Into the homestretch of an electoral nailbiter

Back in 2016, we pointed to plenty of uncertainties in our election watch that year and marveled: “All this sounds like a recipe for uncertainty of the sort that might cause market jitters. Instead, the S&P 500 is trading near all-time highs!” 

Well, the more things change, the more they stay the same. For watchers of U.S. politics, there has been plenty to be excited about all summer, from the withdrawal of Joe Biden from the race and the swift ascent of Kamala Harris to the pick of first-term Ohio Senator J.D. Vance as Republican vice-presidential nominee. Not to mention a second assassination attempt on and a rather underwhelming debate performance by former President Donald Trump, amongst several other moments where his age seemed to show. The net result, though, is that quality-adjusted polling averages have if anything gotten even tighter both nationally and in key states, perhaps hinting at Trump’s appeal to voters just tuning in. 

It was not that hard to guess in advance that this election season would be full of twists and turns, leaving seasoned observers on tenterhooks until the very end. Back in June, we thought that, from a market perspective, this could create opportunities along the way, if markets got unnerved and temporarily ended up overpricing political risks. It was one of those instances when getting the politics right was the easy task – the harder one is often anticipating market reactions if and when a plausible set of events materializes. 

Contrary to what we thought might happen before the summer, U.S. equity markets have been taking events in their strides. Unlike many pundits including some market commentators, we don’t think this has all that much to do with changing probabilities or hopes for what either of the two major candidates might do if elected. Instead, we think it’s quite consistent with our base cases of this particular election being less consequential than widely anticipated, compared to, for example, earnings dynamics at sector level. The set of base-case outcomes is outlined in Section 1. Section 2 describes what surprises investors should nevertheless be ready for in the days, weeks and months that follow the vote – and which ones appear a bit overrated in terms of investor attention. This special concludes by setting this election in a longer-term context, by looking at how 2024 could nevertheless end up boosting U.S. national prosperity.

1 / After a nasty campaign, prepare for gridlock

1.1  Narrowly divided chambers of Congress likely to trim presidential campaign promises

We continue to think that for investors, it makes sense to focus on gridlock and divided government of various stripes, as the range of base cases most worthy of their attention. This is most obvious if we start by considering Congress, specifically the House of Representatives. 

Currently, Republicans are in control, by a razor fine majority. Along with most handicappers, we would expect another closely divided House, with Democrats as narrow favorites to be in the majority.^[1] Democrats have led in quality-adjusted generic Congressional ballot polling averages quite consistently during the last three months. Redistricting following the 2020 census, as well as changing electoral coalitions of both major parties should, according to these polling averages, translate into taking Democrats to House victory – especially if Kamala Harris wins the popular vote nationally. 

Matters are quite a bit more complicated for the Senate, and not only because the next vice president would cast the tie-breaking vote in case of a 50/50 split. Due to what looks like a very unfavorable Senate map, Democrats would need quite a few upset victories to avoid losing their Senate majority. Another possibility is that neither party ends up securely in control. Nebraska independent candidate Dan Osborn, who has run a surprisingly strong challenge to Republican incumbent Deb Fischer, for example, has pledged that he won’t caucus with either party if elected.^[2]

Nevertheless, we would caution that Senate surprises tend to fairly frequently offset each other in terms of the national picture. Big, uncorrelated polling misses at the level of state Senate races have historically been quite common. Highly candidate- and state-specific factors can also reshape dynamics late in the cycle.^[3] It is worth keeping in mind that the Senate majority has gone its own way plenty of times before. There are already signs of a revival in voters’ willingness to split their tickets – as the jargon goes – in 2024 by voting for one side for the Senate while favoring the other party’s candidate for the presidency and House races.

1.2  Probabilistically many scenarios around what we described as the “Mushy Middle”

For the purposes of scenario planning, we would nevertheless point out that the differences in policy outcomes for investors need not be all that big, barring such a large polling error producing larger-than-expected Congressional majorities for either side. As long as House and Senate majorities are narrow, we would not expect either a Harris or Trump presidency to be all that significant in legislative terms. 

Back in June, we described these as middle instances within a probability distribution, capturing all the outcomes that look fairly plausible, while ignoring the more unlikely outcomes at either extreme. Alongside a “Mushy Middle,” requiring downright bipartisan compromises due to divided control of Congress and/or the presidency, we described the two adjacent scenarios as “Liberal Limp” and “Trump Theater.” 

Stylized probability range of plausible outcomes  

Source: DWS Investment GmbH as of 10/24/24

Under the former scenario, we would continue to expect any Democratic sweep to be relatively inconsequential and also short-lived (leading to the loss of one or both chambers in the 2026 mid-terms). Given an even greater reliance on centrist House Members and Senators, as well as already stretched government finances, a Harris administration would probably struggle to finance such costly campaign promises as expanding the child tax credit, providing more generous support for first-time homebuyers and eliminating taxes on tips. 

