Politics and Lingering Uncertainties Drive 2020 Market Outlook
Writing about politics is probably as close as one can come to the proverbial third rail at an investment firm. That was a perpetual issue that I witnessed during my 18 years at Morgan Stanley—punctuated by the time when one of the firm’s senior strategists highlighted objective data that could be perceived as critical of labor unions and their supporters, after which the firm faced the prospect of mass protests that would have dwarfed the infamous mammoth inflatable rats that periodically populate New York City during a labor dispute. Simply put, political issues are sensitive and writing about them tends to elicit strong emotions. However, to ignore the political realities that seem likely to heavily influence markets over the next several years seems foolish and, at some level, negligent. So, I’ll do my best to play umpire and simply call the balls and strikes as I see them.
Caveats Under Consideration
First, some presumably uncontroversial caveats. To state the obvious, President Trump is the most unique president any of us have ever seen—certainly in style and often in substance. As we’ve previously argued, the markets have been far more concerned with his policies and less with his temperament, although the two clearly do intersect at times. At the most basic level, investors have embraced his signature corporate tax cut and broad deregulation, while opposing many aspects of his trade policy. For better or for worse, investors have largely ignored the significant increase in the US budget deficit, his intense Fed jawboning, and the ongoing risks to many of America’s long-standing global alliances. And yet, ironically, barring an unlikely conviction in the Senate, Trump will enter 2020 as the known quantity.
The Democratic nominee will likely win a primary campaign based on appeals to the party’s increasingly prominent left wing. Those appeals will almost definitely include sharply higher corporate and individual taxes, greatly expanded government involvement in healthcare, and some variation of the Green New Deal. The nominee may well feel compelled to moderate his or her views in the period between winning the nomination and the general election to appeal to critical moderate/independent swing voters, but the aforementioned general policies would likely be enacted in some form, especially if the Democrats win a clean sweep of both the executive and legislative branches.
Evaluating Wins and Losses
Again, all else equal, a Trump win would promise more of the same—at least to a point. The issue is that, outside of a few core bedrock principles such as assorted “America First” policies and low taxes, Trump’s priorities tend to be fickle. Moreover, to the extent he has consistently highlighted the relatively strong economy and equity markets as the cornerstones of his presidency, there has seemingly been a “Trump put” in place during his first term to help steer him toward relative moderation to improve his re-election chances. The recent “phase one” China trade agreement was a case in point. A second Trump Administration would have no such check in place other than Trump’s desire to act in ways that he believes are best for the country and for his legacy. That introduces new risks, in my view.
The picture obviously changes dramatically if Trump loses. The current Democratic front-runners are former Vice President Biden and Senator Warren. We would be very surprised if Bernie Sanders ultimately wins the nomination--and just a bit less surprised if South Bend Mayor Pete Buttigieg ultimately gets the Democratic nod. Former New York City Mayor Michael Bloomberg's weak current polling numbers belie his potential to break through in a potential "brokered convention" if Biden falters, in my view.
In broad strokes, Biden would likely be seen as a conventional moderate Democrat who would embrace Obama-like policies but not veer nearly as far to the left as say Warren. He has a long history of seeking to work across the aisle when he believes compromise is necessary to foment change. Buttigieg would also be viewed as a relative moderate. Conversely, Senator Warren is the candidate of whom famous ex-hedge fund manager Leon Cooperman recently warned “they won’t open the stock market” if she wins. That’s classic hyperbole, of course, but I think the general sentiment is correct, at least at first (understanding that any actual sell-off could already be partially embedded into stock prices prior to the actual election). The combination of significantly higher corporate taxes and individual taxes on those in the upper-middle and upper classes would weigh heavily on earnings growth, consumer spending and business spending, in my view.
Still, one shouldn’t completely ignore the lessons of the last eleven years. To the extent that “don’t fight the Fed” has been the defining mantra of the ongoing longest economic expansion on record, I suspect that Warren (like Trump) would likely appoint a dovish chairperson to succeed the more centrist Jay Powell. When push comes to shove (especially if the GOP retains the Senate), a Warren presidency may prove quite similar to the Obama presidency in terms of what actually gets implemented. And while the starting point valuation-wise is very different from 2009, it is reasonable to expect the equity market to come around to embrace a dovish monetary policy backdrop combined with increased fiscal stimulus...for a while. I elaborate on the “for a while” below.
Staunch capitalist Home Depot co-founder Ken Langone has said “the biggest single challenge to America and our future is income inequality.” It is plausible to think that massive fiscal spending will help to level the economic playing field and jump-start the economy after more than a decade of lackluster growth. There’s only one problem that I still can’t reconcile...
For all their policy differences, the element that seemingly unifies the populist-driven Trump and Warren campaigns is an apparent disregard for rising deficits. This reflects the growing acceptance of at least some form of so-called Modern Monetary Theory (MMT). MMT, at the most basic level, argues that taxation and debt issuance are not necessary to fund spending if a country prints its own currency—indeed, MMT argues that cutting government deficits erodes private spending. The MMT proponents, though still a significant minority of economists, argue that, particularly in a world of very low inflation and interest rates, governments should print as much money as they need because they cannot become insolvent. As such, programs such as single-payer healthcare, student loan forgiveness, and a universal jobs guarantee can be funded merely by increasing the deficit.
I could go on for many pages highlighting the logical shortcomings of MMT. However, as just one example, a core tenet of MMT is that the business cycle can best be managed via fiscal policy (i.e., Congress) rather than monetary policy (i.e., the Fed). Yet, there are certainly times, such as, say, after an oil price spike when inflation can accelerate, causing the economy to stagnate. This, of course, was one of the defining economic characteristics of the 1970’s. Raising taxes in such an environment, as MMT advocates would propose, is a surefire way to intensify a downturn. One of the Fed’s most critical roles is to take the proverbial punch bowl away when times get too good—I have no confidence whatsoever that the folks in Congress would jeopardize their re-election chances by doing the same. Suffice it to say, my view is that deficits ultimately do matter.