With the first, and possibly the last, presidential debate in the rearview mirror and less than three weeks until election day, we have been working diligently on ensuring portfolios are properly positioned going into election day. As a team, we discussed the four possible outcomes and how the market might react. Below we will briefly touch on each scenario.
First, an explanation of where we think the state of the race sits now and why. Biden enjoys a 10-point lead in the Real Clear Politics average of polls. Importantly, he is polling above 50%, something Clinton did not achieve in 2016. We constantly remind ourselves that yes, the polls were off in 2016, but just the state polls, not the national polls. National polls had Clinton winning the popular vote by 3-points, a vote she ultimately won by 2%. The issue was at the state-level polling where President Trump managed to secure victory by winning the right states. Again, the state polls do not look good for Trump. Could he manage to pull an electoral win and lose the popular vote by an even greater margin? Certainly, it’s possible, but take Pennsylvania in 2016 as an example – Trump won PA by less than 1%, polls had him losing to Clinton by 2-points. Importantly, none of the PA polls heading into election day had Clinton reaching 50%. Currently, Biden leads Trump by an average of 7-points. We are leaving room for the polls to be wrong, but there certainly is not modern-day precedent for the polls being by a magnitude that would secure victory for Trump.
Now, for a look at the scenarios we see as likely outcomes, and the probability we would estimate of each case happening:
15% President Trump reelection – Democrats take the Senate
We start with the outcome we think is the least likely, but in our opinion would provide markets the most stability. Without a Democratic or Republican sweep in both branches of government the prospect of tax increases, onerous regulations or highly partisan legislation being rammed through is nearly taken off the table. Trump and the Democrats would have to sit down and negotiate an infrastructure package, for example. We think this outcome is the least likely because if the polls are that far off on Trump’s reelection chances, then it’s likely the key Senate race polls are off by a wide margin as well.
25% President Trump reelection – Republicans retain control of the Senate
This outcome, on balance, could be seen as positive for markets because of the greatly reduced risk of tax or regulation increases, but it comes with it the prospect of the bitter partisan politics we’ve seen for the last two years.
30% President Biden victory – Democrats take control of the Senate
We’ve put equal probability to Democratic or Republican control of the Senate with Biden as President. Currently, Republicans enjoy a 53-seat majority in the Senate. Depending on who you ask, there are five opportunities for a Democratic pick-up and one opportunity for a Republican pick-up. If all of those occur, the Democrats will have the four-seat pick-up they need to control the Senate. We think Democrats will most likely add seats in November, but they will have very little margin of error. The risk of a “blue sweep” is the higher probability of market-unfriendly actions and overreach like we saw in the first two years of President Obama’s term.
30% President Biden victory – Republicans retain control of the Senate
Much like a Trump reelection and a Democratic Senate, the split in power could prove stabilizing, taking overreach and the most partisan legislation off the table. Assuming a Biden presidency, we think there is an equal chance of a Republican and Democrat controlled Senate.
One final outcome we think is worth a mention is the unlikely but disruptive contested election result. Much has been made by both sides about delaying or denying the outcome of the election. While markets would not receive an ugly election outcome well, we think it would be a great buying opportunity. For whatever a war of words brings, we do not believe there is even the slightest chance of the military being called in to remove or prevent a candidate from assuming office.
Away from politics, the global economy is trying desperately to emerge from the global pandemic. After a sharp recovery in markets and economic data thanks to unprecedent fiscal and monetary stimulus, the effects are starting to fade. Most global economic indices have started to rollover (see Chart 1). In many respects, the impacts of the pandemic have not been avoided, just delayed. Papered over with free money and abundant lending, government actions accomplished what they set out to do, which was to bridge a gap and replace as much of the lost income as they could. Indeed, personal income from all sources in the month of April soared more than 14% from the previous year (see Chart 2). In August, income is still running 4.7% higher year-over-year. Without government support, income would be down over 2% year-over-year (see Chart 3).
As we head into the election (and considering the known risks), we will be reducing risk slightly in select portfolios. This will come in the form of a position in US equities that show a tendency to have lower volatility than the broader market. We will also increase AAA credit in our fixed income portfolios.
In closing, we at Custos will be working to finalize positioning over the next few weeks. Every two years we are reminded how fortunate we are that we have the right to vote in the greatest democracy the world has ever known. Sometimes we get the politicians we deserve. Sometimes we do not. But every two, four or six years we have the opportunity to try something different. The power of voting gives us a say in how we are governed, and regardless of how we feel in the current environment, it gives us the hope that the future can be better.
The views expressed in this newsletter represent the opinion of Custos Family Office, a Registered Investment Adviser. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment or services. The information provided herein is obtained from sources believed to be reliable, but no representation or warranty is made as to its accuracy or completeness. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results. Investments are not a deposit of or guaranteed by a bank or any bank affiliate. Please notify Custos Family Office if there have been any changes to your financial situation or investment objectives or if you wish to impose or modify any reasonable restrictions on the management of your accounts through Custos Family Office.