BMO Family Office
A lot has happened since our last discussion on geopolitics and the market. Joe Biden is the President-elect, and Democrats flipped the Senate, gaining control of both houses of Congress. We also witnessed a dramatic illustration of the country’s political divisions. Meanwhile, the COVID-19 pandemic shows no signs of abating.
I recently spoke with Matt Gertken, Geopolitical Strategist at BCA Research, and Marko Papic, Partner and Chief Strategist at Clocktower Group to discuss how investors should consider all of these factors as the country prepares for Inauguration Day.
Following is a summary of our discussion, edited for length and clarity.
On our last call we discussed the prospect of a narrow Biden victory, and noted that control of the Senate would be up for grabs. Both of those scenarios played out. Nonetheless, Papic was surprised by the initial market reaction when it looked as if the Georgia Senate runoff election could still result in a divided government.
“I thought that with a divided government, which was the status quo until the Georgia Senate elections, that the market would see that as a problem from the perspective of fiscal policy,” Papic said. “The reason the markets reacted the way they have throughout 2020 is fiscal, and fiscal has surprised to the upside of most analysts. What I underestimated is just how much of a relief rally there was that it was over, and that Biden's victory was robust enough.”
The political environment has been polarized for quite some time, exemplified by the events at the U.S. Capitol on Jan. 6. But have we reached peak polarization? And what does that mean for policy decisions that could affect investors?
"I think it can get worse,” Papic said. “When investors think about polarization or tribalism, their mental framework for this is a whole lot of debt ceiling debates and government shutdowns, because that's what we had last decade. Last cycle, political polarization in the United States manifested itself in market relevance through fiscal clog.”
But Papic doesn’t believe that cycle will continue in this current backdrop of political division. Mainly, with the pandemic still causing economic chaos for millions of Americans, the need for more fiscal stimulus makes gridlock less politically expedient.
“When you combine Trump's loss with the two seats in the Senate in Georgia, I think that every Republican out there is right now pivoting on fiscal policy,” Papic said. “So, you can have tribalism, you can have polarization. I just don't think anyone on the Republican side will run in front of the fiscal train and say, ‘No—I stand for balanced budgets and fiscal austerity.’ So no, we don't have to be at peak polarization. But from a market perspective, I don't think it's going to manifest itself the same way it did last cycle.”
Priorities of the new administration
Everyone will be looking to what the Biden administration’s priorities will be in its first 100 days. He’s already made it clear that COVID-19 relief is the immediate concern. From Gertken’s perspective, that translates to increased spending across the board.
“If you look at the polling, the voters are pretty transparent about the fact that [they] view COVID as a pretext to do broader spending to support society,” Gertken said. “It's not just politicians that think, Hey, I've got this crisis, I don't want to let it go to waste. Even voters are saying let's increase education spending, let's increase food stamps, let's increase infrastructure spending, let's make sure that everybody has the ability to produce our medical supply chain in the U.S.”
Tax reform is also likely to be big on Biden’s agenda. But Gertken believes that will largely be executed through a partial rollback of Donald Trump’s tax cuts, not through a substantial increase on top of that. “From the perspective of prudence, you need to be prepared for Congress to raise taxes,” he said. “It's heartening for the investor to think that they're not looking at a total repeal. From the perspective of U.S. competitiveness, the corporate rate likely won't go back up to where it was, and the individual rate may only go back to where it was in 2016.”
And the timing of any potential tax increases will also be crucial, given the precarious economic situation in the context of the pandemic. "They probably will be phased in in a way that comports with the recovery, so that may buy a little time,” Gertken said.
“The bottom line is, taxes are going up, minimum wages are going up, and regulations are going up,” Gertken added. “But it doesn't mean that you go and sell equities in this environment. You just don't. Equities are the place to be.”
At the conclusion of our discussion, I posed a series of questions to Papic and Gertken to elicit their reactions to some of the key geopolitical issues of the day.
What will the top personal tax rate be in 2022?
Papic: It will revert back to the Obama era [39.6%].
What will the top corporate tax rate be in 2022?
What sector or region is most likely to benefit from the policy backdrop that we've outlined?
Papic: Anything to do with green technology.
What sector or region is most at risk from the policy backdrop?
Gertken: U.S. equities relative to international equities.
Will Federal Reserve Chair Jerome Powell get another term in February 2022?
Papic: Don't care. My chocolate Labrador could be the central banker. Fiscal action will matter more than monetary policy going forward.
What will be the most market-relevant geopolitical issue of 2021?
Gertken: Iran. Biden will do a deal, but the run-up to the deal is risky.
What region is most likely to have a geopolitical crisis this year?
Papic: MENA (Middle East and North Africa).
Do you think the U.S. will launch a digital currency in the near future?
Gertken: Not in the near future but eventually yes.
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