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Investment Strategy Commentary
Investment Strategy Brief: Getting to 50/50
Democrats may take a narrow lead in the U.S. Senate with the special election in Georgia, but political constraints will limit policy action.
While results are not yet final, it appears the Democrats may win both seats — resulting in a 50/50 Senate with ultimate control going to the Democrats through the vice president's tie-breaking vote.
The market will likely run with the preliminary counts communicated today unless they notably tighten. Amongst the three most likely outcomes prior to the election, we viewed a Democratic sweep with a small Senate majority as the second most constructive for one-year growth (behind the continuation of divided government, as shown in Exhibit 1).
The overnight market reaction was much more rotational than directional. Small cap stocks were up 2.5% while Nasdaq futures were down 1.5%; however, S&P 500 futures were marginally down (around 0.3%) and 10-year Treasury yields were slightly up. The initial benign reaction at the macro level reflects policy constraints that will likely be in place (discussed on p. 2), and also a view that the impact of the reopening of the global economy over the next year with widespread vaccine availability will be more impactful to growth and markets than this political change. Our view on the sector impact pre-election was that this outcome would be more positive for health care services (less regulatory pressure) and information technology (less confrontation with China). The areas we felt faced some pressure included energy (increased environmental regulation), financials (more hostile regulation) and communication services (internet; increased regulation).
A 50/50 Senate could ease life for Democrats somewhat in areas like confirmation hearings and introducing legislation. However, a few moderating impacts will likely constrain extreme policy, meaning less tax increase and lower spending than Democrats would prefer. These include:
Committees would be evenly split between parties. The last time we had a 50/50 Senate (2000), there was a "power sharing" agreement negotiated between the two parties on how to run the Senate. This implies that we could need to conclude a similar negotiation this time around — time will tell and the negotiations will likely be more partisan than in 2000. The overall result of the 2020 election, while leading to a Democratic president, did show the Republicans gaining a number of seats in the House. There was no "mandate" for a very liberal agenda, and this will likely moderate policy ahead of the 2022 mid-terms.
Senators have the potential to switch parties. In the 50/50 Senate of 2000, Vermont Senator Jeffords switched from Republican to Independent (caucusing with the Dems) in May 2001 after being courted for months. A major catalyst for his shift was his disapproval of the scope of proposed Bush tax cuts. A Democratic senator from a red state will have significant influence over what gets introduced as they can be a "king maker," as their constituents will likely oppose major tax hikes.
Policy change will still be challenging. The only major policy that can be implemented in Congress without 60 votes are taxes and spending, done through the annual reconciliation process. This is how President Donald Trump's tax cuts passed. President-elect Joe Biden's administration would likely do the same thing.
We are continuing to monitor the election implications, pace of the current economic rebound (still strong) and outlook for the vaccine/economic reopening (great vaccine outlook but slow start to the roll-out amidst continuing high infections). We will be back with more info as developments occur.
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Jim McDonald
Chief Investment Strategist
Daniel Phillips
Director, Asset Allocation Strategy