With Joe Biden’s selection of Senator Kamala Harris as his running mate, the stage is set, and we are entering the sixty-day sprint to the 2020 election. This election cycle is obviously unique for many reasons, and Covid-19 will serve as an ever-present backdrop. Not to diminish the ongoing health crisis, but we do need to pivot our attention to the contest for government power and discern what that may mean for our economy and our portfolios. First let us discuss some outcome probabilities. Since we all know the polls were dead wrong in 2016, we will look to gather information from a variety of sources.
According to the 538 Politics simulation (based on state polls, combined with demographic and economic data) there is about a 70% chance of a Biden Victory.
When it comes to traditional national polls, the gap is narrower, indicating an average Biden +7.4 point lead over Trump.
However, when you look at the betting markets, the spread is much tighter, with Biden only holding a 1.7 point lead, essentially a tie. The betting markets were more accurate than the polls in 2016 and would indicate that this election is going to be very close.
Finally, historian Allan Lichtman, the man who has correctly predicted every election since 1984, including 2016, has used his “13 keys” method linked HERE to predict that Trump will lose this time around.
The polling and model-based strength of Joe Biden is countered by the very real electoral college strength Trump exhibited in 2016 and is surely counting on again in 2020. Some estimates say that Trump could lose the popular vote by up to 5 million votes, almost 4%, and still win the presidency. This is a concrete advantage for the incumbent.
Taking all that into account, we are giving Biden a narrow edge going in to the fall, while recognizing that a lot can still happen between now and election day. Will we see a second wave of Covid-19? Will the economy continue to improve from the lows of the Spring? Will there be continued civil unrest across the country? How will the candidates come out of the debates?
There are really four potential outcomes. We will discuss them in order of my estimate of likelihood.
Scenario 1 – A Democratic Sweep – 50% Chance
The numbers point to a good chance that the Democrats break out the brooms this time around and sweep their way in to complete power. While Biden has not embraced some of the more radical proposals of the Elizabeth Warren and Bernie Sanders wing of the party, he has certainly proposed changes to the tax code, many of which are unfriendly to businesses and investors.
In a Democratic sweep, there is no reason to think that these policies do not get enacted in the first term. Sanders, Warren, et al, will all likely have prominent roles in the administration and the Democratic House will likely push a very progressive economic agenda. The following is via taxfoundation.org and are the base Biden tax proposals:
- Repealing the Tax Cuts and Jobs Act individual income tax reductions for those earning over $400,000 and restoring the top marginal income tax rate to 39.6% from today’s 37%.
- Taxing capital gains at ordinary income tax rates – up from a top rate of 23.8% today – for those earning over $1 million. Biden would also eliminate the step-up in basis for inherited assets with capital gains, instead taxing those gains at death.
- Capping the value of itemized deductions to 28 percent for those in higher marginal tax brackets.
- Raising the corporate income tax from 21% to 28%.
- Imposing a 15% minimum book tax on corporations with $100 million or greater in income.
- Doubling the rate earned by foreign subsidiaries of US firms, from 10.5% to 21%.
- Imposing the 12.4% Social Security payroll tax on wage and self-employment income earned above $400,000.
In addition to these tax increases, Biden has proposed a variety of tax incentives to encourage specific kinds of activity in the economy:
- A restoration of the electric vehicle tax credit
- Tax credits for residential energy efficiency
- Making permanent the New Markets Tax Credit
- Establishing a Manufacturing Communities Tax Credit
- A renter’s credit to reduce rent and utilities to 30 percent of income
- An expanded Earned Income Tax Credit (EITC) for those older than 65
- A $5,000 tax credit for informal caregivers
- Expanding the Low-Income Housing Tax Credit (LIHTC)
- A reinstated Solar Investment Tax Credit (ITC)
- A tax credit for childcare facilities built by businesses
- Providing a 26 percent tax credit to match traditional retirement contributions as a replacement to deductibility of those contributions (Roth treatment remains unchanged)
- Establishing a First Down Payment Tax Credit of up to $15,000
While his domestic tax policies are certainly less friendly than Trump’s taxation policy, for economic and investment purposes, those policies could be counter-weighted by his less aggressive posture towards China. It is possible that under a Biden administration, the tariffs and trade pressures with China will subside, easing some of the uncertainty in global supply chains and spurring capital investment by companies that may have otherwise waited due to trade policy.
