What Would a Biden Presidency Look Like?

Quantitative & Strategy

WHAT WOULD A BIDEN PRESIDENCY LOOK LIKE?

June 8, 2020

Table of Contents EXECUTIVE SUMMARY

Joe Biden has officially clinched the Democratic nomination for president, and his odds of Discounting a Biden Win ...... 2 winning the Presidency in November have been steadily rising, and he is now at 54% on

PredictIt. As well, the consensus view has the Democrats retaining control of the House. The Law and Order Card...... 4 The PredictIt odds the Democrats gaining control of the Senate has been steadily improving over the past few months, and now shows a slight edge for the Democrats. In Biden’s Economic Policy ...... 6 the case of a 50–50 divided Senate, the Vice President casts the tie-breaker and the winner of the White House has control. The Rise of the Bomb Throwers ...... 8

While this is not meant to be an endorsement of any candidate or political party, it is time Health Care Policy ...... 10 to contemplate what a Biden victory might mean for the economy and the markets. If Biden were to win, there is also a decent chance that the Democrats might capture control of both Trade: The Silver Lining ...... 11 chambers of Congress. How should investors react to that outcome?

We believe a Biden victory should be a net mild negative for equity prices. Much depends on the degree of control by the Democrats should Biden win the White House. The chance of a Blue Wave sweep is possible, and it would embolden the progressives within the Democratic Party to steer policy further to the left with bearish consequences for the suppliers of capital.

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June 8, 2020 Quantitative & Strategy

Discounting a Biden Win Joe Biden has officially clinched the Democratic nomination for president, and his odds of winning the Presidency in November have been steadily rising, and he is now at 54% on PredictIt. For the uninitiated, the contract pays off at $1.00 if a candidate wins, so buying the Biden contract at $0.54 implies a 54% of a Biden victory. Exhibit 1: Presidency Betting Odds

Source: PredictIt The consensus view has the Democrats retaining control of the House. The PredictIt odds of the Democrats gaining control of the Senate has been steadily improving over the past few months, and now shows a slight edge for the Democrats. In case of a tie, the Vice President casts the tie-breaker and the winner of the White House has control.

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June 8, 2020 Quantitative & Strategy

Exhibit 2: Senate Control Betting Market

Source: PredictIt While this is not meant to be an endorsement of any candidate or political party, it is time to contemplate what a Biden victory might mean for the economy and the markets. If Biden were to win, there is also a decent chance that the Democrats might capture control of both chambers of Congress. How should investors react to that outcome?

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June 8, 2020 Quantitative & Strategy

The Law and Order Card In response to the current bout of unrest, President Trump has played the law and order card to assert control of the situation. This could be evocative of Richard Nixon’s successful 1968 campaign to win the White House based on a similar law and order theme. For those who can remember, 1968 was marked by incredible political turmoil, marked by:  The Tet Offensive in the Vietnam War, which broke the illusion of a quick victory.  LBJ’s surprising address to the nation, in which he stated that he would not run for another term.  The assassination of Martin Luther King, Jr.  The assassination of Robert Kennedy.  The riots outside the Democratic Convention in Chicago. Nixon’s gamble worked, and he won. Moreover, the stock market shrugged off most of these events and rose in 1968. Exhibit 3: The S&P 500 Shrugged Off Political Turmoil in 1968

Source: StockCharts Could Trump repeat the Nixon experience? Probably not. A recent Morning Consult poll showed that the law and order stance (or at least Trump’s version) is not playing well with the electorate, and an ABC-Ipsos poll came up with similar results . When asked if the respondent approved of President Trump’s handling of the protests and demonstrations in response to the death of George Floyd, the spread between “Excellent/Very Good” and “Only Fair/Poor” among all registered voters was -35%. Even among respondents who already approve of Trump’s performance the spread was only +29%. Normally, he should be winning this demographics by 50% or more.

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June 8, 2020 Quantitative & Strategy

Exhibit 4: Approval Rating of Trump’s Handling of the Protests

Source: Morning Consult Even among evangelical voters, which have been a bedrock of Republican support, the spread was -13%. Fox News report that 700 Club evangelical leader Pat Roberson chided Trump’s actions as “not cool”. Evangelical leader Pat Robertson criticized President Trump Tuesday for berating governors and threatening to deploy the military amid the racially charged protests and riots sweeping the nation following the death of George Floyd. “It seems like now is the time to say, ‘I understand your pain, I want to comfort you, I think it’s time we love each other,’” Robertson said on “The 700 Club.” “But the president took a different course. He said “I am the president of law and order” and he issued a heads-up. He said, “I am ready to send in military troops if the nation’s governors don’t act to quell the violence that has rocked American cities.” Matter of fact, he spoke of them as being “jerks.” You just don’t do that, Mr. President! It isn’t cool!” The law and order card isn’t working, and Trump’s support is eroding. There are five months until the election. While five months is a long time in politics, current polling is not favourable for Trump’s electoral chances.

