Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: contested elections, now and then.
Stocks Record Biggest Postelection Gain Ever
Last night turned out to be the nightmare scenario that investors worried about for months. With the final counts in five states still unreported, we are unlikely to get a definitive result before Friday. Even then, the president has pledged to challenge mail-in-ballot counts through the courts and is already calling for a recount in Wisconsin.
In September, investors were hedging against just such a scenario. The Wall Street Journal reported that:
“Traders are scooping up a variety of investments that would pay out if volatility extends far beyond Election Day itself, concerned that the outcome of the presidential contest could remain unclear into December.”
As illustrated in the chart below (from Goldman Sachs), investors positioned themselves for a jittery two months following the election.
They were right to be concerned about a contested election, and yet . . . stocks recorded their best post-election performance ever today. The Dow Jones and S&P 500 indexes have each gained nearly 3 percent, and the tech-heavy Nasdaq is up more than 4 percent.
Stock-market strength not only defies expectations of a sell-off in the event of an uncertain election outcome, but it also defies the expectations of the optimists. Broadly, the two bullish trades entering the election were:
A blue wave would usher in major fiscal stimulus and a reflation of the economy, in which case “cyclical” stocks sensitive to the macroeconomic environment would outperform. This outcome would be positive for consumer goods and services, energy, financials, and health care.
A divided government would limit fiscal stimulus and inflation, holding down interest rates for a longer time horizon and fueling continued strength in tech stocks. Nasdaq futures traded up on Trump’s early outperformance in Florida on this thesis.
Both bullish trades came in. While Treasury yields have fallen, equity valuations are pointing to broad economic strength as well as continued gains for tech. Markets are looking past near-term election uncertainty.
This broad-based strength is likely due to higher prospects for a modest fiscal package and a low probability of significant increased in taxes and regulations. With Republicans looking poised to hold onto the Senate and Biden the slim favorite for the presidency, the most likely fiscal-policy outcome is a negotiated package in which Republicans give some ground on state and local aid. Mitch McConnell has already expressed willingness to agree to such a bill.
Meanwhile, given the Democrats’ underperformance in Congress, Biden is unlikely to pass his most ambitious policy proposals — a tax increase and sweeping environmental reform. Wall Street analysts estimated the Biden tax plan would put a 12 percent drag on corporate earnings, not to mention environmental regulations.
So far, the markets are happy with the election outcome.
Around the Web
Though Trump currently trails in the Electoral College, his unlikely outperformance this year cements a political realignment.
Within the GOP, Justin Webb argues, “The loser is Jeb Bush.”
It’s him and his country club set. All those genial folks at home in board rooms and hunting lodges, sniffy about the public finances, untroubled by trans rights, unflustered by abortion. They have copped it big time.
Coming to a somewhat similar conclusion, Janan Ganesh argues in the Financial Times that the Democratic Party has yet to devise an effective strategy to counter Trumpism:
After an economic and public health shock, after four years of exhausting drama, after impeachment, Americans have not emphatically rejected either Donald Trump or Trumpism. Even if he loses the White House to Joe Biden, that will be the central lesson of the US election for a watching world, as much as for one nation’s anxious liberals.
Since the Civil War, there have been two contested presidential elections: the 1876 race between Republican Rutherford B. Hayes and Democrat Samuel Tilden and the 2000 contest between George W. Bush and Al Gore.
In 2000, the legal battle over a Florida recount spurred a sell-off in stocks. As Bloomberg’s Stephen Mihm put it:
The market was not pleased. “Wall Street Wants a Winner,” declared the New York Times two days after the election. The NASDAQ took the deepest dive at first, plunging 5.4%. But other sectors endured far less dramatic declines, reflecting optimism that the whole business would be settled pretty quickly.
No such luck. Three days after the polls closed, Democratic candidate Al Gore gave a pugnacious interview, making it clear that he wasn’t going to throw in the towel without a fight. Share prices swooned, and a trader interviewed by the Wall Street Journal described the crux of the problem: “The market doesn’t like not knowing who the Leader of the Free World is going to be.”
In the weeks leading up to the Supreme Court’s ruling in Bush v. Gore, the S&P 500 fell by 10 percent and the Nasdaq by nearly 20 percent. Unlike in 2020, the uncertain outcome caught traders off guard. Because the markets were positioned for turbulence this time around, there will likely be less of a sell-off.
The 2000 experience also served a test run for 2020. Despite the turbulence, Bush assumed office somewhat smoothly in January 2001.
To sign up for the Capital Note, follow this link.