Democrats & Republicans: Two pathways, one destination for markets
Today marks one week until what has become one of the most polarising elections in US history - an election that could have the highest voter turnout since 1908.
We expect the Presidential result to be close and given the high level of postal voting, the ultimate result may be delayed and contested by both sides leading to shorter-term market volatility.
Longer-term, the direction of policy and the markets is less dependent on the election outcome.
There will be more fiscal stimulus whether the Democrats or the Republicans emerge victorious - it’s the nature of stimulus that will vary. Further, we need to watch COVID-19 vaccine developments closely. This is the most important factor lending sustainability to the current economic rebound.
In our view, Democrats or Republicans simply represent two slightly different pathways to a very similar destination.
The Democratic path
Biden has campaigned on a 7 trillion-dollar fiscal agenda with the big-ticket items comprising education, infrastructure/decarbonisation and healthcare spending.
Aggressive income and investment stimulus is positive for economic growth. In that backdrop real rates can rise from record low levels, particularly with the additional pressure of funding the enormous fiscal deficit in the US, and the dollar would potentially weaken over the longer-term.
In global portfolios this favours high-quality cyclicals that have been ignored by the market, particularly stocks that benefit from infrastructure spending like 5G and decarbonisation plays.
In decarbonisation this accelerates the emerging super cycle we’ve been discussing for some time - suddenly you have the three biggest regions – Europe, China and the US - embarking on long-term decarbonisation plans. This could lead to a switch from a ‘virtual’ to a real asset investment cycle. Volkswagen and EDF (Électricité de France) are examples of beneficiaries.
An environment of super-charged fiscal stimulus and higher rates is also likely to be beneficial to financials – which are valued at incredibly attractive multiples in both an absolute and relative sense – as higher rates take some of the pressure off net interest margins and stimulus likely buffers overall credit costs in the economy.
You have to consider how the Democrats’ aggressive spending plans will be funded.
Biden is proposing lifting taxes to cover almost half of the spending, but there will still be a net 2 trillion addition to the fiscal deficit, from today’s 4 trillion dollars.
This will mean greater taxes on the corporates and the wealthy, a negative for domestic US businesses. And there’s the potential for a less friendly policy environment for big tech and pharmaceutical companies.
Much has been said about what might happen if the Democrats win enough Senate seats to remove the filibuster (essentially a tactic used in the Senate to obstruct and delay legislative change). This would open the door to reform and could further embolden the agenda.
Removing the filibuster rule is extreme. It’s not out of the question, but remember the Republicans and Democrats have previously controlled both the House and the Senate and haven’t removed the filibuster for legislation.
There is also the possibility of Biden winning and the Republicans maintaining control of the Senate. The Democrats would have a difficult time passing legislation and progressing their fiscal policy agenda.
There would still be fiscal stimulus, but it may be more muted as each stimulus package would have to be a negotiation between the Republicans in the Senate and Democrats in the House.
The Republican path
You can’t rule him out.
But for Trump, it can’t get better as he already has the Senate and is unlikely to gain the House. There is the possibility of a weakened scenario where the Republicans lose the Senate, but this is generally the status quo scenario. Will it be status quo for markets?
In the more immediate term that is likely. The market reaction won't be as friendly to cyclical stocks as a Democratic clean sweep, and secular growth stocks could extend their rally in the short-term, especially if vaccine news was to disappoint.
Naturally, Trump wants economic success, so there will still be more stimulus but it will be negotiated. That additional stimulus upside will flow through to cyclically-exposed businesses, but perhaps in a less accelerated fashion than what could happen under a Democratic clean sweep.
The final destination
In a situation where Biden wins and the Democrats take control of the Senate we will simply see more aggressive fiscal stimulus and accelerated regime change in market leadership – one where value, or lower multiple stocks, lead the market.
We still see this regime change emerging under a Republican president, albeit at a slower pace.
Stimulus is likely to be further amplified by COVID-19 vaccine success, which is ultimately far more important to the long-term direction of markets than the election. Our discussion with leading vaccine expert, Dr Michael Farzan regarding vaccine development issues and the likelihood of success can be found in this recent wire.
Listen to our latest Antipodes Partners podcast episode – a special 20-minute US election edition, where I discuss some of the above points in further detail with Alison Savas an explain how investors should position for the 'destination'.
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Jacob Mitchell is Antipodes’ chief investment officer. He is an award-winning fund manager, with more than 25 years' experience investing in equity markets. Jacob founded Antipodes in 2015 after deciding to leave Platinum Asset Management where he...
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