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June 8, 2020 Quantitative & Strategy

Biden’s Economic Policy For investors, the most important focus is economic policy. While we don’t know the exact makeup of Biden’s economic team, we can get some clues of the philosophical direction by analyzing the writings of Jared Bernstein, who was Biden’s former chief economist. Bernstein penned a Washington Post OpEd in December outlining what he believed to be the “big economic lessons of the decade”. He followed up with further details in a blog post, with our interpretation in brackets.

 The unemployment rate can fall a lot lower than most economists thought without triggering inflationary pressures (run a hot economy, keep rates low).  Budget deficits cannot be assumed to place upward pressure on interest rates (implicitly supports Modern Monetary Theory, or MMT, which states that a country can borrow in its currency as long as the bond market signals support).  Weak worker bargaining power has long been a factor driving inequality. In the last decade, the increasing clout of certain employers has joined the mix (expect the returns to capital to compress, and the returns to labor to rise).  Progressive health care reform, wherein the government plays a larger role in coverage and cost control, works (support expansion of Obamacare, and Medicare for All remains an open question).  [Lesson re-learned] Trickle-down tax cuts don’t work (watch for higher taxes).  Antipoverty programs don’t just reduce poverty today; they improve the outcomes of their beneficiaries many years hence (bad news: higher taxes, good news: more spending by lower income Americans to support growth). . The most immediate effect of these implicit policy prescriptions is higher taxes and lower operating margins from inequality initiatives. The Trump tax cuts of 2017 boosted earnings by 7–9%. While Biden’s official position is he will unwind some, but not all, of Trump’s corporate tax cuts, expect greater regulatory burden and inequality policies such as higher minimum wage laws to cut into operating margins under a Biden Presidency. Pencil in a $10–$20 cut to S&P 500 2021 earnings from Biden’s tax policy.

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June 8, 2020 Quantitative & Strategy

Exhibit 5: Trump 2017 Tax Cuts Will Be Largely Unwound

Source: FactSet Information Systems, Pennock Idea Hub Longer term, the following are all likely under a Biden presidency, and they are not mutually exclusive.

 Higher taxes for both individuals and corporations  Profit margin compression from higher labour costs  Higher GDP and sales growth from a broadened consumer base Until we know the exact makeup of Congress and the cabinet, it is impossible to forecast the exact magnitude of those factors.

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June 8, 2020 Quantitative & Strategy

The Rise of the Bomb Throwers Should the Democrats win in a landslide, or Blue Wave, and gain control of the White House, the Senate and the House of Representatives, there is a distinct possibility of a radical shift in the Overton Window, or the range of acceptable political discourse. A Blue Wave would embolden the progressive wing of the party to bring in the radical thinkers and metaphorical bomb throwers into government. One of the leading candidates for a bomb thrower to challenge orthodoxy in a Biden administration is Stephanie Kelton, who is a leading advocate of MMT. As I pointed out before, MMT postulates that a country can borrow in its currency as long as the bond market signals support. Instead of asking “how will you pay for that” when proposing a government spending program, the question turns to “can we finance it at a reasonable rate?” When the market is willing to lend to the Federal government for 10 years at well under 1%, the question is an easy one to answer. The implementation of MMT as policy will become a Grand Experiment, just as the Laffer Curve was under Reagan. Expect greater expansion of government spending programs. We will find out in a decade whether inflation pressures rise significantly, as the Austrian economists predict, or if the MMTers are right. A more radical economic bomb thrower is Mariana Mazzucato, who questioned the fundamental question of how value is created and the policy implications of the answer. This YouTube video of her TED talk raised the following provocative questions:

 Who are the value creators? Who doesn’t create value, the couch potatoes, the value extractors?  What happens to the economy if it becomes dominated by unproductive value extractors? This begs the question of how you define value extraction.  During the agrarian era 300 years, François Quesnay produced the Tableau Economique broke down the value chain into the farmers, or the “productive class”, the merchants, the “proprietors” who effect transactions, and the landowners, the “sterile class”.  During the industrial revolution of the 1800s, economists like Smith, Ricardo and Marx focused on an industrial theory of value. Adam Smith’s landmark book, The Wealth of Nations, had an example of a pin factory where a single worker could produce one pin a day, but sufficient investment into capital equipment and the division of labour could see 10 workers produce 4,800 pins a day. Smith went on to define “unproductive” activities as churchmen, lawyers, physicians, men of letters, players, buffoons, musicians, opera singers and opera dancers.  Neo-classical economics came next and changed the definition of value creation from “objective” to “subjective”. A subjective definition of value is based on an individual’s view of value, individual utility maximization and firm profit maximization. While past thinkers viewed the value creation process objectively by trying to determine value, neo-classical economics determines value from the price of a good or service. Anomalies can arise if you measure GDP when a good or service has a price. Mazzucato cited the examples of someone who marries their babysitter, GDP falls because there is no price paid for babysitting services; or if a company pollutes, GDP rises because there is a cost to the cleanup.

