A November trifecta for the Democrats?
by Gary Schlossberg, Global Strategist and Paul Christopher, CFA, Head of Global Market Strategy
- Former Vice President Joe Biden’s double-digit lead in several presidential polls, if maintained, lessens the probability of another split popular-electoral vote while increasing the chances of a Democratic-led government.
- Although President Trump still could engineer a reversal in the polls, steadier sampling results and the president’s unfavorable rating make a repeat of 2016’s victory less likely in our opinion.
- Financial markets could begin to anticipate material policy changes, should investor expectations move beyond prospects for a Biden win to chances for a Democratic-led government and progressive influence in the new administration.
Front-runner Joe Biden built up a sizable, double-digit lead versus the president in early and mid-July polls, according to PredictIt and certain other canvassing groups, less than four months before the November elections. This widening lead suggests a reprise of 2008, when the incumbent party in Congress and the White House lost at the polls amid an economic crisis. In much the same way, rapid-fire events have upended the 2020 presidential race even earlier in this campaign, flip-flopping from polls tilted toward Trump as recently as March to the widening gap favoring the former vice president over the past month.
Chart 1. Can the president close a yawning gap in the presidential polls?
Probability of a presidential win by Joe Biden or by Donald Trump, in percent
2020 might not repeat 2016
In our view, a Biden lead in the polls that is not very different from Hillary Clinton’s in 2016 might be cause for concern among Democrats. However, Biden’s advantage has been more stable and broader across polls than it was for Clinton. Equally important is the difference in unfavorable ratings, never dropping below 52% for Clinton during her campaign according to a Washington Post article on June 8, 2020 (“Why Trump’s Bad Poll Numbers are Worse Than in 2016”). Biden’s unfavorable rating was 46% last spring and lower than Trump’s. Moreover, Biden’s advantage in the polls extends to all six key swing states (Arizona, Florida, Michigan, North Carolina, Pennsylvania, and Wisconsin)—and with an advantage that should absorb the kind of state polling errors that likely contributed to the president’s surprise victory in 2016.
We believe that the wide margin favoring Biden nationally and in key states (if maintained) is significant for several reasons. First, it lessens the risk of another split election decision, in which a loss in the popular vote is outweighed by the historically more important Electoral College tally. Second, a large winning margin lessens the chances that mail-in votes (and associated litigation) will draw out the vote count and keep the financial markets on edge for weeks after the election.
And third, Biden’s wide margin in the polls increases the chances of presidential “coattails” long enough for a Democratic victory in the closely-contested Senate vote atop what’s considered to be secure Democratic control of the House of Representatives. We believe a “One-party” government eventually could have far-reaching effects on financial markets, broadening the scope for another swing in the policy pendulum.
However, we believe that it is too soon to anticipate confidently the policy priorities in the next Congress. Our belief comes from the difficulty of knowing how moderate and progressive Democrats will share power, or how effective the Republicans may be as a minority party. We recall 2017, when the anticipated policy agenda was upended repeatedly by division among Republicans.
Another against-all-odds election win?
Long odds or not, a lot can happen in the nearly four months to Election Day. Just what will it take for lightning to strike twice for the president? First, there’s President Trump’s aggressive campaign style and the possibility of mistakes by the challenger—who is still juggling the sometimes widely different views of moderates and progressives.
Economic and social issues weighing on the president’s approval rating could swing his way as well. Economic growth could remain strong as the threat from the coronavirus-infection surge unexpectedly subsides. Or worsening racial protests could play to voter concerns about public order and safety. And then there’s the international dimension. Tensions with China, the most apparent “known unknown,” could deteriorate enough to bolster the president’s reputation as a hard-liner against that country.
All that to say that, in the words of that well-known native son of St. Louis who found greatness with the New York Yankees, “It ain’t over ‘til it’s over.”1
Pandemic-inflicted strain on state and local finances
by Michael Taylor, CFA, Investment Analyst
- The surge in new virus infections and the re-imposing of stricter measures have raised fears about the potential for more economic damage, particularly for state and local governments.
- Stay-at-home orders and business shutdowns imposed early on to help slow the spread of the virus impeded local economies and proved problematic for state budgets.
- In today’s environment, we believe that municipal bonds offer compelling yields and attractive tax benefits versus U.S. Treasury bonds and corporate bonds, but selectivity is important.
