gives Biden an 88% chance of winning, Trump a 6% chance of winning and a 6% chance of a tie. As a reminder, in the case of a tie in the Electoral College, the presidency would be decided by the House of Representatives by state delegation, which would hand the presidency to Trump.
Compared to the opinion polls and projections, Joe Biden is outperforming in Arizona, Minnesota, Wisconsin and Michigan. He is also performing well in Pennsylvania and Georgia.
Donald Trump is outperforming his polls in Florida, Ohio, and North Carolina. However, that is unlikely to be enough to win the Electoral College.
Joe Biden has several ways to win the Presidency: i) winning Arizona, Michigan, and Wisconsin, in which case he does not need either Georgia or Pennsylvania, ii) win Georgia, Wisconsin and Michigan, in which case he would not need Pennsylvania or Arizona (Arizona has already been called by Fox News and the AP for Biden), and iii) win Pennsylvania, Wisconsin and Michigan, in which case he would not need Georgia (where Trump leads by 3 points but the outstanding votes are all in deep blue Atlanta) or Arizona.
Most troubling, Donald Trump falsely claimed that he won Pennsylvania, Michigan, and several other states that he is unlikely to win. To provide some clarification, Biden won Minnesota by 8 points. In 2016, the difference between Minnesota and neighbouring Michigan was a mere 3 points, which indicates that Biden is likely to win Michigan by 5 points or so. This chimes well with the current projections for Michigan, where Trump is currently in the lead by 8 points based on the votes that have been counted. However, the outstanding votes are from Detroit, which so far seems to go 5-to-1 for Biden. Biden needs to win Michigan by about 3-to-1 to 4-to-1 to win the state overall. A similar picture is in place in Wisconsin where Trump is currently ahead by 4 points, but Dane County (Madison) and Milwaukee County are still open and both are deep blue. With Trump leading by a mere 119,000 votes at the moment, Wisconsin may well swing for Biden if the outstanding 211,000 ballots that have to be counted are 3-to-1 for Biden, which seems likely, though it is too close to call.
Trump also threatened to go to the Supreme Court to intervene in the counting of votes and stop the counting of votes in crucial swing states. This is very unlikely to succeed since state laws are very clear on that matter, but the legal actions and false claims by Trump that he won several states he did not win or is unlikely to win serve the purpose of creating uncertainty and doubt about the election outcome, thus further undermining institutions and setting markets up for an extended period of uncertainty.
Senate race: Republicans likely to hold on to majority
Unlike the Presidential race, Republicans are outperforming across the board in Senate races. Before the election, Democrats were projected to be favoured to win the majority in the Senate. For that to happen, they would have to flip four seats while losing their one senate seat in Alabama. As of the time of writing, Democrats have managed to flip a senate seat in Colorado and lost their senate seat in Alabama. Meanwhile, Joni Ernst managed to retain her senate seat in Iowa, which was a must-win for Democrats. The other very close race that Democrats hoped to win was Susan Collins’ seat in Maine. Collins currently leads her senate race by 7 points and remains on course to re-election.
At the moment, the best possible outcome for the Democrats would be a tie in the Senate, which will crucially hinge on the second Senate seat in Georgia where Democrat Raphael Warnock and Republican Kelly Loeffler are on track for a run-off in December. If Democrats manage to win the Presidency and win a tie in the Senate, the Vice President could act as a tie-breaker in the Senate and open up a way out of legislative gridlock. However, in that case the moderate Democrats in the Senate would hold the key to power, blunting any efforts by the left wing of the Democratic Party to push through ambitious projects like a Green New Deal or significant tax hikes.
The most likely outcome, though, remains that the Republicans hold on to a slight majority in the Senate, which would give them the power to block any ambitious legislative agenda originating in the House of Representatives or the White House.
House: Democrats hold on to clear majority
Democrats were highly favoured to retain control of the House of Representatives. It is virtually certain that Democrats will retain control of this chamber, though their majority is likely to decline somewhat, yet not enough to put them into any kind of trouble.
