Tackling the biggest questions facing the markets and economy

Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

• Gridlock in Congress remains the most likely scenario
• Macro fundamentals remain the long-term driver of the market
• Avoid knee-jerk reactions to portfolios based on election outcomes

The long and winding road to one of the most unusual presidential elections in history is coming to an end – with Election Day now just 11 days away. There have certainly been many twists and turns over the last three months – from President Biden dropping out of the race, to a new Democratic nominee and two assassination attempts on former President Trump. And yet, the race to the White House (and the composition of Congress) still appears to be a toss-up. While there may be a few more twists before all is said and done, it is important to keep perspective – particularly when it comes to making investment decisions as historically, the market has looked through any election related volatility. With that said, this unique election cycle and potential policy shifts ahead have raised some key questions for investors. Below we delve into some of the biggest questions facing the markets and the economy in the weeks and months ahead:

• What Is The Most Likely Outcome Of The Election? | We view the race as a toss-up, with each of the seven swing states within the margin of error. However, regardless of who wins the White House, the most likely scenario is a split Congress. In fact, our political analyst is forecasting a 75% probability of Republicans flipping the Senate and a 65% probability that Democrats flip the House. If this happens, it will be the first time in history that both chambers of Congress flipped but remained split following an election. Why is a split Congress important? Because the system of checks and balances reduces the probability of one party enacting sweeping policy changes. That is why, for now, we are not expecting major changes in corporate taxes, regulations, and new ‘outsized’ spending initiatives.
• Will An Unknown Outcome Hamper Equities? | History suggests a mixed bag. There are only two instances in modern history when the election was not called on election night—2000 and 2020. In 2020, the S&P 500 looked past the uncertainty and was up ~11% from election night until the Georgia Senate run-off in January—powered by the positive tailwinds post the COVID vaccine announcement. 2000 was a different story, with the S&P 500 down ~5% from election night until Democratic candidate Al Gore conceded the race 36 days later. While the election may have been a factor, the weakness was largely due to the unwind of the dot-com bubble. In fact, the Tech sector was down ~17% over that time period, while the S&P 500 ex-Tech was flat. The point: while fears of a contested election or prolonged legal battles may be unnerving and lead to short-term volatility, macro factors (e.g., economic/earnings growth) will remain the long-term driving force.
• The Two Biggest Risks To Monitor – Taxes And Tariffs | With the 2017 Tax Cuts expiring at year end tax policy will be a focal point in 2025. With a split government, any lack of compromise leads to a sunsetting of the tax cuts that will (according to a Brookings Institute study) cost the average household as much as ~$1,900/year, negatively impacting consumer spending and the economy. Tariffs are another wild card—particularly as Trump has called for 60% tariffs on China and 10% on the rest of the world. Put into effect, our economist calculates that these tariffs (which can be unilaterally put in place by the president) could cost the average household ~$1.9k. But the question is whether these tariffs will go into effect immediately or serve as a starting point for negotiations with China and the EU. Aggressive tariffs could be a drag on growth and potentially result in higher inflation. The point: there are big policy uncertainties that could impact the economy next year that we need to watch.
• Should We Worry About The National Debt And Deficit? | Sadly, yes, it is a concern as the long-term fiscal outlook is troubling with the national debt nearing $36 trillion with trillion-dollar deficits forecasted through at least 2034. And that is before the generous tax and spending plans put forth by both candidates. But, from a market perspective, there is no near-term reason to panic. Why? First, while the level of debt may be growing, the Treasury has found willing buyers (retail investors) and demand remains healthy (bid-to-cover >2.0). Second, despite media headlines to the contrary, the historically elevated deficit could improve in the near term—thanks to solid economic growth, healthy withholding tax collections and the booming stock market (which will lift capital gains revenue next year). Another thing to consider historically, with a mixed Congress, the party that does not win the presidency tends to find fiscal discipline post the election. That is why we expect ‘shutdown risk,’ especially around the potential raising of the debt ceiling, to increase significantly next year as the opposing party looks for concessions to curb spending.

Bottom Line | Presidential elections can spark intense emotions, but it is important to maintain perspective. While politics is an important consideration, it ranks eighth in the 10-factor framework we employ to develop our asset class views. Fundamentals, such as economic growth, earnings growth, valuations, and Fed policy far outweigh politics. With the economy on track for a soft landing, corporate fundamentals on solid footing and the Fed easing, the macro-backdrop remains positive for equities—regardless of the election. Importantly, regardless of the party in power—Republican or Democrat—or whether we have a unified or split government, both the economy and equity markets have, for the most part, thrived and moved higher.

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