A second round of lockdowns
In June, states were continuing to ease lockdown restrictions and gradually reopen their economies. Yet, in recent weeks, many states have paused or reversed course, given the resurgence of COVID-19 outbreaks in certain regions, particularly across the Sun Belt and the West. President Trump granted latitude to states in lifting restrictions, and there are variations in how governors are managing the economic reopening. The surge in new infections and the re-imposing of stricter measures have raised fears among consumers and businesses about the potential for more economic damage to come.
On July 1, a large majority of states commenced their fiscal years, and many are facing grim budgetary prospects for 2021. States generally are required to balance budgets to prevent unlimited borrowing, so a decrease in revenue could lead to cutbacks, including layoffs and reductions in capital investment. Below, we consider the strain on state and local government finances inflicted by the pandemic—and the implications for the municipal bond market and broader economy.
Important growth contributors
Since March, widespread unemployment and economic fallout from the coronavirus pandemic have impacted state and local finances. The stay-at-home orders and business shutdowns—imposed early on to help slow the spread of the virus—impeded local economies and proved problematic for state budgets. Overall, approximately 50% of state revenues come from taxes, primarily from personal income and sales taxes.2 Shuttered businesses curtailed retail sales and sales taxes during the pandemic outbreak, and unemployed workers diminished income tax revenues and increased demand for unemployment relief. Moreover, many states delayed income-tax filing deadlines, and this extension will exacerbate the drag on revenue.
State and local governments are important contributors to the broader U.S. economy. Investment by states in education and infrastructure is crucial for the long-term potential economic growth rate. Employment by state and local governments represents roughly 13% of total U.S. employment and approximately 20 million workers, while state and local consumption and investment composes about 11% of U.S. gross domestic product (GDP).3 Since February, state and local government payrolls have declined by 8%.4 While some state and local jobs likely will return as economies reopen, budgetary restrictions and shortfalls could lead to more layoffs or even permanent job losses ahead.
Chart 2. Change in state and local government employment (June versus February 2020)
It is unclear how COVID-19 and the economic fallout will impact congressional and gubernatorial races at this point in the election season. President Trump generally delegated reopening logistics to the states. A key factor that will drive state and local election outcomes is how voters perceive the success of the recovery and control of regional outbreaks. Another key issue for voters (and state leaders) is state and municipal solvency. Federal stimulus for states is being considered, which may help to mitigate the expected financial impact of COVID-19. Budget shortfalls, coupled with the loss of tax revenues during the lockdown, have exacerbated financial issues for many states. At this point, it is unclear whether the next fiscal package from Washington will include aid for states and municipalities. Like the economic reopening and virus control, incumbents who manage through the crisis successfully could prevail in November.
What does this mean for investors?
The pandemic clearly is impacting states, cities, and other municipal issuers. Yet, we believe that municipal bonds still offer compelling yields and attractive tax benefits versus U.S. Treasury bonds and even corporate bonds. Today, we see opportunities for long-term investors in this sector. We generally favor essential service revenue bonds in the 6-13 year maturity range, and those with 3-4% coupons.
Admittedly, municipal bonds in the health care and transportation sectors tend to carry higher-than-average risk today, along with those secured by economically sensitive revenue sources (i.e., sales taxes, hotel taxes, convention centers, and sports facility revenues). These bonds likely would have greater inherent risk than many essential service and general obligation bonds in the event of a prolonged economic downturn. While economic headwinds are likely to persist, we believe that an emphasis on quality and selectivity is essential in the current environment.
Taking trade policy’s fork in the road
by Paul Christopher, CFA, Head of Global Market Strategy and Gary Schlossberg, Global Strategist
- Simmering disputes with China and Europe will keep trade policy on the front burner in the run-up to the November presidential election.
- We expect fundamental changes in U.S. trade policy if there is a broad-based Democratic win in the November elections. The extent of the change likely would be dependent on control of both congressional houses and the presidency, along with progressive influence within the party.
- Stark differences between the two presidential candidates on trade policy—and in potential outcomes for the global operating environment—add to the case for a portfolio tilt toward U.S. investments.
A slow simmer
Trade policy never has strayed far from the campaign debate, even during the worst of the pandemic’s economic impact in the spring. Its visibility is bound to rise in the homestretch of the presidential campaign, given the stakes in the election outcome.
