Election likely to highlight near-term vulnerabilities
Try to stay focused on long view, which is good in almost any outcome.
As we’ve noted in recent market memos, we are bullish on the long-term setup for stocks regardless of who wins tomorrow’s election, with 2021 proving to be almost as good a news year as 2020 was a bad year. Covid almost certainly will be in retreat as vaccines are introduced, treatments continue to improve and sensible self-protection measures grow more prevalent. The economy will be in sharp recovery with important year-over-year earnings comparisons at historically positive levels, especially off 2020’s first-half shutdowns. The Fed will remain on hold. And the election, whatever the outcome, will be behind us, with either winner likely to add another fiscal stimulus package—the only difference being how big and how long.
This said, we see the immediate post-election period as one with a high probability of a further modest 5-10% correction in stocks. “Modest” because the markets already have a lot of protection in place against the well-flagged chance of post-election uncertainty. But a correction nonetheless because there virtually is no outcome Tuesday that would be all summer sunshine. This, with the backdrop of the worsening Covid news out of Europe leaving all economic forecasters here cautious to begin with, is likely to spark the extension of the pullback that began in September.
Specifically, we see three possibilities:
- The Blue Wave hangover (30% probability) Until now, many Wall Street economists and market participants, perhaps overly enthusiastic to embrace “anyone but Trump,” have convinced themselves Biden’s policy agenda is relatively benign, even stimulative. Whether doing so consciously or subconsciously, we suspect most are ignoring the obvious deleterious effects from Biden’s “tax and regulate” platform, lest they give voters, or themselves, a reason to vote with the bullying and harsh-talking President Trump. But should Biden prevail and take the Senate with him, we expect the numbers crowd on Wall Street—perhaps for the first time—to start running his policy agenda through their economic models. While the case is real that the near-term spending stimulus will help in 2021, most rational economic models will need to adjust downward their expectations of long-term growth and, with it, forward stock prices. At Federated Hermes’ equity division, we believe a fully implemented Biden platform could shave a full percentage point off our long-term GDP forecasts for 2022 and beyond, leading us to likely adjust down our 3-year S&P 500 target from 5,000 to 4,000—still higher than where we are today, but less attractively so. Importantly, we continue to expect 2021 to be sharply higher from here, as the long-term negative impacts of a Blue Wave likely come later and, in any case, would not be entirely certain until signed into law and/or an executive mandate.
- No decision/legal battles through December(50% probability) As we’ve noted elsewhere, we see this probability as quite a bit higher than the market sees it, largely because we believe the election is far closer in the battleground states than the popular national polls project. Doubters of this idea assert, simply, “there is just no way these guys are going to get this wrong again! They’ve adjusted from their errors in 2016!” Our concern, however, is that the pollsters are committing the most common of mistakes in their projections this time around: “fighting the last war.” In 2016, pollsters miscalculated voter enthusiasm on each side (low for Hillary, high for Trump), mistakenly building turnout models off the turnouts achieved in 2012’s Obama-Romney fight. This time around, turnout might not be the key factor, as President Trump’s popularity/unpopularity seems to be driving record turnout on both sides. As such, we think the issue may more be the “hidden/embarrassed Trump vote,” which given the last four years of sound policy offset by the endless midnight tweets, bullying behavior and erratic governance, is likely to be much, much higher today than it was in 2016. Question: if you received today an anonymous phone call asking whether you supported the president for reelection, would you answer it? I doubt it. If the “hidden Trump vote” is real, which we think it is, the president is likely to win this election, or at least make it too close to call until the key swing states of Pennsylvania and Michigan count all their mail-in ballots. This latter process, which probably will skew heavily toward Biden given the bias of Democratic voters in the Covid era to use mail-in ballots, will take days and fleets of lawyers, which both sides have at the ready. When done, the survivor will face legitimacy issues that may make it difficult to govern. None of this will be helpful to markets already worried that Covid lockdowns may be coming as the days shorten and the winter weather rolls in.
- Trump wins “Bigly” in a shocker (20% probability) Though the lowest odds of our three scenarios, this could happen if not only the “hidden Trump vote” shows up, but also if relative turnout on both sides proves again to be far more favorable to Trump than anyone expected, even after 2016’s post-election adjustments. Some of this could be Covid-related. For instance, Democratic voters appear to be more Covid-concerned, and hence more mail-in oriented, than Republicans. Should some or many of the mail-ins either not show up at all, or are disqualified for such procedural mistakes as “failure to sign,’’ misuse of a “naked ballot,’’ “no postmark,’’ etc., the Biden turnout may end up being much lower than projected. On the other hand, the president’s rallies around the country seem to be generating enormous enthusiasm—one gets the impression that many Trump voters would drag themselves a mile over broken glass to get to the polls. If the Trump vote is boosted versus the national pollsters’ forecasts, the president could win in a landslide bigger than in 2016. If so, we’d expect a slow motion replay of 2016: an initial sell-off, this time lasting weeks not hours, amid the legal fights and rioting that may ensue, followed by a strong rally as markets looked not just into the positive catalysts in store for 2021, but also the very positive long-term growth implications of four more years of the current low tax, lower regulation and private-economy-supportive Trump second term.
As for election night, here’s my advice. Florida is counting mail-ins and early votes as it goes, so this time around, fewer hanging chads; it’ll report relatively clean numbers tomorrow night. If Trump wins Florida, as we anticipate, go to bed. It’s going to be a long three to four weeks ahead and you’ll need the sleep. If he loses the state, it’s the Blue Wave and time to start adjusting your portfolio if you haven’t done so already. Either way, we’ll be back on Wednesday with our interpretation of where we are.