In early November, which is not far off, the U.S. will hold an election in the midst of a pandemic.
(We say “in the midst” because, by November 2020, there is a very small chance the virus will be gone — and an overwhelming likelihood it will not.)
The stock market is ignoring the election, or otherwise failing to adjust the odds as of this writing.
We say this because three out of four election scenarios are bearish, and one is a full-on nightmare.
As a market event, the 2020 election can be viewed dispassionately. The inherent market bearishness in 75% of outcomes is not a matter of right or wrong, or which party is better for the country, but a simple weighting of policy impacts on corporate earnings.
For example, on June 29, presidential candidate Joseph R. Biden said the following at a fundraiser:
“I’m going to get rid of the bulk of Trump’s $2 trillion tax cut. And a lot of you may not like that. But I’m going to close loopholes like capital gains and stepped-up basis.”
Biden also said he would raise the corporate tax rate, from 21% to 28%.
Whether this would be a good move for the country, or a bad one, is up for debate. What seems fairly clear is that the stock market wouldn’t like it.
This is because, when the stock market is functioning properly, it values the corporate profits outlook above most everything else. A tax hike, paired with a middling-to-weak profit outlook, would be negative.
Then, too, in order to change policy in a major way, the White House needs Congress to cooperate. If the president and Congress are at odds, the general result is gridlock, where few things get passed at all.
With that in mind, we can divide the 2020 election result into four rough scenarios:
- Scenario 1: Republicans keep control of the White House and Senate.
- Scenario 2: Democrats win the White House; Republicans keep the Senate.
- Scenario 3: Democrats win the White House and the Senate.
- Scenario 4: The election dissolves into chaos and a bitter legal fight.
The U.S. House of Representatives is not a factor here because a change of control is highly unlikely for that body. The White House and U.S. Senate, on the other hand, are very much up for grabs.
We also leave out the possibility of Democrats winning the Senate, but not the White House, because that is not a likely sequence either.
From a stock market perspective — which, again, is narrowly focused on the corporate profits outlook, to the exclusion of almost everything else — the first scenario is the only bullish one.
That is because, if Republicans retain the White House and Senate, the Trump tax cuts would remain intact, which means the corporate tax rate would stay low.
Also in that scenario, with four more years of control, Republicans would feel free to authorize more fiscal stimulus, a fair amount of which would flow to Wall Street.
Scenario 2 is where things start looking grim.
If the White House changes hands and the Senate does not, President Biden would likely see his tax hikes blocked by Mitch McConnell.
In fact, a Democrat White House would likely see most everything blocked by a McConnell-helmed Republican senate, as Washington returns to “gridlock” status.
When it comes to preventing tax hikes, the stock market would like gridlock. It would not favor gridlock, however, with regard to future stimulus programs.
If the economy turns sour again, to the point where additional help is needed, a gridlocked Washington would likely have none to give. With Biden as a foil, Senate Republicans would probably transform into deficit hawks.
That could be bad for Wall Street — no more “helicopter money” — but potentially favorable for safe-haven assets like gold, as the Federal Reserve would be forced to step up even more with fiscal policy help taken off the table.
The third scenario, where Democrats win the White House and Senate, would be a true wild card.
Because Democrats already control the U.S. House of Representatives, a taking of the White House and Senate would represent true “regime change” in Washington.
In this scenario. not only would the Biden tax hikes be all but assured, a whole host of new programs and policies would be implemented.
If it felt strategically safe to do so, Democrats might even get rid of the U.S. Senate filibuster rule — at which point truly wild possibilities arise.
In this scenario, markets would be subject to a mind-boggling array of policy uncertainties, with tax hikes baked into the cake, and a serious overhaul of environmental rules and labor laws also likely.
This possibility is real, as confirmed by not just a handful of polls, but dozens of polls on a nationwide basis. It thus seems odd, almost bizarre, that the market is ignoring this scenario for now. (If it weren’t, valuations would be lower, to account for heightened uncertainty.)
The fourth scenario, which is sadly also plausible, is the true “”nightmare” result: A pandemic-themed jam-up where polling stations and mail-in ballots and vote-counting systems all go haywire, all in parallel, in an election where outcomes in the battleground states are close.
In this “nightmare” scenario, on the day after Election Day, there is no clarity as to who actually won.
Worse still, this lack of clarity could descend into lawsuits and finger-pointing and legislative chaos — with the final result unknown for weeks or even months, and possibly determined by a 5-4 vote in the Supreme Court. If it truly got bad enough, even the Pentagon might have to weigh in.
All in all, when the scenarios are considered dispassionately — not picking sides, just weighing odds and policy impacts — the election is a notably bearish event, with great uncertainties looming in November.
There is a caveat here, however, and it’s a big one: Gold and precious metals stocks look favorably positioned in a majority of election scenarios, even though the rest of the market does not.
This is because, no matter what happens in Washington, the Federal Reserve is likely to keep doing what it’s doing (expanding the balance sheet), and furthermore because gold and gold stocks have a track record of doing quite well in dystopian environments (like the 1970s and 1930s).
The uglier it gets, the more that investors will want a place to hide, with the added protection of assets that don’t lose value when the economy stagnates, or the dollar gets debased, or chaos reigns — or a combination of all three, which is what we might get.