In November, the bond and stock markets reacted to serial shifts considering the potential for a near-term, partial settlement of the U.S./China trade negotiations.
The 2020 election is likely to dominate headlines for the next 10 months. However, our base case expectation for the election cycle is that it should exert only a limited influence on the municipal and corporate bond market fundamentals in 2020. In our view, the partisan makeup of the House and Senate is likely to remain unchanged. Such an outcome is unlikely to move markets dramatically, since the federal policy trajectory is unlikely to change much.
For investors, this means that the least likely election outcomes are the most important to consider, because they bring the threat of transformational and less-predictable policy. An unexpected election result could alter current demand/supply dynamics, improve or weaken credit fundamentals in certain sectors and inject volatility into the market. The potential risk of an unlikely election result may become clearer in the months leading up to November 2020.
Currently, we see four possible outcomes. Below, we briefly summarize each scenario.
Status Quo (40%)
Trump wins, House = Democrats, Senate = Republicans
How it happens: A strong economy and the advantage of incumbency are generally reliable predictors of presidential elections. Based on these factors, most presidential election models predict a victory for President Donald Trump despite the president’s historically low approval ratings.1 Importantly, Trump’s performance against hypothetical opponents in key battleground states is generally better than his competitiveness for the national vote total.2 Likewise, Congress is likely to remain under Democratic control, based on the “generic ballot.”3
Impact: Re-election of Trump alongside the current Congress is likely to have marginal impact on the municipal market. Under this scenario, we expect little change to tax policy or federal spending priorities. Marginally more spending for infrastructure, health needs and higher education may be likely, which would promote the current stable credit environment for state and local governments, hospitals and higher education issuers.
Under this same scenario, we would expect marginal impact on the corporate market, given the potential for gridlock. A sustained business-friendly environment could prompt further corporate mergers and shareholder enhancement activities. Corporate taxes would be expected to remain low, supporting after-tax earnings, particularly for higher-tax, domestic-focused (Banks, Insurers, Rails, Telecom) and small-cap companies. Corporate taxes and, potentially, interest rates would be expected to remain low providing for a risk-on markets posture. An increasingly emboldened administration could take a more aggressive stance toward tariffs and international policies, which could create volatility and impact exporters (Aerospace/Defense) and basic materials producers (Energy, Metals/Mining, Agriculture).
Bond issuance may increase on elevated merger activity. Further deregulation could benefit exploration and production companies and others in the Energy sector in terms of their ability to drill and operate in certain areas of the U.S. Banks could benefit from a further rollback of Dodd-Frank rules, permitting more speculative, potentially lucrative activities. Defense firms may benefit as military spending is unlikely to decline under a Trump administration.
In light of all the above possibilities, we see a re-election of Trump alongside the current Congress as a credit neutral and spread positive for the corporate market.
Democrat wins presidency, House = Democrats, Senate = Republicans
How it happens: Although most election models point to a Trump victory, the president is historically unpopular.4 There is evidence that voters are less inclined to reward the incumbent based simply on a strong economy.5 Also, traditional models may poorly account for high voter turnout, which is likely in 2020.6 High voter turnout generally favors the Democratic candidate. Still, turnout and support for the opposition candidate may not spill over to Senate elections to the point of a shift of party control in that chamber.
Impact: Election of a Democrat alongside a Democratic House and Republican Senate is likely to result in only modest policy changes. In this scenario, we expect a push for higher marginal personal income tax rates and a higher corporate income tax rate. Depending on who the Democrats nominate, there could be a very high degree of gridlock. Recent federal budgets that have delivered marginally more aid for infrastructure, health care and higher education spending would likely continue. Municipal credit quality would likely remain stable.
Notably, an infrastructure bill becomes meaningfully more plausible in this scenario. As we have noted in prior years, House Ways and Means Chairman Richard Neal (D-Mass.) supports the Build America Bonds program and favors more federal infrastructure spending. He is likely to work closely with a Democratic president on these issues.
This same election scenario would be expected to result in a modest impact to the corporate market, given a potential high degree of gridlock. We see this potential outcome as credit-neutral and spread-neutral.
Corporate taxes would potentially increase, negatively impacting after-tax corporate earnings. Domestic-focused corporate sectors (Banks, Insurers, Rails, Telecom) typically have higher tax rates compared to multinationals (Pharma, Technology). In this scenario, the executive branch may also push for modest regulatory changes to some sectors. Bank regulatory relief could be reversed, potentially impacting profits but increasing stability. Energy companies and utilities may face some restrictions on carbon-related investment. Bond issuance could decrease modestly with greater regulatory scrutiny on large mergers.
Transformational Liberal (25%)
Democrat wins presidency, House = Democrats, Senate = Democrats
How it Happens: If turnout is extremely high and Senate Republicans are unable to hold the upper chamber, the election could result in a Democratic sweep.
Impact: Under this scenario, the possibility of much higher marginal tax rates and/or a public option health plan becomes more real. If summer and fall polling data point to this possibility, we would generally expect more volatility in markets.