Bipartisan support for a tougher stance toward China will keep trade relations with that country on the front burner during the campaign. Difficult negotiations centered on core grievances with China over access to its market, subsidies, and intellectual property protections have been compromised materially by U.S. accusations of a coronavirus cover-up by China, along with geopolitical disputes over Taiwan, China’s treatment of its Uighur minority, and its new National Security Law in Hong Kong.
Moreover, China has fallen well behind in its promised imports from the U.S. as part of the January 2020 trade agreement. Chinese purchases from the U.S. of $20.4 billion in the first four months of 2020 were less than half the targeted $47 – $48 billion.5 Threats to national security also have been used as a rationale for restrictions on China’s U.S. exports.
Trade policy at a crossroad
The need to rekindle world trade’s historic role as a growth engine in a fragile global economy has enhanced trade policy’s election-year visibility. Added visibility is coming from trade policy’s fundamental changes under the Trump administration—inviting an assessment of its strengths and weaknesses in fostering growth at home and abroad.
A Trump victory in November would be viewed as a mandate for bilateralism in trade talks, giving the U.S. maximum leverage to pursue its “America First” agenda. Trade negotiations likely would be geared toward business-oriented goals of intellectual property protection, unfettered local-market access, and subsidies that are aimed at balancing bilateral trade. That same bilateralism implies a continued multifront trade war with China, Europe, and other trading partners of the United States. It also suggests a willingness to “weaponize” the U.S. dollar’s role as an international currency by using sanctions and financial restrictions to achieve foreign-policy goals.
A Biden presidential victory likely would tilt policy toward a more cooperative approach with U.S. trading partners. Policy likely would focus on revitalizing and reforming the troubled World Trade Organization and even rekindling regional trading agreements with Asia and Europe. However, the U.S. and its allies have different national trade objectives. These only partially aligned objectives risk complicating any consensus to the point of diluting any trade pressure on China.
The impact of national goals is clear in the new U.S.-Mexico-Canada trade agreement (USMCA) that replaced the North American Free Trade Agreement (NAFTA) on July 1. Some financial-market participants are happy to see a replacement for NAFTA as an alternative to no agreement at all. However, the new agreement’s wage and local content restrictions on imported cars and other goods— inserted by Congress to protect U.S. workers—we believe are a step back from free trade. And implementation of the USMCA still could stumble over Mexico’s ability to implement new labor standards viewed as part of the agreement.
In addition, whoever wins the presidential election will face headwinds of moderate economic growth and political disagreements that predate the pandemic. Europe may “go it alone” late this year in implementing a 3% levy on digital revenues—translating to a more sizable tax on profits—after the U.S. broke off talks in June. The tax would hit hardest at large U.S. technology firms, creating a new flashpoint in U.S.-European trade. New ground would be broken on multinational taxes by applying them to the market where the service is consumed, not the domicile of the business. The proposed levy is viewed as leveling a playing field in which the tax rate of global technology companies averaged 9.5% in Europe compared to 23.2% for more traditional firms.6
A second risk from a Democratic sweep in the November elections could come from a reversal of the 2017 federal tax cuts, as that could encourage U.S. multinationals again to park overseas earnings abroad. That could invite U.S. government countermeasures that strain relations with host countries abroad. In sum, it is difficult to see how either U.S. political party has a clear path to promoting stronger global trade. Such problems, collectively, could continue to aggravate trade tensions.
Voters face a stark choice in the November election between the administration’s go-it-alone strategy and Biden’s more cooperative trade-policy approach, with China tensions an ongoing irritant. The president’s more targeted strategy may provide greater benefits to specific industries and sectors of the economy, but in a more unsettled environment for multinationals and trade-sensitive firms generally. The Biden approach likely would mean a more stable backdrop for the group as a whole but with benefits diluted by compromises inherent in a more cooperative strategy. Widely differing, uneven outcomes in either strategy affecting the international operating environment, combined with attractive longer-term opportunities at home, continue to favor a portfolio tilt toward U.S. investments.
1 Lawrence Peter “Yogi” Berra, July 1973.
2 House Committee on the Budget, April 27, 2020.
3 Bureau of Labor Statistics, June 2020; Wells Fargo Securities, June 17, 2020.
4 Wells Fargo Securities, June 17, 2020.
5 Bloomberg Economics, “Trade War Redux: Gauging Odds, Adding up Costs”, Tom Orlik, July 9, 2020.
6 As cited in a New York Times article, “Targeting Tech Giants, Europe Unveils Digital Tax Proposal”, March 21, 2018.