‘If you are pained by external things, it is not they that disturb you, but your own judgment of them. And it is in your power to wipe out that judgment now’
– Meditations, Marcus Aurelius
The 2020 US presidential election is approximately a year away. Markets are forward-looking but the range of possible outcomes from the Democratic nomination process, let alone the general election, remains quite disparate. However, it is not too early for investors, asset managers and strategists to begin factoring it into their analysis.
As of the writing of this piece, prediction markets roughly assign a 75% chance that the Democrats retain the House, an even split between President Trump and his Democratic challenger of sitting in the White House, and a two-thirds chance that the Republicans maintain their majority in the Senate. In other words, odds are that the federal government will remain divided, and history suggests that markets can do very well in an environment where government impulses are stymied.
The largest source of uncertainty to this benign outcome lies squarely on the presidential race, which, as previously shown, amounts to a flip of the coin. Drilling further down, the real unknown is who will be the eventual Democratic nominee. As the crowded field narrows, two candidates have emerged as the frontrunners: former Vice President Joe Biden and Massachusetts Senator Elizabeth Warren. Within the framework of today’s Democratic Party, Biden can be described as a centrist or moderate, working within the parameters of orthodox policy, while Warren represents a paradigm shift that emulates elements of the New Deal and Great Society programs.
The times they are a-changing
Before assessing the merits of Warren’s candidacy, it makes sense to scrutinize the conditions that fomented her meteoric rise. Last month, the US Census Bureau released a report showing that income inequality in the country has reached its highest point in over 50 years. If this trend persists, it will lead to a decline in the US’s long-term fiscal health and debt profile while concurrently elevating political risk premia. In fact, rising inequality in the US is fueling the malignant surge of populism, both on the right and the left. In 2016, Trump’s victory and Bernie Sanders’ surprising performance during the Democratic primaries were initial signs of these underlying political shifts. Elizabeth Warren’s ascendant candidacy is merely the latest symptom.
The US electorate is unequivocally shifting to the left. It is unsurprising that polling shows the number of self-described liberal democrats is increasing at the expense of moderate and conservative democrats. This explains why Senator Warren is quickly closing the gap on Biden. And it seems that Sanders’ followers are more likely to fall into the Warren camp than Biden’s. In my opinion, this makes her ceiling potentially higher than the former vice president’s as she consolidates this leftward shift.
Warren in the oval office
So, would a potential Warren presidency alter our fundamental bullish thesis? While Warren’s potential election may not be the doomsday scenario that many pundits believe it to be, she will certainly prompt us to reconsider or avoid certain sectors and possibly reassess equity multiples.
While she would need unlikely House and Senate majorities to pass the most onerous parts of her legislative agenda, the president can still affect economic behavior by influencing regulatory agencies via executive orders. Based on her academic and congressional career, the sectors most at risk in this scenario would be tech, healthcare, defense and large-cap bank stocks. In other words, this year’s best performers. Her Medicare-for-all proposal would wreak havoc on the healthcare industry, and she has called for a breakup of companies like Amazon, Facebook and Google.
Thanks to the American constitutional framework’s checks and balances, a healthcare overhaul would require Democratic majorities in both chambers of Congress. But the calls for breaking up Big Tech could also be addressed by a Justice Department intent on beginning investigations into monopolistic practices.
In sum, if current polling trends continue, the probability of a Warren presidency must be considered, despite the overall strength of the US economy and our prediction that global growth will pick-up in early 2020.
If the US economic landscape were to darken, President Trump’s chances of reelection will plummet and a Democratic president would become the base case scenario. If Warren is the nominee then, at a minimum, regulatory risk would increase even under a divided government. Thankfully, her most radical policies are unlikely to become law given the institutional constraints imposed on the presidency by the political system. But the fact that we must now account for these probabilities in our risk assessment models reveals the gravitas of the upcoming 2020 election.
Ahmed Riesgo is the chief investment strategist of independent Miami-based broker-dealer Insigneo. He is responsible for devising and implementing the firm’s global market views and investment strategies, and managing the firm’s model portfolios.