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June 8, 2020 Quantitative & Strategy

Mazzucato believes governments to be more ambitious in ensuring the public good. She cited the as an example difference between airline bailouts in Austria and the U.K. Austrian airlines received bailouts on the condition of meeting emissions targets, while the U.K. government bailed out airlines without no conditionality. Bottom line: There is a distinct possibility that policy could take a dramatic lurch to the left after the election.

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June 8, 2020 Quantitative & Strategy

Health Care Policy Biden is on record as stating that health care reforms should be made slowly. He would begin by improving on the ACA, or Obamacare, and then by possibly adding a public option. He is pragmatic about Medicare for All, and does not believe the Democrats have the political capital to fight another health care battle in the space of 10 years. However, the pandemic-induced recession has exposed the cracks in the American system of employer-funded health insurance, and that may induce greater popular support for a single-payer or public health insurance option. Health care stocks are currently moving more or less in lockstep with each other, but a Biden win is likely to put greater downward relative pressure on health care providers in particular. At a minimum, investors who want exposure to this sector during the COVID-19 era should focus on the healthcare momentum ETF (PTH).

Exhibit 6: Technology Layoffs in Silicon Valley

Source: StockCharts

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June 8, 2020 Quantitative & Strategy

Trade: The Silver Lining The one silver lining under a Biden Presidency is trade policy. Biden has made it clear that he does not favour Trump’s America First approach, and he would work with allies through international organizations built since the post-World War II era to resolve trade and other frictions. While that does not necessarily mean a softer line with China, the nature of the dialog will be very different. As an example, Obama negotiated the Trans Pacific Partnership as a multi-lateral firewall against Chinese trade dominance, and Biden would return to that approach. One of the contradictions in Trump’s trade conflict with China is the tension between lowering the trade deficit and the desire to open the Chinese market to American companies through the protection of intellectual property rights. If China were to fully open its economy to foreign companies, FDI would rise and American companies would pour into China. American-owned Chinese factories would produce goods for export back to the U.S. and raise the trade deficit. So what does Trump really want, a lower trade deficit or expanded protection for IP? The Biden approach would tone down the trade rhetoric, but the strategic competition between the two countries will remain, which has the possibility to turn into a new cold war. However, expect the level of trade friction between the U.S. and other countries and regions like the EU to fall significantly. The trade war factor, which measures the relative performance of domestic companies to the index, should see a dramatic decline in tensions. While Biden’s tax policy is likely to reduce earnings, his trade policy is the silver lining that lowers uncertainty. Exhibit 7: Trade War Factor

Source: StockCharts In conclusion, a Biden victory is expected to be a net mild negative for equity prices. Much depends on the degree of control by the Democrats should Biden win the White House. The chance of a Blue Wave sweep is possible, and it would embolden the progressives within the Democratic Party to steer policy further to the left with bearish consequences for the suppliers of capital.

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June 8, 2020 Quantitative & Strategy

Disclaimer

I, Cam Hui, certify that the views expressed in this commentary accurately reflect my personal views about the subject company (ies). I am confident in my investment analysis skills, and I may buy or already own shares in those companies under discussion. I prepare and edit every report published under my name. I depend on my colleagues for constructive criticism on my research methods and conclusions but final responsibility is my own.

I also certify that I have not and will not be receiving direct or indirect compensation from the subject company(ies) in exchange for publishing this commentary.

This investment analysis excludes any target price, and is not a recommendation to buy or sell a stock. It is intended to provide a means for the author to share his experience and perspective exclusively for the benefit of the clients of Pennock Idea Hub (PIH). My articles may contain statements and projections that are forward-looking in nature, and therefore subject to numerous risks, uncertainties, and assumptions. The author does not assume any liability whatsoever for any direct or consequential loss arising from or relating to any use of the information contained in this note.

This information contained in this commentary has been compiled from sources believed to be reliable but no representation or warranty, express or implied, is made by the author or any other person as to its fairness, accuracy, completeness or correctness.

This article does not constitute an offer or solicitation in any jurisdiction.

Confidential — Do not duplicate or distribute without written permission from Pennock Idea Hub

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