How Campaign Pledges Help Election Uncertainty Fall

Editors’ note: MarketMinder is nonpartisan and favors no party or politician, as we believe political bias blinds and leads to investing mistakes. Our political commentary serves only to assess elections’ potential economic and market impacts—or lack thereof.

In one sign 2020 is slowly returning to normal, the presidential campaign has moved to more traditional ground in recent days: Former Vice President and presumptive Democratic nominee Joe Biden has begun unveiling sweeping economic proposals, previewing the tack he will likely take on the campaign trail. Pundits have accordingly been crunching the numbers in his tax package, $700+ billion “Buy American” economic plan and $2 trillion in proposed energy infrastructure spending, commencing the typical election year speculation about proposals’ impact on the deficit, taxes, the economy and markets. In our view, this is all quite premature. It is far too early to assess not just the presidential winner, but also the Congressional races and the likelihood any sweeping proposal from any party can become law. For now, campaign pledges are merely a way of drumming up election support. In the process, they help markets slowly get clarity on how the political backdrop may look post-vote.

Given the scope of Biden’s proposals—which is not at all unique for any candidate in any party—and his large polling lead, it is natural for investors to try to discern some market impact. Last week’s plan featured $400 billion to buy American goods, $300 billion in research and development and $50 billion in worker training. Tuesday, Biden announced a $2 trillion, four-year infrastructure plan attempting to spur an energy transition to carbon-neutral electrical generation by 2035. Biden’s previously announced tax plan aims to pay for at least some of these efforts by reverting individual tax rates for those earning over $400,000 to 39.6% from 37% and corporate tax rates to 28% from 21%. Elsewhere on the tax front, Biden proposed raising Social Security payroll taxes. Currently, earnings above $137,700 aren’t subject to Social Security taxes. Biden would keep this but re-impose the tax on incomes exceeding $400,000, creating a barbell structure.

Whether you think the above would be great or awful for markets and the economy is largely beside the point. All legislation, regardless of anyone’s personal opinion, creates winners and losers. So the question to ask is: How likely is enactment? That question is impossible to answer today. Presidential polls at this juncture aren’t predictive. In July 1988, then-Massachusetts Governor Michael Dukakis led then-Vice President George H. W. Bush by 17 percentage points.^[i] Four years ago, former Secretary of State Hillary Clinton led then-candidate (now President) Donald Trump through the summer and in October commanded a 12 percentage point polling lead.^[ii] Polls provide an early snapshot, but the results depend on each campaign’s ground game and which can mobilize voters better in individual states. Assessing their get-out-the-vote efforts now is anyone’s guess when the general election campaign is only in its infancy, but it will become clearer over the coming months.

It is similarly premature to handicap Congressional races. Due to COVID-related delays, several states haven’t even completed primary races. Without knowing the candidates, you can’t assign probabilities to the outcome. Parties’ ground games also matter in Congressional races, as does whether the presidential victor generates big coattails. These factors, too, will gradually become clearer in the coming months. For now, no outcome is off the table—a Democratic sweep, Republican sweep and split are all feasible results.

Even if January 2021 sees the inauguration of a Biden administration with a Democratic Congress, that doesn’t mean these proposals pass exactly as outlined. They may not even be submitted to Congress in their present form. Campaign proposals are mostly intended to generate voter enthusiasm. Once the winning candidate is in office, regardless of party, they typically moderate. The reality of having to work with a diverse Congress—and all the horse trading that comes with it—asserts itself, as does the need to retain moderate voters’ support in order to win reelection.

Two recent examples illustrate this: 2010’s Affordable Care Act and 2017’s Tax Cut and Jobs Act. On the campaign trail, then-Senator Barack Obama proposed subsidized health insurance exchanges, including the so-called public option, which could allow individuals to access Medicare. But President Obama left it to the Democratic Congress to draft the actual legislation. They bickered for months, slowly ditching controversial aspects including the public option.

As for 2017’s tax reform, candidate Trump proposed slashing taxes on corporations and households. Initial discussions with Congress included a border adjustment tax (BAT) that was intended to replace corporate taxes. It also involved flattening the personal income tax code to three brackets. The final version lacked the BAT and changes to personal and corporate taxes were much less sweeping. Most importantly, the lengthy debate and watering-down process meant both laws were old news to markets by the time they passed, bringing little to no discernible impact for good or ill.

That process of gradually pricing in change starts now, as Biden’s unveiling his plans should help uncertainty fall. Many questions abounded beforehand, including how big an influence Senator Bernie Sanders’ followers would have on Biden and the Democratic Party’s platform. These plans are the first demonstrable answer, giving markets something to work with. They also hint at a Biden administration’s priorities. As stocks figure out more and more of what Biden and a potential second-term President Trump stand for, the uncertainty over both potential outcomes dwindles.

Investors and markets can form expectations, setting the baseline for 2021 returns. In our experience, this sets up what we term the “Perverse Inverse.” When markets expect Democrats in office, election-year returns are generally less than stellar, as markets fear (rightly or wrongly) sweeping reforms unfriendly to business. But inaugural-year returns tend to be above average on relief when those reforms are harder to pull off—or less extreme—than anticipated. The opposite usually occurs when it looks like Republicans will win—stocks rise more strongly during election years, but then underperform when hope fades that they can accomplish much.

Whether the Perverse Inverse plays out this year and next remains to be seen, but as election races take shape, we think falling political uncertainty—sooner or later— should aid stocks’ recovery.