Statewide runoff elections occur with relative frequency in Georgia, but rarely do they garner so much national attention. The state’s unique requirement that a winning candidate capture an outright majority triggered a runoff for two US Senate seats nine weeks after the general election. As we conclude an unprecedented season of political turmoil, Peach State voters were accorded the right to decide which party controls the upper chamber of Congress and the fate of President-elect Joe Biden’s legislative agenda.
We expected two very competitive contests for the US Senate and, in that regard, were not disappointed. In the first race, several media outlets projected that Reverend Raphael Warnock defeated incumbent senator Kelly Loeffler by about one percentage point. The second election, pitting incumbent David Perdue against challenger Jon Ossoff, was closer still. As the votes were tallied overnight, Ossoff took a narrow lead. Georgia law does not require an automatic recount, but a candidate can request one if the margin is less than or equal to 0.5%. A recount in the wake of the second election is likely if Ossoff’s lead stays below that threshold.
The razor-thin margins in both elections are not at all surprising. The gubernatorial election in 2018 was decided by fewer than 55,000 votes. The margin was even narrower in November, with the Georgia Secretary of State certifying a Biden victory by fewer than 12,000 votes. Georgia has joined the ranks of America’s battleground states for the foreseeable future.
In the first two hours of the US market opening, the S&P 500 is up about 1%, while the Nasdaq has rallied 20bps after the futures were down over 1.5% prior to the opening. The bigger move occurred in interest rates, with the 10-year US Treasury yield rising 9bps, primarily due to higher inflation expectations, both the consequence of expected additional fiscal spending. Higher rates and a steeper yield curve are a main reason why tech and growth stocks are lower even as the S&P is higher, as they’re long-duration assets sensitive to higher interest rates. On the other hand, US financials are a beneficiary of that outcome, reflected by their 4.4% rise today. The US dollar initially declined 20bps overnight but is now up by that amount.
The market volatility following news that Democrats may hold a working majority in the US Senate is not surprising. Financial markets had been priced for a divided government, which would constrain the incoming administration from implementing new legislative initiatives. To the extent that Ossoff survives a recount, Vice President-elect Kamala Harris will be able to cast tie-breaking votes and hand effective control of the Senate to the Democrats later this month.
However, it is worth noting that while Democrats will be able to control the flow of legislation in Congress, their majorities will be exceptionally slim. If both Warnock and Ossoff are certified as the winners by the Georgia Secretary of State, we expect Congress to enact increases to corporate and personal income taxes through budget reconciliation. But the ability to pass the most progressive pieces of legislation still may be somewhat constrained, especially considering that moderate Democratic senators have voiced opposition to abandoning the filibuster.
As we indicated in our last ElectionWatch report, the importance of these two runoff elections in terms of policy implementation is difficult to overstate. We have expressed a view in prior reports that a unified government will lead to more fiscal stimulus. The enactment of another emergency coronavirus relief package (Consolidated Appropriations Act, 2021) in December has been termed a “down payment” by the president-elect, which suggests to us that he will push for another round of federal spending in the first quarter. Whether or not he is able to convince enough members of Congress to support such a plan, we expect the debate to trigger a steepening of the yield curve and greater (though generally misplaced) anxiety over higher inflation.
We believe a tax increase is possible if Ossoff is certified as the winner, but it would be more limited in scope than either the Democratic Party platform or Biden’s own plan. The tax hike is likely to be smaller than the potential overall spending increases and might not take effect until 2022, so Biden’s policies would add stimulus to the economy, on balance. Moreover, any tax increase would require unanimous support among Democrats in the Senate and near unanimity in the House. It took the GOP 11 months in 2017 to enact comprehensive legislation that reduced taxes. To the extent that Democrats are able to maintain unprecedented party unity to raise taxes, we expect such legislation to move a little faster but not likely advance in early 2021. Moreover, the president-elect has returned time and again to the topic of infrastructure reinvestment, which could include some green energy initiatives. We believe this holds more attraction for him in the near term.
All of this suggests to us that the near-term volatility over the prospects of a unified government will be short-lived and soon overshadowed by investor expectations for the winding down of the pandemic in the months ahead. We retain a positive longer-term outlook for US equities in general, and cyclicals and small- and mid-caps in particular, as the economic recovery accelerates in the second quarter.
With President Joe Biden inaugurated and the 2020 election cycle complete, our focus now turns to the new administration’s policy agenda and what it means for investors’ portfolios. For our current views throughout this presidency, visit ubs.com/cio-potus46.
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