A watershed event in politics reflects a “fundamental shift” in the federal government’s role in domestic economic, financial, and social affairs. Based on the unprecedented governmental actions already taken by Congress and the Federal Reserve 2020 is a “watershed” year in American political history.
But will it be followed by a “watershed” election in which a majority of the electorate vote for a fundamental “shift to left” in governmental policies? Are investors prepared for what a potential increase in governmental activism means for the economy and finance?
Larger Role of Government
Never before during the post-war period has there been so much fiscal and monetary stimulus injected in a single year into the economy and financial markets. According to most estimates, the combination of federal stimulus programs and the expansion of the Federal Reserve balance sheet amounts to $5 to $6 trillion in aggregate fiscal and monetary stimulus.
That amounts to about 25% of Nominal GDP. According to the Treasury Department data, the 1981 biggest tax cut was the largest in scale and it only equaled 2.9% of Nominal GDP.
And more fiscal stimulus is in train. The Democrat’s and the White House are negotiating another $2+ trillion fiscal package. Additional fiscal help will not be voted on until after the election, and depending on the results on November 3 it might not become legislation until a new Congress is seated in January.
But according to a recent poll, 72% of likely voters support another $2 trillion in fiscal stimulus. So the odds remain high that an additional stimulus bill will get passed, although questions remain on scale, details, and timing.
The same poll also showed a large majority of voters (60% to 70%) support the ability of people to buy health plans through the government, favor an increase in paid family and medical leave, an increase in government spending on new energy infrastructure, and a hike in the minimum wage.
If people vote along the lines of these poll results investors need to prepare for an earthquake of change in politics as it represents a new era of federal activism and social policies.
To be fair, election outcomes do not translate immediately and directly into new legislation. But “watershed” elections do come with mandates.
The 1980 election was a “watershed” event in American politics. Ronald Reagan defeated the incumbent President Jimmy Carter by winning 489 of 538 electoral votes and 55.3% of the two-party votes. The 1980 election results obviously presented Mr. Reagan with strong public support for his platform of a fundamental shift to a smaller role of government in economic and social affairs.
But a mandate for change needs the congressional arm to pass legislation. Mr. Reagan’s victory ushered in a major change in the makeup of Congress with the Republicans winning 12 Senate seats (from 41 to 53), marking the first time since 1954 that the Republican Party controlled either chamber of Congress. So the outcomes of the congressional elections are as important as the presidential election.
2020 is not 1980. From a policy and market standpoint, it’s the polar opposite. The federal government is increasing its presence in domestic economic, social, and financial affairs, and people are asking it to do even more before the election on November 3. Meanwhile, today’s S&P price/earnings ratio stands at a level that is higher than only one other period in the post-war period (early 2000s), whereas in 1980 it was at the lowest level other than 1949.
Statistically, an additional dollar spent by the federal government has the same impact on Nominal GDP as a dollar spent by people or companies. But a dollar spent by the government is directed toward the “holes” that the private sector often misses and most of the income growth associated with the additional spending tends to flow towards labor and not in corporate profits. That suggests the potential earnings increase from additional stimulus may not be as powerful or as broad as investors think.
Yet, the bigger risk for the equity market is the earning’s multiple. If the rejection of federal activism and social welfare policies in 1980 were partially responsible for the secular drop in market interest rates and inflation (two catalysts behind the long rise in the equity market multiple) a reversal in those policies would trigger the opposite effect. As such, equity investors should be cautious regarding the election outcome and the potential rebirth of federal activism. Studies have shown that equity markets price-earnings ratio reverts to the mean, and the speed can be fast.