Policy, not politics

Durable market moves come from real policy change – not politics. The biggest areas of policy difference between Trump and Biden-Harris (or the Democratic candidate) are trade, immigration, tax, and industrial policy (spending and regulation – impacting tech, financials, and healthcare the most). We’re wrapping up an extensive white paper that will cover these key areas in detail.

Today, the market is betting that Trump will win in November. Even with a split Congress, the President has meaningful authority on market-moving factors such as inflation (tariffs) and the labor market (immigration). Investors are asking what and what isn’t priced in. We’re likely to see election-related volatility until November, when the president is elected, and Congressional makeup is known. What would bring the biggest market moves? 

First: the candidates themselves. President Biden's performance in the first general election debate on June 27th raised serious concerns about his age and mental acuity. With either Harris or a different replacement, we would be wary of strong market moves related to policy differences between him and any successor Democratic candidate. Though a replacement may have different skills, interests, and preferences within an overall policy framework, the general arc of policy priorities and how to achieve them is likely to be consistent.  

Second: the probability of a sweep. Both candidates and their parties have shown a willingness to spend, if on different things, and meager plans to make up for that spending with higher taxes or spending cuts elsewhere. As a result, the higher likelihood of a sweep on either side of the aisle makes a higher deficit more likely too. A higher deficit would require more Treasury issuance; higher Treasury supply, all else equal, may lead to higher market interest rates as investors demand more compensation for the risk they’re taking.

Third: presidential power. Much of the real impact of candidates’ proposals depends on Congress to become reality. But there are a few things presidents can do on their own. Levying tariffs are one such thing, and so we expect markets to react to rising probabilities of a Trump victory. Tariffs have historically been inflationary – effectively a tax on consumers, which could depress corporate earnings and thus drag on equity market strength. Notably, Trump and others see a way for tariffs to replace revenues lost to tax cut extensions (and reduce the deficit), but as we show below, this doesn’t seem likely.

The president also has significant discretion with regards to administrative appointments, such as choosing key officials within the executive branch, including Cabinet members, heads of federal agencies, and federal judges (including Supreme Court justices), subject to Senate confirmation. These appointments carry out the agenda of the president so they can significantly influence the direction of federal policy, the judiciary, and regulation.

Fourth: sector head fakes. We’re wary of sectors trades reflecting the traditional split between Republicans and Democrats. Why? For starters, Trump and Biden/Democratic policies are certainly different in many areas but have been more similar to one another in some policy arenas such as oil drilling and competition with China. In addition, the Supreme Court may have already taken the wind out of future policy differences after it overturned the Chevron deference doctrine. For this reason, for most investors, the most powerful strategy for election years is simple: stay diversified rather than chase tactical bets.

Finally: elections don’t stand alone. Much ink has been spilled describing how different election outcomes may drive meaningfully different economic and market outcomes, but the election isn’t the only game in town. In fact, the relationship between the economy and politics is much looser than many investors expect. Though elected officials control fiscal policy, they don’t control monetary policy or the economic cycle. Fiscal and monetary policies can create a system of incentives—such as reducing taxes and interest rates to promote economic activity—but these can only encourage, not enforce, certain behaviors for consumers and corporations.

Portfolio strategy

It may be simple, but this is a good week to talk about diversification. There are a lot of factors at play in this week’s market moves. Small caps experienced a 99th percentile move, likely driven by still-good growth and hopes for a friendlier Fed – a strong combo for risk assets. At the same time, we’ve seen a selloff in large cap tech companies, which could be election related. As we described above, sector impacts in this election year may be complicated. A typical “red sweep” trade my have pointed to less regulation – likely constructive for tech valuations – but the likelihood of higher tariffs on China are prompting concern. 

As we mentioned above, diversification is key at this point in the cycle, and it can help portfolios weather volatility. We are seeing many portfolios under allocated to structural themes (e.g. infrastructure), global opportunities (e.g. international equity), and credit (e.g. high yield) relative to a balanced benchmark and where wea re in the economic cycle. 

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