In the municipal market, the Democratic candidate’s public statements could cause municipal/Treasury ratios to either fall or rise. For example, if the Democratic candidate announces plans to raise marginal tax rates significantly, investors might increase their holdings of municipals. In contrast, if policymakers begin discussing removing access to the exemption for high-income taxpayers, demand for tax-exempt bonds could weaken and ratios could rise.
From a credit perspective, a Democratic sweep might result in a public option health care proposal. Depending on its structure, such a proposal could prove helpful or hurtful for hospitals. A public option plan that expands the number of insured patients would likely reduce bad debt expense at many hospitals. However, if the plan displaces private insurance, hospital margins would likely suffer over time because we expect that reimbursement rates would be lower under a public plan.
A Democratic sweep might also result in a federal infrastructure bill or climate change bill that impacts the transportation or utility sectors. We would also expect a sweep to result in a material impact to the corporate market. We see this potential outcome as credit-negative and spread-negative.
In this scenario, an increase in the corporate tax rate and/or a boost in the federal minimum wage become more plausible, both of which would likely be negative for corporate credit. An increase in the corporate tax rate would hit all corporate sectors, although domestic-focused industries (Banks, Insurers, Rails, Telecom) would be impacted the most. Higher marginal tax rates would reduce consumer disposable income, which would impact consumer-focused sectors such as autos, consumer durables and retailing, among others.
If the risk of Medicare for All were real, it would negatively impact health sectors such as Insurance, Pharma, pharmacy benefit managers, and others. Regulatory oversight and anti-trust scrutiny would be expected to increase, which could weigh on margins and/or force divestments and spinoffs, particularly in duopoly and oligopoly sectors such as Technology, Telecom and Cable. Issuance could modestly decrease with greater regulation and a decline in merger activity. As an offset, potentially materially higher corporate taxes would increase in the relative attractiveness for corporate debt-financing.
Importantly, even under a Democratic sweep, the Democrats’ hold on the Senate is unlikely to be filibuster-proof. Absent changing Senate rules, the new president and Congress would be less able to push through legislation than the market might expect. This could create buying opportunities on the aforementioned volatility.
Transformational Conservative (10%)
Trump wins, House = Republicans, Senate = Republicans.
How it Happens: Under this scenario, which we believe unlikely, Republicans take back the House of Representatives.
Impact: A Republican sweep is likely to create late-year volatility because the market is unlikely to anticipate it. It would validate many of the president’s policy choices. We expect that under this scenario, Congress would again seek to reform the Medicaid program. This might include converting Medicaid to a block grant program or allowing states to limit eligibility standards. Both changes would negatively impact hospitals and states. An infrastructure bill might be possible, given the president’s interest in this policy area. However, we expect that a Republican-led infrastructure bill would include only modest new federal aid and, instead, focus on public-private partnership incentives and the privatization of certain kinds of infrastructure.
A Republican sweep would be expected to result in a modest impact on the corporate market. We see this potential outcome as credit-neutral and spread positive.
Corporate taxes would be expected to remain low, supporting after-tax earnings, particularly for higher-tax domestic focused (Banks, Insurers, Rails, Telecom) and small-cap companies. Corporate taxes and potentially interest rates would be expected to remain low, providing for a risk-on markets posture. An increasingly emboldened administration could take a more aggressive stance toward tariffs and international policies, which could create volatility and impact exporters (Aerospace/Defense) and basic materials producers (Energy, Metals/Mining, Agriculture).
Expected further deregulation activity could benefit exploration and production companies and others in the Energy sector in terms of their ability to drill for oil and gas and operate in certain sensitive areas of the U.S. Large banks could benefit from a further rollback of Dodd-Frank regulations, permitting more speculative, potentially lucrative activities (e.g. private equity, hedge funds and proprietary trading). Defense firms may benefit as military spending is unlikely to decline under a Trump administration. Bond issuance could increase on less regulatory scrutiny and a continuation of debt-funded mergers.
 Ben White, “Warning to Democrats: Economy points to a Trump Win,” Politico.com, October 15, 2019, and Katia Dmitreiva, “Trump’s Re-election Likely if Economy Stays on Course, “ Bloomberg.com, November 3, 2019.
 Nate Cohn, “One Year From Election, Trump Trails Biden but Leads Warren in Battlegrounds,” The New York Times, November 4, 2019.
 The generic ballot is a poll question that asks voters whether they will vote for Democrats or Republicans for Congress. See realclearpolitics.com for poll averages.
 Fivethirtyeight.com polling average. https://projects.fivethirtyeight.com/trump-approval-ratings/?ex_cid=rrpromo.
 Ben Casselman and Jim Tankersley, “Why the Economy Might Not Sway 2020 Voters,” The New York Times, October 29, 2019.
 William A. Galston, “What does high voter turnout tell us about the 2020 elections?” Brookings.edu, November 20, 2019.
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