With the election just a couple weeks away I wanted to spend this letter discussing some things to watch to see if an early winner can be determined, how the Senate race is shaping up and our expectations under different scenarios. Of course, a delayed or contested result is possible, sparked by a record number of mail-in ballots.

A delayed or contested result

  • In 14 states ballots must be postmarked by election day and ballots that arrive within 14 days after the election are still counted
  • In 11 states officials are not allowed to open ballots until election day itself, among them three key swing states, Michigan, Pennsylvania and Wisconsin
  • President Trump has not closed the gap in the polls much on a national level, but he has closed the gap in a few of the battleground states, to levels even less than what he trailed Ms. Clinton by at this time in 2016
  • The market is likely prepared for a result to not be known on election night, but if the election is contested and the process drags out for a long time, volatility will be significant

A red wave

  • Admittedly, this is not very likely, but it is not impossible. If the President surges in the last two weeks and wins easily he could pull enough GOP seats with him to see the House go back to the Republicans
  • A few traditionally democratic Senate seats are surprisingly close in the polls, notably in Michigan and Alaska
  • No one is prepared for this outcome, but the stock market would probably respond well

A split government

  • The status quo: President Trump wins, the Senate stays with the Republicans, House to the Democrats
    • The President needs to carry three states he won in 2016 which are currently polling as tossups: North Carolina, Florida and Arizona
    • If he did that, he would just need to win one of the three battleground states in which he is currently trailing: Wisconsin, Pennsylvania or Michigan
    • The stock market would likely react well to this initially as the fear of major tax increases would fade. However, if this scenario causes delays in the next virus stimulus package that optimism could fade
  • President Trump wins, both houses of Congress to the Democrats
    • The Senate usually goes the way of the presidential race, so this is probably less likely but with a couple traditionally strong GOP seats showing very even polls, South Carolina and Montana especially, it is not impossible
    • Markets would probably respond similarly to the status quo, although more likely a larger stimulus bill would be passed, so maybe a more positive result
  • Mr. Biden wins, House to the Democrats, GOP barely keeps the Senate
    • Possible if enough GOP Senators successfully distance themselves from the President—this has been happening more recently as the likelihood of a win by Mr. Biden has been increasing since the virus hit
    • The market may very well like this result, as it would probably mean the big tax hikes would be more difficult, although some sectors would sell off due to the fear of increased regulation via presidential decree

A blue wave

  • All six election years since 1952 that were accompanied by a bear market and a recession saw the incumbent lose
  • Florida closes polls early at 630pm eastern, it also allows mail in ballots to be counted upon arrival, not starting only on election day. If Mr. Biden wins Florida, especially by a decent margin, the blue wave is probably happening
  • If Senator Graham in South Carolina loses his seat, held since 2003, the blue wave is probably happening
  • Senate races in Iowa and North Carolina are very tight, if they stay blue, the wave is probably happening
  • In Texas, polling is dead even, the state has not backed a democrat since 1976, if Mr. Biden wins Texas, the blue wave is probably happening
  • The Senate could very well finish tied, 50-50, the vice president casts the tie-breaking vote
    • If the Dems take the Senate this way or just 51-49, there are enough moderate democrats that the full Biden Plan would not likely be passed, but if the blue wave sees more like 54 or 55 Democratic seats, look out below
  • The stock market would react least positively to this scenario, especially if we do not get the answer for a long time. That said—
    • Taxes are going up no matter what, even if the President wins, we have to pay for this stimulus somehow
    • A blue wave would most likely result in a massive stimulus package and probably a quick infrastructure package
    • While higher taxes, especially higher corporate taxes, could slow the economy over the long term, more spending by incremental earners (those more likely to spend an extra dollar than save it) and infrastructure projects would boost the economy
    • Stocks have done better under Democratic Presidents since 1990, and it is basically a tie going back to 1900. Stocks have done better under unified party government than under split government

As you might imagine, there are too many unknowns to suggest taking investment action. As long-term investors, we would not recommend that anyway. However, it does make sense to review your personal planning needs in case taxes go up aggressively. The economy and the markets will be impacted more by how bad this next wave of the virus is, and by vaccine progress. There is a massive demand wave coming once we can go back to normal; we just do not know when that will be. And, of course, some things will never go back to the way they were, but that is not always a bad thing.

I hope you and your family continue to be healthy and that you can find enjoyment in the coming holiday season, in whatever form that takes in the current environment.

Edward J. Durica, III, CFA