A Democratic sweep in the 2020 elections could lead to a stock market rally if Wall Street sees a unified government as helpful for fighting Covid-19 and easing U.S.-China trade tensions, Bank of America told clients on Monday.
Such a market rally following a sweep would be surprising since Wall Street typically performs best when Congress is gridlocked. But this is no ordinary election, and an empowered Democratic White House and Congress could be an unusual boon for the market in 2020 if investors think a unified government may better handle the coronavirus crisis, Bank of America said.
"The big surprise under a Dem sweep would be a rally. But positives include the potential for unleashed capex amid less tariff uncertainty," wrote Michelle Meyer, head of U.S. economics at Bank of America Merrill Lynch.
"Even hiking [the] minimum wage and raising taxes of the wealthy could perversely benefit stocks, as discount retail is >6x luxury retail's US public market cap," she added.
Setting aside the pros and cons of any specific Republican or Democratic proposal, the notion that a unified government could lead to a market rally is noteworthy.
Those who study the relationship between U.S. politics and the American stock market have long shown that equities tend to outperform when Congress is gridlocked and unable to pass either party's reforms or initiatives.
In a note subtitled, "United we fall, divided we rise," Goldman Sachs wrote in late 2019 that since 1928, the median S&P 500 12-month return under a divided government is 11% versus 8% under a unified government.
But Bank of America contended Monday that investors remain focused on mitigating the impact of Covid-19, and will likely cheer for whomever they believe will enact the most effective policies to fight the disease and safeguard the economy.
In that respect, Meyer argued, former Vice President Joe Biden's plans seem more involved compared wito those pursued by President Donald Trump, who's often deferred to the judgment of local authorities. There have been more than 3.7 million Covid-19 infections confirmed in the U.S.
"Containment of the coronavirus is critical, and the differences in each candidate's approach merits consideration," she wrote. "Stocks have recovered since March, suggesting that investors are looking past 2020's recession and valuing companies on out-year earnings. But a meaningful uptick in new COVID-19 outbreaks could reverse this optimism."
The former vice president's call for greater federal coordination on Covid-19 testing and tracing, Meyer wrote, represents a good trade-off between economic damage and virus control.
The Biden campaign has thus far proposed a public-private pandemic testing board to boost infection testing, a state and local government emergency fund as well as support for greater tracing through a national public health jobs corp.
"Based on experiences abroad, countries that have stronger testing, tracing and quarantining programs have tended to more successfully contain the virus, limiting the economic damage," she wrote. "As such, we think Biden's agenda for fighting the coronavirus would prove to be more beneficial for the economy."
And even though some may balk at Biden's plans to increase taxes, Bank of America noted that the current downturn may work to soften those plans. Biden's original corporate tax proposal would raise the rate to 28% from 21%, partially reversing the Trump administration's Tax Cuts and Jobs Act of 2017.
But raising taxes on an already-stressed U.S. economy may be too risky to pursue, the bank said, and more-pressing Covid-19 stimulus legislation may take priority for the Democrats.
"Biden has called for greater support for the middle class to be offset by higher income and corporate tax rates. But the risk of tax increases derailing an already struggling economy may drive a softer stance; while stimulus to combat COVID will likely play a larger role," Meyer wrote.
— CNBC's Michael Bloom contributed reporting.
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