The same holds, arguably even more so, for a Republican sweep, especially if Trump were to win again only through the vagaries of the Electoral College. Do not get us wrong, another Trump presidency would likely bring plenty of day-to-day drama for market participants to watch, but its legislative legacy would probably not go much beyond extending most of the Trump tax cuts. This is because, in this scenario, Republican majorities would be narrow and Congressional delegations divided, making it hard to get much done, even leaving aside potential hostile market and voter reactions if and when they seemed on the verge of passing legislation.^[4]

Moreover, tax cuts for wealthy households and corporations are increasingly at odds with the new working-class coalition Republicans have been relying on for – relatively rare – electoral victories ever since 2016. Without a sharper reversal on “taxing the wealthy,” there would be a significant opening for populist alternatives – and one or two upsets in this cycle, such as an Osborn victory or near victory in Nebraska, might well suffice to bring home that message to Congressional Republicans. 

Most of all, investors should remember that Joe Biden’s ability to pass consequential laws in 2021 and 2022, despite very narrow majorities, was very unusual, and probably owed a lot to an understanding of how to cobble together Congressional compromises over many decades. Neither Harris nor Trump (as well as their running mates, as far as the Senate is concerned) can point to anywhere near as much experience.^[5] Unable to run again in 2028, another Trump administration is likely to be severely constrained by tight majorities in Congress as well as Republican fractures, to an even larger extent than was the case from 2017 to 2018. 

Not to mention the law. To be sure, tariffs and other trade measures have increasingly become a bipartisan pursuit, especially with regards to China. Given that Congress has the power to set tariff policy under the U.S. Constitution, however, the direct impact of another Trump term even on trade should not be overstated.^[6] Especially if and when some of the negative consequences mainstream economics would predict of Trump’s tariff plans were to materialize, sufficient numbers of Congressional Republicans would presumably feel compelled to act.

1.3  The race for the White House and market implications of plausible scenarios

What then, about 2024’s marque event – the race for the White House? We will keep this brief, not least as you have probably read more than enough horse-race coverage already. For investors, though, three points are worth keeping in mind.

First, swing-state polling can be subject to big, only partially correlated misses – and even what really counted as the pivotal state(s) in any given U.S. presidential election contest can only be determined with hindsight. The same holds for estimates of how small or large an advantage either side might have in the Electoral College.^[7]

Second, events and reality unfolding in any new administration’s early months tend to do more to shape policy than campaign promises. And third, chances of polling misses of some sort are actually unusually large this time around for the presidential contest, due to some methodologically questionable choices by many pollsters.^[8]

All this should lead to reasonably well-behaved market reactions in the days following election day; or potentially weeks or months if things get very tight in either the Senate or the House (though this seems less likely, as we argue in the next section, for the presidency). For equity markets in particular, we would think that even a Republican sweep might see anxiety about trade policies and higher interest rates mixed with relief and tax-cutting hopes. However, some sectors would no doubt benefit from the removal of election-related uncertainty. For example, both sides have pledged to boost spending on technology and encouraging innovation, while anything short of an overwhelming Democratic victory might boost sentiment towards healthcare stocks. 

The main exception we would highlight from a market perspective would be a Harris win so unexpected and decisive as to enable Democrats to not just win the House but also hold the Senate. Harris would then claim that she and Democrats had a mandate and quickly try to move forward her agenda. It is worth keeping in mind that Senate Democrats, led by Majority Leader Chuck Schumer (D-NY) have threatened for years to further restrict or altogether abolish the filibuster. This parliamentary procedure allows one or more Senators to delay or entirely prevent a vote on many legislative proposals, provided there is no super majority in favor (currently 60 out of 100 Senators). 

Changing those rules would in principle be possible through a simple majority. Two Senators adamantly opposed to such a change in the current Congress are retiring, namely Democrat-turned-independent Senators Joe Manchin of West Virginia and Kyrsten Sinema of Arizona. A third Senator open to reform but not to elimination of the filibuster is Montana’s Jon Tester, already mentioned above.^[9]

It is very hard to see Democrats holding the majority in the Senate if Tester loses in Montana, but for markets, mere but serious post-election talk of abolishing the filibuster could come as a shock, as it would have big, potential implications from healthcare policy to tax policy. The precise effects in terms of actual legislative changes are hard to gauge. Take prescription drug costs, for example. Apart from a specific pledge to “extend the $35 cap on insulin and $2,000 cap on out-of-pocket costs to all Americans, not just seniors,” the Harris campaign website mentions vague plans to accelerate the speed of Medicare prescription drug negotiations and “increase competition and demand transparency in the health care industry."^[10] On taxes, pressure on individual Republican Senators (under a new, less experienced minority leader) might prove immense, moreover, to compromise on corporate tax rates or taxes on wealthy households, perhaps in return for the filibuster to nominally survive. And after the strong run U.S. equities have had, it may not take much of a disappointment on future U.S. tax policies to cause some market jitters.