Linda Duessel: Hello and welcome again to the Hear & Now podcast from Federated Hermes. I'm Linda Duessel, Senior Equity Strategist, and today I'm joined via phone by Phil Orlando, Chief Equity Market Strategist, and RJ Gallo, Senior Fixed Income Portfolio Manager, for part two of our discussion of the 2020 election. Let me start with you, RJ. What indicators are you watching to predict the outcome of this election?
RJ Gallo: Well at this point, with a pretty high profile and consequential election coming up, poll watching has become a bit of a national sport. RealClearPolitics must love it, they get a lot of hits because they and places like FiveThirtyEight do a good job of aggregating across all the different polls, both at a national and to the state level. The problem with polls, of course, is they're polls. They're predictions, they're not certain. There have been some high profile failure of polls in the recent past, including most notably President Trump's election in 2016, so you've got to take them with a grain of salt. The polls are pretty strongly leaning towards Biden at a national level. I almost laugh that we even have national polls because that's not how we elect a president, we elect a president with 50 different state elections in the electoral college. When you look there, it's pretty tight, much tighter than the national popular vote polls would suggest. It's all coming down to 11 or 12 swing states and I think it's going to be a little closer than market convention.
RJ: Another indicator I like to watch are the betting markets. The betting markets are a way that have evolved outside the United States really to put money down on a political outcome. The price that an individual pays to bet that Biden or Trump will win translates directly into a probability of that outcome. When you look in those markets, Biden has a pretty good lead. Again, RealClearPolitics, I'm basically giving them a little bit of a plug here, but if you look at the latest betting odds on RealClearPolitics, which again samples across eight different offshore betting markets, they give about a 62% probability of Biden claiming the White House and about 38% of Trump being reelected. Clearly it lines up pretty well with the polls in which Biden is in front.
RJ: But in short, both of these I think might overstate the balance of risks as we head into this uncertain election. It's all coming down to swing states, a number of them are very close. Hillary Clinton won I think three million more popular votes nationwide than Trump did but she didn't get inaugurated in January because that's not how we elect a president. The state polls were also wrong last time, and there was a risk that the polls were misleading at the time because they under-sampled certain populations, most notably the shy Trump voter, if you will, and there's a risk of that happening this time as well, which is one of the biggest reasons why you have to take polls with a grain of salt.
RJ: Betting markets also were a little off last time. They had Hillary winning, probably for the same reasons. Betting markets have had a better track record in other elections, like in Israeli election the betting markets sniffed out Brexit when the polls did not, and that's how betting markets became more popular as an indicator, and that's why we look at them now. But we'll see how it all unfolds when we get to election day.
Phil Orlando: Like RJ, I look at this every day, this is a great indicator. But you go back to just Labor Day, six weeks ago. Biden and Trump were tied, they were dead even. And then you look at where we were a week ago and Biden had surged to a 65 to 35 lead, a 30 point lead, in part because Trump contracted COVID and his first debate was a disaster, the way he handled the whole SCOTUS thing. And now a week later that 65-35 lead is down to 60-40, you've gone from a 30 point Biden lead to a 20 point Biden lead in a week.
Phil: It was interesting that you asked the question about how did Hillary do in this poll four years ago. We went back and checked. Hillary, just before the election, was leading then candidate Trump in this RealClearPolitics thing, 88 to 13, she had a 75 point lead and as RJ said, she didn't get inaugurated, we know what happened there. The betting markets tend to move very quickly in both directions, and while it's a great indicator of where we are at a given point in time, you don't necessarily take it to the bank.
Linda: Not even the night before election.
RJ: You've got to remember, Hillary losing was a surprise to most. I think it's almost easy to forget that, but it really was. If you go back and look at how the expectations had clearly built heading into it, it's the cautionary tale for having too much confidence about what we think will come out on November 3rd as we move forward.
Linda: Phil, any other indicators you're watching to predict the election?
