The Election is finally over (at least mostly), and we are busy analyzing the outcomes of the Presidential and Congressional races and the possible impact on policy, the economy, the markets and your finances. Rest assured we are gathering the latest thoughts of economists, strategists and money managers, and evaluating whether any changes might be required in our planning work with clients or our management of your portfolio. In the meantime, we thought you might find the following Q&A about the election results interesting and informative.
Q: What’s the biggest election takeaway for investors?
The outcome of the presidential election became clear over the weekend, with major news networks and the Associated Press calling the race for president-elect Joe Biden.
While it initially looked like Republicans would maintain their majority in the Senate, it now appears that control will come down to run-off elections for both Senate seats in Georgia. Those elections will take place January 5, 2021.
The outcome of those races will determine whether Democrats have the ability to control the agenda in Washington, or whether the new president will face a divided Congress that will make it very difficult to pass his agenda.
Q: What’s likely to get done over the next two years that would matter to investors?
Until we know which party controls the Senate, it’s difficult to say. But we think four things may happen regardless of the outcome in Georgia:
Economic stimulus. Another round of stimulus is likely, but the timing and size of an aid bill remains uncertain. Congress is likely to work on a package during the November/December “lame duck” session. If they can’t reach a compromise, however, look for economic stimulus to be at the top of the policy agenda in early 2021.
Infrastructure spending. Both parties have supported needed spending on roads, bridges, ports, airports, broadband capacity, and other infrastructure projects, but the two sides have been unable to agree on how much spending and how to pay for it.
Greater scrutiny of Big Tech. There is already a Senate hearing scheduled later this month with the CEOs of Facebook and Twitter to review how the social media platforms performed during the election. Next year, it’s likely we’ll see more scrutiny from Congress that probably warrants investors keeping an eye on.
Retirement savings legislation. A bipartisan bill that would increase the required minimum distribution age to 75, increase the 401(k) “catch-up” contribution limit from $6500 to $10,000 for individuals over 60 and take other steps to enhance retirement saving opportunities could be a contender for action next year.
Q: What is the likelihood of significant tax legislation being enacted that would take effect during and apply to the 2021 calendar tax year?
In a divided Congress, extremely unlikely. Major tax increases just cannot happen in a divided Congress.
A narrow Democratic majority in the Senate, however, brings into play potential increases in the corporate tax rate and the top individual tax rate, as well as changes to the estate tax, the treatment of capital gains and dividends for the wealthiest filers, and more.
While it’s possible that any tax changes passed in 2021 could be retroactive to the beginning of the year, new taxes—if they happen—would more likely not take effect until the beginning of 2022.
Q: When will the legal challenges to the vote end?
A key focus will be getting legal challenges resolved by December 8, which is the date by which states must certify their results in anticipation of the December 14 meeting of the electors in the Electoral College to cast their ballots.
While the legal process could take several weeks to unfold, it appears unlikely that those challenges could overturn the outcome in enough states to reverse the outcome of the election itself.
Q: What does the election map look like for the next mid-terms?
Historically, mid-term elections are bad for the incumbent president’s party. In fact, only twice since the 1930s—in 1932 and in 2002—has the president’s party gained seats in both the House and the Senate in a mid-term election. Since 1934, the president’s party has lost an average of 30 seats in Congress during mid-term elections.
In 2022, it’s likely we will once again be carefully watching the battle for control of the Senate. Of the 34 seats up for re-election in 2022, 22 are currently held by Republicans and 12 are currently held by Democrats.
Q: Both parties seem to dislike Big Tech companies, but for different reasons. Why?
Democrats have tended to focus more on the anti-competitive behavior of these companies and recently released a scathing report after a 16-month anti-trust investigation into Amazon, Apple, Facebook and Google.
Republicans have clashed with Big Tech leaders over perceived biases against conservative voices, content management and foreign influence. The Justice Department did recently sue Google for anti-competitive behavior in its search and advertising businesses.
Further scrutiny of these companies is a near-certainty in 2021, but it’s difficult to see the two parties reaching consensus on how to deal with them. Strong action by Congress or the regulators to break these companies up seems less likely with a divided Congress.
Q: What’s going on in the stock market?
The S&P 500® Index rose 1.17% and the Dow Jones Industrial Average rose 2.95% on November 9, largely driven by Pfizer’s surprising news that its vaccine is 90% effective. The company anticipates 50 million doses will available by the end of this year.
Last week’s rally (marking the strongest week since April) may have been partly driven by increasing investor confidence that government would remain divided, decreasing the risk of major policy changes—particularly in regard to taxes.
