What if the market can't surf the Blue Wave?

The counter-argument to the market impact of a Blue Wave election might have nothing to do with a massive stimulus or government composition

[Note: Originally posted October 13, 2020 on my now-defunct Substack]

The Blue Wave consensus and the market

Chart: Bloomberg’s John Authers

I don't have many rules about the market or investing because they would almost certainly be wrong. That's basically why I buy broad market ETFs and never individual stocks. I'd be so much more interesting at cocktail parties (if I went to cocktail parties anymore) if I could give some thesis on why semis are going to plummet, or why Peloton can go to $1,000. (I usually opine on Fed policy, which has the desired effect of turning people off and walking away).

And yet, one thing that's worse than making predictions is following some broad, consensus prediction. The latest example of this is everyone calling a Blue Wave, which would set up a massive stimulus package, propel value stocks higher, cause the yield curve to steepen, and push the dollar weaker.

The thing is, it is hard to really disagree with this. Based on any measure - polling, PredictIt, betting sites - a Dem sweep is a more likely outcome than not, an outcome that would set off a sequence of events described by numerous sell-side analysts.

In an attempt at being a good contrarian (or at least coming up with and considering the contrarian argument), I want to map out the opposite side of that argument (in perceived order from most probable to least).

  • Perhaps the biggest threat is that the Blue Wave doesn't materialize. Maybe Trump wins - PredictIt is still pricing that in as a 40% chance. Maybe the GOP holds onto the Senate - a 39% chance. Maybe Biden wins and the GOP holds the Senate. Any of those options are objectively bad for the market, because there's not going to be a massive stimulus in the pipeline.
  • Maybe the contrarian argument is around stimulus. Maybe the Dems go smaller than expected. Some estimates have put a price tag of up to $5T, including all the pet projects like a Green New Deal. If that whole package was chopped down to $2T, that's clearly going to hit stocks that are currently banking on a bigger package.
  • Maybe the market turns on a Biden administration. Maybe a potpourri of factors like a tax increase or trade policy that weigh on the expectation for a swift recovery. Or a rise in inflation that forces the Fed to act. There are a lot of tail risks to consider, but nothing is guaranteed.

But that's the thing - outside of a Trump win, the rest of the scenarios are relatively low(ish)-probability risks. Any stimulus is going to be larger than any bipartisan agreement that could hypothetically happen before the election. Tax policy historically hasn’t really mattered to markets or economic growth. There’s an extremely low chance of inflation spiking anytime soon.

Maybe the biggest risk is exogenous to a Biden administration

I think the biggest risk has nothing to do with any set of policies or composition of the government. A massive COVID-19 second-wave is clearly the highest probability risk for stocks in 2021. And maybe 2022. And possibly 2023. Every day features a horserace of COVID-19 headlines, but nothing is guaranteed around a vaccine, reinfections, or just our inability to do the things that need to be done to control the spread of the virus.

The takeaway: The unknown and uncontrollable is a lot harder to game out than any set of policies.

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