Phil: Yeah. One indicator that has met the test of time is the stock market itself, that investors tend to vote with their feet. As we study the performance of the S&P 500 over the last century, it's been a very good indicator of the election. How does it work? Well, it collectively looks at the performance of the stock market in the three months leading up to the election, quite literally August, September and October. If the stock market is collectively positive in those three months, the incumbent has to win the election. This actually has worked a hundred percent of the time, nine out of nine elections from 1984 to the present and it's worked 20 out of 23 times, 87% accurate, since 1928.
Linda: That's a pretty good track record, so what's it telling us?
Phil: Pretty good track record. If the stock market is negative the incumbent party tends to regain. But where are we now, you're probably going to ask. Well, we're up about 6% positive from July 31st through today. On this indicator, this would suggest that Trump's in pretty good shape. But the betting markets and polls, as we just talked about, are pointing in a completely different direction.
Linda: Wow. Well, I might say the S&P this time around may be trading on all of that unprecedented stimulus, and I've read where the dollar gives us some clues too. A weak dollar likes Biden and a strong dollar likes Trump, so we'll see what that indicates. But now I want to put each of you on the spot right now and say, all right RJ, who do you think will win this thing?
RJ: I think it will be very close and I think we might end up with a contested election where whomever is the apparent loser on election night doesn't concede, but when we get through the full counting ... You have a number of states, including Pennsylvania where a number of us live, they're going to keep counting mail-in ballots for up to three days after election day. I think Biden will actually end up winning, I think it will be much closer than the polls and the betting markets suggest.
Phil: I agree with my esteemed colleague. I think this solution is going to be a lot closer than the polls are suggesting. I think Vice President Biden is going to win the popular vote by a huge amount, five or 10 million votes, because of California, Illinois, New York, Massachusetts, New Jersey. But as he pointed out correctly, this election will be decided by the electoral vote and you've got a number of swing states that are right now very, very close. I think we're going to have a record number of mail-in ballots, maybe something close to 70 or 80 million, more than twice we've ever seen before. It's going to take us a month or six weeks or so to open all these things and process them and tabulate them and count them.
Phil: There are going to be challenges and court cases and whatever. I think ultimately this could end up looking like Bush-Gore 2000 all over again with the court needing to step in at some point in the middle of December to make some sort of a ruling that gives us some guidance on the direction and the path we should go. At this point I think it's going to be a coin flip election that will be decided in the electoral college. I'm wondering if that huge GDP number that we think we're going to see next week, which could be somewhere between 30 and 40 percentage points positive, whether or not that turns any heads in the direction of the president's chance of reelection.
Linda: I didn't catch who you thought was going to win then still.
Phil: I think it's going to be really close, Linda.
Linda: I know you do. Who's going to win?
Phil: I'll take the other side of RJ's bet. I'll take Trump as the winner in the electoral college with Biden having won the popular vote.
Linda: Okay. I would like to close up this piece of our discussion here by saying I've always thought that the winner would be the one who got out his base, but this time, as you mentioned Phil, we're going to get 10 times the historic volumes in mail-in voting. You don't have to get out of bed this time. I think I saw 30 million Americans have already voted. One thing I want to leave the listeners with is this question, if you didn't know either person and you said, Well, a group is going to vote for somewhat, but then another group is going to vote against someone. Who would you put your money on, the one that they're voting for or the one who's the recipient of the voting against the other guy?
Linda: I'm now going to move on to my second question and start with you, Phil. Of the most likely election outcomes, which do you see as most market-friendly and which as least market-friendly?
Phil: I think the most market-friendly, this is easy, is the Senate. The Senate, the Republicans need to hold onto a modest majority in the Senate in order to maintain a legislative check and balance with the democratically controlled house, and that way it doesn't really matter whether President Trump wins reelection or Vice President Biden wins because you will maintain that check and balance. I would argue that the Senate is a more important election than the presidency, and that I think will be the most market-friendly. I think you will see a rally in stocks if the Rs are able to maintain a split government in Congress.
Linda: Okay, and then the least market-friendly, what do you think, Phil?
