Extra Innings - Divided We Stand / Election thoughts

Following both an unprecedented campaign and Election Day, I wanted to share a few thoughts on the vote and the day after. As the pollsters scrape the eggs off their collective faces and the lawyers arm up, the one clear verdict coming from the elections last night is no one party won. While we don’t yet know who won the White House – and might not for several days, if not longer – we wanted to share our thoughts on the action so far:

The Democrats held onto the House of Representatives yesterday, while control of the Senate remains up for grabs. That said, we think it is more likely than not that Republicans retain control of the Senate, which would mean at least two years of divided government, regardless of the outcome of the Presidential race. A divided government could have a meaningful impact on fiscal policy, which in turn could have a significant impact on the economy and the markets. It is the outlook for fiscal policy we will be paying close attention to as we move past election day

To that point, it is received wisdom on Wall Street the market likes a divided government as it precludes the possibility of big policy changes, and historically the market has done well under such a political construct. If we are correct in assuming a divided government for the next two years, we think the market would look favorably on a status quo tax code through 2022. However, we also think the market wants – and expects – additional fiscal support for the economy, and a divided Washington, D.C. could make that less likely. A lack of additional fiscal support could impact the pace of economic recovery, bond yields, the performance of growth vs value stocks, and the direction of the US dollar. Markets will be weighing the pros and cons of a divided government over the coming days.

The key risks for the market in the next few weeks come down to two, in my view. First, we could see a rise in civil unrest as the recount continues. Depending on how bad this gets, it could negatively impact economic forecasts for the economic revival. Second, the Covid resurgence we are seeing in Europe could start to pick up steam here as well. We see both these risks as real but also short term in nature.

Looking forward to the spring, Covid should be waning with the combination of improving treatments, the arrival of multiple vaccines, warmer weather, and fewer and fewer people left to infect. The economic revival already underway should be gaining steam with another fiscal stimulus deal likely and visibility on the election/forward tax environment encouraging an investment resurgence. Cyclical companies in particular will be lapping very weak or negative numbers, helping the cyclical side of the market which has been a key drag till now. The Fed will likely keep short rates pinned near zero, and with deficits likely to rise in a divided government scenario, the yield curve should steepen somewhat; more good news for financials, a big piece of the value trade, where stocks are cheap on a relative basis.

So, while we had no clear political winner last night, we did have a winner: Mr. Market as of right now!

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