What if we get a Blue Wave?
Dramatic policy shifts are likely under a Biden administration and Democrat-controlled Congress
The upcoming US elections could bring about some of the largest shifts in US domestic economic policy in decades.
These changes are most likely to happen in a so-called Blue Wave scenario, where Biden becomes President coupled with a Democrat-controlled Congress.
Recent polls are pointing to an increasing probability of such a scenario playing out, barring another "October surprise” (for instance, see FiveThirtyEight’s forecasts on the Presidential election and on the Senate race).
In this note, I focus specifically on the investment implications of a Blue Wave outcome, given that it will have the most dramatic impact on the global economy, taxation policy, interest rates, climate change and the technology sector.
Assuming a Biden administration and Democrat-controlled Congress, I expect:
Significant improvement in US and global growth in 2021, notwithstanding another COVID wave
Reflation trades to become more prominent. Increase overweight in equities.
Yield curve to steepen, front end rates to remain anchored by the Fed, while inflation expectations to rise. Investors should reduce duration risk in their portfolio.
US dollar to weaken, led by lower USDCNY. Asian investors can look to hedge US dollar weakness, either directly, or indirectly through some allocation to gold
Equities improvement to broaden beyond mega-cap tech stocks
US materials and to a lesser US industrials to outperform, reflecting infrastructure push.
Global renewable and clean stocks could have further to run, notwithstanding the significant rise in valuations already this year. Underweight energy sector.
Outside of the US, I'm positive on EM equities, especially in Asia. Look to add Asian cyclicals in particular (eg. Singapore banks).
Mixed views on global credit/corporate bonds. Asian credit might look more attractive. Stronger global growth should reduce default risks, but higher tax burden could weigh on cash flows of US corporations.
I detail the investment and economic implications of a Blue Wave scenario below:
1. Significant boost to US and global economic growth through more stimulative fiscal policy
I believe that global economic growth will improve significantly under a Blue Wave scenario, contrary to what many analysts believe.
While most commentators focus on Biden's plans to raise taxes, a Blue Wave scenario should also result in very aggressive spending plans.
In the near term, it will sharply raise the probability of a fiscal stimulus package of at least US$2 trillion being passed early in 2021, focusing on unemployment benefits and transfers to states.
Over the medium to long term, Biden's plans imply US$7trillion (>30% of GDP in today's terms) in spending increases on education, healthcare, and infrastructure, including on green initiatives.
These spending will more than offset his planned tax increases, such a rise in the marginal corporate tax rate to 28% from 21% currently (see chart below).
Source: University of Pennsylvania (see link here)
2. Yield curve to steepen; weaker US dollar in 2021
With significantly more stimulative fiscal policy, a Blue Wave scenario will also imply an earlier rise in US Fed Funds rate compared with the status quo, with inflation also rising faster than most analysts expect.
In the near term, I expect the yield curve to steepen. Longer-end US Treasury yields should rise, factoring in stronger global growth expectations coupled with increased fiscal spending plans. The short-end of the curve should remain anchored by the Fed’s commitment to keep policy unchanged until inflation overshoots.
As such, investors should look to reduce duration risk in their portfolio heading into 2021, assuming a Blue Wave scenario happens.
Over the longer term, we expect the Fed to start raising interest rates from 2023, compared with the current status quo forecast of 2025.
3. Taxation policies - most negative for US tech sector
Biden's taxation plans are progressive and imply significant redistribution. On the flipside, some commentators believe his proposed changes further add to corporate taxation complexity in the United States.
The combined impact of corporate tax changes are likely to be most negative for the US technology sector (see chart below). This will add some headwinds to the sector, on top of antitrust regulation that is currently under discussion in Congress.
Nonetheless, I believe that a Biden administration will find it difficult to implement the full extent of tax changes as planned, even with a Democrat controlled Congress. He will need to look for compromise amongst more centrist members of Congress. He will also likely wait for signs that the economic recovery is on a stronger footing before pushing through tax increases.
4. Climate Change - rejoining the Paris accord, while mandating climate disclosures for public-listed companies
A Biden administration will also bring about a generational shift in climate change policies, some of which he can already probably implement without the help of Congress.
Among other things, he plans to:
Rejoin the Paris accord
Increase global cooperation on climate change
Set net-zero carbon goal by 2050 for the US
Require public-listed companies to disclose climate risks and greenhouse gas emissions in their operations and supply chains
Increase investments in green infrastructure and renewable energy
Implement a carbon tax
While I believe that renewable and clean energy stocks have further to run over the long-term, I will probably look for some pull-back before adding given the significant run-up in valuations already this year.
5. Approach to decoupling between China and foreign policy
Many analysts believe that the relationship between US and China will improve in a Biden administration. We disagree with this optimistic view, given that the strong bipartisan support in the US to be tough on China.
As such, we believe the current trajectory of decoupling in trade and technology between the US and China will continue, even in a Blue Wave scenario.
If anything, conflict between the US and China could broaden to encompass historically touchy subjects such as human rights, cyber-espionage, and areas such as technology standards.
The one bright spot is that global cooperation between the US and China on climate change should improve.