Phil: I think would be the blue wave, the Ds running the table, which would provide them with a legislative mandate and then why wouldn't they execute that impressive list of tax increases that RJ discussed at the beginning of the call. As someone that studies the economy and tends to vote by pocketbook, Biden's fiscal policy proposals scare the bejesus out of me, and that would be one thing that I would be concerned about.
Linda: What do you think, RJ? Which is the most and least market-friendly from your vantage?
RJ: I'd pick up where Phil just left off there. I think that the immediate reaction to a blue wave, you've got Capitol Hill, you've got the White House, you're going to have a large fiscal expansion, you're going to have higher taxes which could motivate adjustments to people's portfolios leading into inauguration day. It seems like there would be sort of a risk off reflexive reaction to that blue wave and that would include stocks, obviously, and treasury yields might actually go a little lower.
RJ: From a fixed income standpoint, I don't know how long treasury yields would stay at that lower level because fiscal expansion will come with a lot of debt issuance. We already had a record budget deficit for fiscal year 2020, 23.1 trillion. It'll just stay very elevated under probably either president, but more so under Biden. I would think that ultimately that reflexive risk off, lower yields, lower stock prices, it might start to wear off because I think, Linda as you said earlier, the stock market long-term discounter, do we really think Biden's going to fundamentally change the American economy and make corporate America that much less profitable for a really long time? I personally don't think so. I think that capitalism will win and if you expand the social safety net, that doesn't make us a socialist nation, and that the markets will adapt.
RJ: I would think ultimately what is a reflexive risk off reaction ends up turning around and the stock market would do okay under a blue wave, they would like the fiscal stimulus, they would like what that is doing in the context of an unemployment rate that's almost 8%. The COVID hangover is still with us, we still are struggling with nearly peak COVID infections. Maybe having some different leadership on that key issue could actually be refreshing in terms of the potential for economic reopening. I just don't think in the end that that risk off would be some crash or would be long-lived. I think instead it would be reflexive.
RJ: In terms of more favorable market outcomes, Phil hit the nail on the head. If you can restrain policy extremes by having divided government, especially with the Republicans in the Senate, then Biden can take the White House, Nancy Pelosi can stay as the Speaker of the House of Representatives, and I think there would be a little bit of a relief trade in risk assets, and I would think yields might head a little bit higher on that. But they wouldn't rise too much because, let's face it, under any scenario the Fed is at zero and buying tons of bonds so I wouldn't expect a big washout in a risk on scenario for treasury yields.
RJ: I think ultimately a scenario we haven't discussed, if President Trump wins but is facing an entirely blue Capitol Hill, watch out for the impeachment version 2.0 because this time the House of Representative would be able to impeach on something, they'll find something, and the Senate would be in the hands of the Democrats and that actually might convict and remove President Trump. That would be a pretty tough outcome if Trump wins the White House but the Democrats take the Senate.
Phil: And Linda, historically from a stock markets point, that scenario that RJ just laid out, a consolidated democratic Capitol Hill and a Republican president, that combination over the last century has been the worst for the stock market, so I'd be rooting against that as well.
Linda: Oh, well if Trump wins we hope he has at least some Senate coattails then. I think it's very, very interesting that both gentlemen agree that the best thing is generally the checks and balances of a split Congress, and I just have to say that I'm reading more in my research here recently that the market would like that the least because the market is really hoping and expecting for this unbelievable stimulus, which I agree with the gentlemen here is definitely short-sighted and if we do have a blue wave will a Biden administration at least lean towards being more moderate, I think that's what we would look for.
Linda: Excellent. Okay, well thank you so much Phil and RJ, and thank you to our listeners. We look forward to joining you again on the Federated Hermes Hear & Now podcast. If you enjoyed this podcast we invite you to subscribe to the Federated Hermes channel to get every Hear & Now episode, as well as our other series, Amplified and Fundamentals, our global perspective on the issues, challenges and trends shaping the investment landscape.
Disclosure: Views are as of October 20, 2020 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Past performance is no guarantee of future results. Federated Advisory Services Company 20-40496 (10/20).