They say that a fair deal is negotiated when each party walks away a bit disappointed. I think that it’s fair to say that most American voters are a little upset at the current election results because they didn’t get everything they wanted. But given the split decision, we could also say that we did get something that we voted for. While many of us in the investing world had looked at the polling data and prepared ourselves for a blue wave takeover in Washington, D.C., the end result could end up being a better outcome for investors.
Instead of a significant $4 to $8 trillion spending program anticipated by Congress and the White House across COVID aid, infrastructure, education, and healthcare funded by higher taxes, every increase in spending and taxation will now be significantly negotiated and new taxation will be constrained. Expect a new COVID aid package to be assembled this month with Senator McConnell now negotiating with Speaker Pelosi. Senator McConnell indicated his willingness this week to pass a package before year end, and even suggested that it could include state and city municipality aid. Of course the size of the package will no longer be $2 trillion, but more likely in the $500 billion to $1 trillion window. While the smaller size of this aid may not be the boost that we were looking for in the Q4 and Q1 GDP numbers, it should help to keep many in their homes and to put food on the table through the holidays, and until we have a few approved COVID vaccines.
The elimination of potential massive government spending has also significantly lowered the outlook for inflation spikes, higher interest rates and a steepening yield curve. The Treasury will need to issue much less debt than had been expected and cement, aggregates and F-150 pickup trucks will no longer be in short supply anytime soon. As a result, longer Treasury bonds jumped by a couple of percentage points Wednesday.
The equity markets reacted violently to the election surprise. In fact, at one point Wednesday, growth stocks were outperforming value stocks by the largest spread in 19 years. Why? Well, a significant reduction in the outlook for interest rates made growth stocks more attractive to investors given their longer duration of earnings. Meanwhile, many of the stocks that we thought would benefit the most from a significant COVID aid and infrastructure spending package are lower-valued industrial, material and financial companies.
Below is a chart of the best performing industry groups for the last 1.5 days since the election results. Very growth-stock heavy with internets, semis and biotechs leading the list, as you would expect. But also making the list are the HMOs who will benefit from business as usual, and no significant changes to the pricing or loss ratios of their plans under a split Congress. The homebuilding sector also shows up on the list as a beneficiary of interest rates not rising as fast as we were expecting.
Underperforming sectors over the last 1.5 days were concentrated in areas of the economy that we thought could benefit from a significant uptick in government spending. So, you will see construction materials, engineering and steel industries have lost, along with their outlook for a $2-3 trillion infrastructure package. Banks also were hit as the outlook for a flatter yield curve and lower long-term rates began to sink in. REITs have also been weak as a reduction in massive economic stimulus potential may be affecting their tenants.
So, where do we go from here? Clearly the market outlook has shifted quickly from one of massive government spending to one of more limited government spending. Congress will do enough to get America past COVID, but don’t expect any major new programs that will require dramatic changes in funding or taxation. Hopefully, Congress will still put together a solid infrastructure package of needed projects that has a trillion-dollar figure on it. But America is going to be running lean and mean for a while until we get back on our feet again. Interest rates will stay lower for longer, which will help. Tax rates will stay low, which will also help. And the capital markets should enjoy both of these effects—helping to maintain good prices and valuations that can aid fundraising and confidence in our recovery. This is a good backdrop for equities and the Fed still has our back. While many of us may have expected future outperformance in other areas of the market this year under a blue wave, I bet that we will all end up pretty happy with our equity portfolios if our future government ends up doing just enough to keep us out of trouble.
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