But the continuation of the rally today—led by classic cyclicals like Energy and Financials, whose performance tends to mirror the overall economy—may also be related to the possibility of Congress passing an economic stimulus package in the upcoming “lame-duck” session and a vaccine’s longer-term benefit to the economy.
Q: Of the priorities that were laid out on the campaign trail, which are likely to have the most impact on investors?
Markets appear to have been betting on Biden’s environmental priorities. The MSCI Global Alternative Energy Index widely outperformed traditional energy stocks (as reflected by the MSCI World Energy Sector Index) as Biden’s lead in the polls solidified over the summer, and saw an extra surge after the debate on September 29.
However, if the Senate remains in Republican control, it’s unlikely the U.S. will embrace major climate change legislation. Because alternative energy stocks have already rallied sharply, there may be risk to those gains if the Senate doesn’t flip.
Q: Foreign adversaries have, in the past, used the transition period to stir up trouble. What form might that take this time around?
We know there are countries looking to advance their influence when they think the U.S. is distracted or unable to effectively respond: Iran, North Korea, Venezuela, Syria, Russia, even China. It’s possible we’ll see actions that could upset markets—even if only temporarily.
Geopolitical actions in conflict with U.S. goals have been common to all transition periods to a new administration, from Election Day to Inauguration Day. But stock markets have reacted differently to them during recessions, recoveries and expansions.
When in a recession, stocks posted losses during the period from Election Day to Inauguration Day in 2000 and 2008. In contrast, stocks went up in 1988 and 2016, while the global economy was in the midst of a long economic expansion despite geopolitical threats.
The current environment could be compared to the transition periods following the 1980 and 1992 elections: Recessions had recently ended, the economy was beginning to recover, and the stock market was vulnerable to shocks. In January 1981, the Iran hostage crisis came to a head, with American hostages finally released shortly after incoming President Ronald Reagan’s inauguration. In January 1993, Iraqi missile movement prompted outgoing President George W. Bush, with Britain and France, to bomb Iraqi missile sites. In both cases, stocks posted gains, although with heightened volatility.
Q: What do the election results mean for the bond market?
The initial reaction sent Treasury yields sharply lower and flattened the yield curve, on the expectation that it will be more difficult to get a large fiscal stimulus package through Congress. Senate Republicans favor a much smaller fiscal aid package than House Democrats. A compromise will likely be less robust than what the market had been pricing in over the past few months.
The Federal Reserve is likely to continue with its easy monetary policy. Short-term rates probably will remain near zero for the next few years, until the Fed sees inflation pick up and/or the unemployment rate fall closer to where it was pre-pandemic. That could mean the zero interest rate policy remains in place into 2024. We expect that 10-year Treasury yields will likely remain lower for longer. For the next six to twelve months, we expect yields to stay in a range of 0.5% to 1.0%.
Municipal bond yields may rise relative to treasuries, especially for issuers affected most directly by the COVID-19 crisis. There will likely be downgrades to bonds issued by state and local governments that already had high debt levels and have seen revenues decline due to the COVID-19 crisis.
Similarly, we see credit quality as a driver of performance in the corporate bond market. Highly rated investment grade corporate bonds benefit from the Federal Reserve’s lending facilities and typically have the wherewithal to withstand a slow economy. Also, it’s less likely that corporate taxes will rise, which should help the cash flow and earnings of many issuers. However, high yield bonds are likely to see more downgrades and defaults due to slow economic growth and high debt levels.
Q: What’s the outlook for the U.S. dollar?
The dollar has fallen by about 10% on a trade-weighted basis since March, when the Federal Reserve lowered rates and eased its monetary policy aggressively. In lowering rates aggressively, the Fed pushed real rates (adjusted for inflation) in the U.S. to levels that are similar to those in Europe and Japan. With the real yield gap closed, demand for dollars fell.
We see more room for the dollar to fall, but at a slower pace over the next six months to a year. The U.S. budget and current account deficits are large, which means we have to import dollars. Without a yield advantage, that likely means the dollar will move lower.
Q: How does the election affect the outlook for the dollar as the world’s reserve currency?
We don’t see any change to the dollar’s status as the world’s reserve currency any time soon. The dollar still accounts for about 80% of global transactions and the bulk of central bank reserves. Usage of the dollar has actually grown substantially over the past 20 years, and it dominates the world’s financial system.
Source: Schwab Center for Financial Research. The election analysis provided by Charles Schwab & Co., Inc. does not constitute and should not be interpreted as an endorsement of any candidate or political party.