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An Election Digestif

The results … and the stock market consequences.

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On Saturday morning, the Associated Press called the 2020 presidential election for the Democratic former Vice President Joe Biden. Meanwhile, Congress appears to be headed for a split decision. Democrats lost seats in the House of Representatives but should maintain their majority, and Republicans lost seats in the Senate but should maintain their majority (assuming both Georgia runoff elections do not flip to the Democrats).

The stock market clearly liked the results. The U.S. large company index (S&P 500) increased 7.4 percent for the week, which was its best weekly gain since April. The rise may be attributed to moving past a volatile event — a sigh of relief.

The period of uncertainty over the election results appeared to have a negative impact on markets, as the S&P 500 steadily declined in the three months leading up to the election. However, the more likely reason for the positive reaction is that the market preferred a divided government.

That might seem like a strange preference. Who likes gridlock? Nobody whistles through traffic on I-240. It was Abraham Lincoln who gave us "a house divided against itself cannot stand." But 2020 is a strange year. Let's go through the prospects of a (probably) divided government and how that might be a bullish scenario for stock investors.

From an economic policy standpoint, the election results did not fundamentally change the potential for a coronavirus fiscal aid package follow-up to the CARES Act. An aid package might have been larger in a Democratic sweep scenario, but we could still see a $1 trillion bill, and possibly sooner than February. The spotlight of the election drove months' worth of negotiations to an impasse. Now, post-election, and with the U.S. enduring a third wave of COVID-19 cases, congressional leaders have declared that they are ready to resume negotiations. A $1 trillion (approximately 5 percent of the overall U.S. economy) boost combined with a vaccine and pent-up demand could fuel the economy in 2021 and going forward.

On domestic policies, a divided government should provide President-elect Biden room to negotiate on trade, energy, immigration, healthcare, and regulation while limiting the potential for tax reform and large-scale spending expansions (i.e. healthcare, education, housing reform). And there are some bipartisan issues that could easily come to fruition, like an infrastructure bill, prescription drug pricing bill, and antitrust regulations for technology companies.

On foreign policy, the focus will be mending ties with allies, and then trade policy with China. Biden will likely still be tough on China, although perhaps through multilateral trade agreements rather than bilateral agreements and tariffs. More importantly, a Biden administration should use a more predictable policy approach, which could reduce market volatility and business uncertainty relating to U.S.-China trade.

From a stock market perspective, a "Biden portfolio" favors stocks in renewable energy, infrastructure, emerging markets and international regions, and healthcare (excluding big pharma). Keep in mind that substantial stock sector rotations under different presidential administrations are unlikely. Presidents Obama and Trump could not have been more opposite, but there was a strong correlation between stock sectors under both. Technology and consumer discretionary stocks (e.g. amazon.com, Home Depot, McDonald's, Nike, etc.) performed the best under both, while Energy stocks performed the worst under both.

Since World War II, there has been a divided Congress in 14 of 76 years. The average annual stock market return during those years is 10.5 percent, which is slightly lower than the entire time frame (11.5 percent). However, there has been one occurrence of a divided Congress with a Democratic president — President Obama from 2010 to 2014 — and the average annual return of 16.7 percent was the highest of any political scenario.

Maybe gridlock is Goldilocks. (Sources: JPMorgan and Bespoke Premium)

Tim Ellis, CPA/PFS, CFP, is senior investment strategist and wealth strategist for Waddell & Associates.

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