Implications for the US economy and the US Dollar
At the time of writing, the US Dollar Index (DXY) is up 0.6%, up 0.9% vs. Sterling, and up 0.5% vs. the Euro as uncertainty remains high, while 10-year Treasury bond futures are up 1.5%.
In my main case scenario of a Biden Presidency with a Republican Senate, I expect to see a return to the Obama years with the Senate blocking any major legislation by Democrats. This would mean that the President has to rely largely on executive orders to enforce changes in the health care system or to enforce environmental protections. However, a Biden presidency would at least end the threat of erratic trade wars and international relations and while we expect Biden to remain sceptical in his dealings with China, it seems likely that he will try to roll back tariffs implemented against China, which would be good for US consumers.
However, more ambitious goals would likely fail in the well-known gridlock. The Democratic plans to hike corporate taxes would be dead on arrival, which is marginally positive for stocks, but any fiscal stimulus package would likely be smaller than currently expected, as Senate Republicans will try to prevent Democrats from claiming victory on the economic recovery. Thus, in this scenario, the growth prospects for the United States in 2021 diminish somewhat. This, in turn, puts more of the burden to stimulate the economy in the current economic crisis on the Fed and monetary policy, which means that we will likely see even more aggressive QE than currently anticipated. In sum, in such a scenario I would expect the US Dollar to weaken in 2021 under the influence of weaker than expected growth and more aggressive monetary stimulus.
In the case of a Trump presidency and the Senate under Republican control, it would be a continuation of the policies of 2017 to 2019 with the 2018 tax cuts remaining in place but an intensifying trade war with China that frequently rattles stock markets. As Democrats are likely to restrict the manoeuvring space for Senate Republicans in terms of fiscal stimulus measures we should expect a moderate fiscal stimulus package based on a deal between the House of Representatives and the Trump White House as was expected in the past couple of months.
Finally, in the case of a Biden presidency with a tied Senate, Democrats would have the ability to hike corporate taxes and increase the stimulus spending on infrastructure, green technologies and other projects. However, the narrow majority of Democrats in the Senate would thwart any attempts by the party’s left wing for more ambitious projects like an large Green New Deal or the expansion of Medicare to all citizens.
Implications for stocks: Ho-hum
As can be expected in a highly uncertain environment, stock markets declined while the US Dollar and bonds rose. Futures on the Dow Jones Industrial are currently down 1.2%, while futures on the S&P 500 are down 0.6%. Tech stocks reacted positively to this uncertainty with Nasdaq futures up 1.0%.
From a sector perspective, the strength of the Republicans in the Senate mean that regulation for health care stocks and oil & gas will likely be limited. Thus, on the margin, the current situation looks slightly positive for health care and energy. Meanwhile antitrust action against technology companies will likely have less teeth than previously anticipated under a Biden presidency, which is marginally positive for tech stocks. The current situation is also marginally negative for green technology stocks, which can rely on supportive regulation but not on massive fiscal spending.
Overall, however, we do not think that the outcome of this election has any significant impact on different sectors. With gridlock highly likely in Washington over the next two years, we anticipate top line growth for companies to be marginally lower due to a slower economic recovery after the pandemic, while profit margins remain high as tax hikes are off the table.
In the UK and Europe, the impact on stock markets is likely to be even less pronounced than for US stocks. On the margin, health care, miners and oil & gas might benefit as typical Dollar earners, but in the end, this election is likely to be a non-event for UK and European stocks.
What to do?
Overall, the election is not going to have much of a long-term effect on stocks. Given that we will have to wait for several days for the results to come in and for litigation to be settled, investors should remain calm and not change their portfolios too much (if at all). Instead, take deep breaths, relax and remember that in New Jersey a ballot initiative to legalise recreational use of marijuana has been accepted with 60% of the votes – though the corresponding changes will likely come too late to calm people down while waiting for the results to trickle in.