Are markets scared of a “blue wave"?

Are markets scared of a “blue wave"?
Source: Andrew Kelly, Reuters
Democratic control of the White House and Congress would be big news for investors, putting a rollback of Trump-era tax cuts and higher government spending on the menu.

The 2020 Presidential Election signals two very different futures for the United States, leading markets and investors to brace themselves for all possible outcomes.

An increasingly likely outcome is that of a “blue wave” in which Democrats not only secure the presidency and maintain the House, but also flip the US Senate.

Democratic control of the White House and Congress would be big news for investors, putting a rollback of Trump-era tax cuts and higher government spending on the menu.

For investors, a strong Biden and Democratic victory would appear, on the surface, to be a resounding negative. Biden’s platform has committed his potential administration to higher taxes for wealthy individuals and their investment profits, as well as higher corporate taxes, which could affect company stocks.

Yet, at the same time, a “blue wave” would offer likely relief for investors. With coronavirus cases surging, a new stimulus package nonexistent and uncertainty over whether President Donald Trump would even accept the results of the election, a dominant Democratic victory in the White House and Congress would provide increasingly beleaguered markets with something they’ve lacked during the Trump presidency: certainty.

Market fears

On the surface, a “blue wave” would not appear to be at the top of the wishlist for many market investors.

A Democratic “trifecta” – i.e. control of the White House and both houses of Congress – is likely to result in higher government spending in the form of Biden’s multi-trillion dollar climate plan, as well as greater government revenue in the form of higher taxes on high-income individuals, corporations and capital gains by rolling back the Trump-era tax cuts.

According to Morgan Stanley analysts in June, the “deficit spending and redistribution” which would likely occur under a “blue wave” scenario could impact corporate confidence, investment and stocks, with corporate profit margins trimmed down due to higher taxes and more stringent regulation.

Beneficiaries of Trump’s 2017 tax cuts on the S&P 500 have underperformed since March, both as a result of the coronavirus pandemic, but also likely due to the sustained lead that Biden, and Democrats in general, have had in polling, suggesting that these cuts are likely to be reversed.

In contrast, those industries most likely to benefit from a Biden presidency and a “blue wave,” such as the health care and construction industries (Biden’s platform calls for billions of dollars to be spent on both infrastructure and health care), have outperformed competitors on the stock market in likely anticipation of a Democratic victory on November 3.

Market certainty

For the markets, while a “blue wave” would undoubtedly bring with it the return of stringent regulations, higher taxes on corporations and investments, and even bigger deficits, the news is not all bad.

Though the employment rate began to recover over the summer from its springtime low, that recovery has begun to show signs of stalling as a new coronavirus stimulus package appears no closer to passing.

The confusion in Washington hasn’t helped. President Trump has called for one thing, Senate Republicans another and Democrats something else.

Alongside the continued uncertainty stemming from the lack of stimulus and a pandemic still out of control, investors are wary of recent reports coming from the Trump campaign itself.

Reports suggest that President Trump plans to declare victory on election night if he is shown to be ahead, even if millions of ballots across the country remain uncounted, with the president publicly stating that as soon as the election is over “we’re going in with our lawyers” to stop the counting of ballots.

The continued resurgence of the coronavirus, an ailing economy and an incumbent president repeatedly unwilling to commit to a peaceful transfer of power and reportedly making plans to declare victory, whether justified or not, is bad news for markets.

It is in this climate that a “blue wave” has become less of a specter of doom for investors and more a marker of certainty.

Laura Kane of UBS Global Wealth Management believes a “blue wave” scenario could be “quite positive” for markets, in that not only would it provide a clear-cut winner in what could possibly prove to be a contested election, it would also likely provide a more generous stimulus package, which many economists believe is vital to solidifying the US’ economic recovery.

According to UBS analysts, “Biden’s widening lead in the polls and prediction markets, and along with it the likelihood of a Blue Wave, is reducing election uncertainty.”

Though a “blue wave” could mean more deficits, regulation and taxes, reduced uncertainty is a positive for investors, with “a delayed or contested election outcome” profoundly “more unsettling,” UBS reported.

A “blue wave” would mean consolidated Democratic control of the presidency and Congress, allowing Democrats to pass much of their agenda unobstructed and, thus, allowing an easier to forecast future for investors. This would avoid the “nightmare” scenario, as Bloomberg reports it, of a Biden win with a Republican Senate Majority.

On the other hand, a Biden win coupled with a Republican Senate would see much of Biden’s agenda blocked and familiar disagreements over stimulus negotiations and economic priorities continuing into 2021, giving rise to yet more long-term uncertainty for the markets.

Though a “blue wave” would not, in ordinary times, appear to be a prospect that would thrill investors, the electoral cycle of 2020 has carried with it many surprises, not least the growing support for a Biden presidency among Wall Street.

Wall Street banks and bankers have warmed to a Biden presidency, which, despite likely meaning higher taxes and regulation, would nonetheless act as a counter to the uncertainty caused by President Trump’s erratic leadership style, delayed stimulus and continued spread of the coronavirus.

With the 2020 campaign nearing its close, investors are eager for the election to deliver some form of certainty. This year, that certainty looks most likely to be in the form of a “blue wave.”

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