A Blue Wave: Crashing Down on the Market or Letting it Ride?
Author: Kevin McCreadie
October 28, 2020
A Blue Wave, or Democratic sweep of the White House and both chambers of Congress, is now the most likely U.S. election outcome facing investors. But as AGF’s CEO and Chief Investment Officer explains, its potential impact on markets is complex and could prompt increased volatility in the weeks and months ahead.
Current polls have Joe Biden winning the presidency and the Democrats taking the U.S. House of Representatives and U.S. Senate. Is this result a foregone conclusion with just days to go before the election?
A Blue Wave is widely expected at this stage, but it’s not inevitable and several of the Senate races are still too close to call. Remember also that polling has been spotty in the past and was well off the mark in the lead up to the 2016 presidential election. In fact, some polls showed Hillary Clinton having a 90% chance of winning the presidency on the day before the election and had no account for the massive surge in Trump supporters that ultimately secured the President’s victory. Now, four years later, there’s an argument to be made that polls are still not precise despite changes made in the interim to how polling is conducted. The U.S. has become so divided along political affiliation that some people are more reluctant than ever to disclose their voting preferences out of fear they will be targeted unfairly by family, friends and others who may disagree. So, while it does seem like the Democrats have all the momentum going for them, it’s important that investors not take it for granted. In other words, understand what a Democratic sweep could mean for markets, but remain cautious about putting what you know into action until the results are in.
On that last note, what are the market implications of a potential Blue Wave?
It should be expected that a unified Democratic government would pass several different types of legislation that will impact markets. This is especially true of a “deep” Blue Wave that results in the Democrats controlling the Senate with 53 seats or more. In this case, there is an increased probability of even more fiscal stimulus being passed than is currently on the table. And while that would likely push stock prices higher in the near term, it also raises longer term questions about the market’s growing dependence on government spending and central bank accommodation. At some point, ballooning deficits that are a consequence of unbridled stimulus need to be addressed and may swing sentiment in a less favourable direction. A Democratic deep sweep also solidifies the market-negative prospect of higher corporate taxes in the future. Maybe not right away, as the government continues to focus on the here and now of the pandemic. But it’s almost surely not a question of if taxes are raised but when they are raised, leaving investors to pay even closer attention to the economic recovery as it continues to unfold in 2021. Then, of course, there’s the market’s ongoing concern regarding some of the left-leaning policies and regulatory restrictions that might arise from a deep Blue Wave. Mr. Biden has been scrutinized throughout the campaign, in particular, on his stance towards the oil and gas industry and whether he will cut subsidies and/or enact restrictions on mining technologies such as fracking. At the same time, rumours persist that Elizabeth Warren could be named U.S. Treasury Secretary, raising the spectre of new limits on the banking sector.
And what could happen in a “light” Blue Wave scenario whereby Democrats win a narrower majority (52 seats or less) in the U.S. Senate?
For one, it may diminish the likelihood of Ms. Warren giving up her seat in the Senate to become U.S. Treasury Secretary. The chance of a Republican taking her place may be too great a risk for the Democrats if it tips the balance of the upper house of Congress against them. In addition, some of the moderate Democratic senators may be more inclined to side with their Republican counterparts on more controversial legislation and other decisions including the size of any fiscal stimulus package that is forthcoming.
Any final thoughts heading into what some people are calling the most important U.S. election of all time?
In addition to what’s already been noted, investors should be prepared for a contested election result if Biden and the Democrats win by a narrower margin than current polls suggest. President Trump has already warned as much, noting on several occasions that mail-in ballots will lead to voter fraud. In the case he doesn’t concede, it would mark just the fifth time in U.S. history that an election outcome has been disputed, including the Bush/Gore race in 2000 that took just over a month to settle and coincided with negative stock market returns. Short of that, but also given the prevalence of mail-in balloting this time around, investors may still experience increased volatility from the prospect of not knowing who wins on election night. And then another potential wrinkle is the roughly two-month transition period that would take place between the election and inauguration if Biden is victorious. In the recent past, at least, U.S. stock markets have either swooned during this stretch of time, as they did following President Obama’s victory near the height of the financial crisis in 2008, or they’ve rallied as they did after Trump’s triumph in 2016. But given how contentious the current U.S. political climate is, there’s every chance that a transition period this time around will be more volatile than ever.
Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd. He is a regular contributor to AGF Perspectives.
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