However, his rhetoric on China has been relatively muted when compared with the obvious bombast from Trump on the China topic. It is possible that once in power, he actually picks the China ball back up where Trump left it.
He will also likely reinstate much of the federal regulation of business that has been rolled back by Trump.
This scenario will likely depress corporate earnings expectations and GDP growth expectations, albeit in a less drastic way than the proposals of Bernie Sanders would have.
Scenario 2 – Trump Victory / Democratic Congress – 30% Chance
With Trump’s strength in the electoral college, this scenario cannot be ignored. While the polls on State-based races were more accurate in 2016, the “Silent Majority” in swing states that propelled Trump to an electoral victory in 2016 could certainly show up again in 2020.
However, the Senate does not have any advantages of the electoral college, and the math does not look good for Republicans. For the Senate to flip Blue, the Democrats need to win a net of 4 seats (or 3 and the presidency). There are a number of vulnerable Republican Senators to choose from, including Cory Gardner in Colorado, going up against popular former governor John Hickenlooper, Marth McSally in Arizona, who already lost a statewide race in 2018 but was appointed to her current seat by the governor, and Kelly Loeffler of Georgia, who is facing allegations of insider trading. Add tough races for Susan Collins in Maine and Lindsey Graham in South Carolina and you have a difficult road ahead for Senate Republicans.
This scenario is total gridlock, and likely favorable for markets. There is a calming sense of certainty when you know that nothing of substance will get done in Washington. Trump will almost certainly sign no progressive legislation out of a Democratic Congress, and Democratic majority leaders will almost certainly send no Trump policies to his desk. He will still have his bully pulpit, still be able to act through executive action, continue to push for deregulation of corporate interests by the executive branch, but no lasting legislation will come out of this scenario.
This scenario does however present the potential for a significant crisis emerging from the Supreme Court. With both Stephen Breyer and Ruth Bader Ginsburg in their 80s, there is a significant chance of another vacancy in the next four years. How that would be handled with Trump and a Democratic Senate is anybody’s guess.
Scenario 3 – Trump Victory / Republican Senate / Democratic House – 15% Chance
The status quo option. This one just feels unlikely, are we really going to travel all this ground and end up right where we started? While the Senate numbers don’t look great for Republicans, there is always an inertia to incumbents and unseating well-funded Senators is not an easy task.
In this scenario, we can expect the next four years to look a lot like the last two. The Republicans will further secure their hold on the judicial branch, perhaps with another contentious Supreme Court nomination during the term. China will likely continue to draw the ire of Trump and tensions with them could ratchet up significantly with the realization that they have to deal with him for another four years. On the other hand, Republicans will likely not get any major legislation through a Democratic House, just as has been the case in the last two years.
In any Trump victory scenario, expect significant civil unrest heading in to 2021. However, as we have seen throughout the summer that does not necessarily have a negative effect on markets and economics.
Scenario 4 – Biden Victory / Republican Senate / Democratic House – 5% Chance
It is very unlikely that the top of the ticket would flip to Biden while leaving the Senate intact. Much less so than Trump carrying the presidency with a Democratic Congressional counterweight. However unlikely it is to occur, this scenario is my choice as the most favorable to markets. None of the progressive tax policies would make it through a Republican Senate, tensions with China would potentially ease, and you would still have mostly gridlock on the legislative front. This would likely create a more certain environment for doing business and present a relatively favorable scenario for markets.
Scenario 5 – Republican Sweep – 0% Chance
It is not going to happen. While technically mathematically possible, the election map in the House just does not show a viable path to a Republican majority.
Finally, it is important to talk about election season itself this time around. In 2016, while the result was a political earthquake, we had our answer ON election night. If you remember, the equity futures market was down significantly overnight, only to rally by the morning once everyone had a chance to think through the implications.
In my estimation, there is a high probability that we will not know who wins the election right away, and there is the potential that it devolves into a worse situation than we saw with Bush/Gore in 2000. With the millions of expected mail-in ballots to count, Covid restrictions in various states, and potential court cases to arise as a result, it would not be surprising for there to be significant unrest and uncertainty for days or weeks after the election. If neither side concedes and an election gets decided in the courts, we could have a full-blown constitutional crisis emerge in January. While I hope that it does not get to that and our election infrastructure can handle everything we are throwing at it this year, the probability of an adverse outcome is higher this year than at any time in living memory. That kind of protracted uncertainty would very likely lead to volatility in the financial markets.
One thing is for sure, it won’t be boring.