This May Be The Biggest Long-Term Risk For Stocks And The Economy

On Tuesday, I talked a bit out the possible disinflationary read-through in the event the GOP manages to hold the Senate next week.

It seems likely that the market would interpret such an outcome as bullish for the dollar, at least in the near-term. While the never-ending negotiations between Nancy Pelosi and Steve Mnuchin grabbed most of the stimulus headlines in October, the real obstacle was, of course, the Republican-controlled Senate. The fact is, even if Pelosi and Mnuchin had reached an agreement, the Senate wasn’t likely to back a $2 trillion spending package, Donald Trump’s insistence that he could help Mitch McConnell herd cats notwithstanding.

If the Senate stays with Republicans, the market will need to adjust expectations for massive spending. Both Trump and Joe Biden favor more stimulus, and I’d be remiss not to note that in the event Trump were to win and the Senate stays Republican, GOP lawmakers would be in a very tough position when it comes to denying Trump the stimulus package he wants. The House would (still) back more spending, and Trump would simply demand it. Facing four more years of tweets, it seems unlikely that reluctant Senate Republicans would totally stonewall a newly emboldened Trump.

However, they could insist that any package be as “small” as possible. While “small” would be an (extremely) relative term in this case, such an outcome could bolster the dollar, especially if the market contextualizes any new bill by reference to what “could have been” (so to speak) under a Democratic sweep.

At the same time, yields would likely drop as inflation expectations adjust to the reality of more partisan rancor and smaller stimulus. That could mechanically drive reals higher, feeding dollar strength in a disinflationary (not-so)merry-go-round. Poor virus outcomes could exacerbate the situation.

With that in mind, note that the last several sessions offered a preview of sorts. The dollar firmed up, yields fell, and the curve flattened against a macro backdrop characterized by failed stimulus negotiations and a rapidly deteriorating public health situation both domestically and in Europe. At the same time, crude has come under renewed pressure.

Oil is being pushed and pulled by the usual hodgepodge of supply/demand factors, but in the current environment, the trajectory of the pandemic is perhaps the single-most important determinant of demand.

Inflation expectations rebounded to touch pre-pandemic peaks over the summer, and while oil’s recovery stalled, it’s worth asking what fate would befall crude in the event breakevens were to stumble and the dollar were to find some solace in an ostensible limit on government spending (i.e., with a GOP Senate acting as a “firewall” of sorts).

There’s quite a bit of commentary out there that suggests US equities would find a lot to like about a Trump victory and/or a situation that sees the Senate stay with Republicans, but what I would be concerned about is the possibility that once the “no tax hike” boost fades, economic reality will kick in.

The fact is, the current administration in the US does not accord the proper role to science when it comes to fighting the pandemic (unless it relates to vaccines, in which case yeah, sure, everyone agrees a shot would be great).

At the same time, Republicans’ insistence on presenting themselves as a human roadblock to comprehensive spending packages which fund aggressive, nationwide testing and tracing efforts, provide resources to safely re-open schools, and help ensure local governments aren’t forced to cut payrolls, is not generally conducive to facilitating economic momentum for the hobbled economy beyond the mechanical third quarter bounce. Remember: Supply-side solutions have an objectively poor track record. The idea that we can tax cut our way out of a pandemic is borderline lunacy.

It seems just as likely as not that a “surprise” Trump win and/or a Republican Senate would eventually lead to deflationary outcomes, especially when you consider the possibility that were Trump reelected, the dollar could also catch a bid from the assumption that confrontational trade policies will continue. JPMorgan said as much in a new note, which also found the bank arguing that US equities would likely get a boost, at least initially.

But here again, we need to ask ourselves about the viability of a policy conjuncture that sees the  fiscal impulse snuffed out prematurely. The figure (below) makes a similar point as the chart above, only it substitutes US equities for crude prices.

I don’t know about anybody else, but that seems prone to going awry in a situation where fiscal failure undercuts the reflation narrative. That goes double when you consider the possibly bullish read-through from that failure (i.e., less spending) for the dollar.

You can draw your own conclusions, but what I would suggest (again) is that trying to supply-side our way out of a pandemic or otherwise clinging to misguided notions of fiscal rectitude, is perilous both for the economy and for stocks, if not in the near-term, then certainly over the longer-term.


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16 thoughts on “This May Be The Biggest Long-Term Risk For Stocks And The Economy

  1. I think a potential adverse effect of a “surprise” Trump reelection is a four year suspension of the payroll tax. With a friendly Supreme Court, an executive order suspending the employee and employer payroll taxes until January of 2025 and upheld by the court would force Congress to fund social security and medicare. With a Republican Senate, I can imagine social security entering a “death spiral.”

    At the end of 2019, the combined OASDI trust funds had $2.9 trillion and the annual expenses were a bit over $1 trillion. Assuming the trust fund balances are about the same at the end of 2020 and the payroll taxes are all “suspended,” the Senate would only need to provide about $300 billion per year to keep social security going until it is completely drained at the start of 2025. A new President and Congress would face a completely broke social security system and taxpayers and employers on the hook for four years of payroll taxes.

    How would people react to the possibility of social security ending in 2025? Savings might skyrocket and spending might probably crash. Would you invest in nursing homes or other sectors of the economy that depend largely on social security funds?

    1. “A new President and Congress would face a completely broke social security system.”

      There is no such thing as a “broke” social security system. There is only broken politics. Social security cannot go “broke” if Congress doesn’t let it. Say it with me: Uncle Sam. Cannot. Under. Any. Circumstances. Be. ‘Broke.’ Because. He. Prints. Money.

      The government cannot go broke. But politicians can be moronic. That latter bit is the problem.

      1. I think it should also point out that the US approach of having pre-funding/trust funds is not the norm. Most countries fund such activities out of current income (ignoring the MMT argument for the moment). Unfunded commitments are the norm not the exception.

  2. Imagine a reelected Trump and a Republican Senate. With a friendly Supreme Court and a Trump executive order suspending employee and employer payroll taxes until January, 2025, what happens to social security and medicare? If the Senate allowed $300 billion per year in social security spending, the trust funds would be depleted at the start of 2025 and workers and employers would face paying four years of payroll taxes. Would the new Congress and President really require these tax payments or would they say “Let’s forget social security, medicare and payroll taxes”?

    1. It’s the roadmap for greatly reducing, and perhaps even eliminating for a portion of the population, these entitlements. Reasonable steps would be exaggerated on purpose. An example are high income earners. They would be means tested out while still contributing. This would stir more dissatisfaction, more calls for reducing or eliminating, providing more support to take these actions. Three years from now: “The system is broke, gone, there’s no money for it. It’s over. Sorry.”

      After a payroll tax holiday, my guess for funding is it would go on the Fed’s balance sheet. There would be some deal to sell 100-year Treasuries at 1.2% or whatever, that would fill the pot that funds the entitlements programs, and the Treasuries end up on the Fed’s balance sheet.

      Then, let’s consider an equity market that goes nowhere for the next 10 years as Baby Boomers are all in retirement The Baby Boomer generation is the wealthiest in history. This wealth is not evenly distributed across the generation. My point is, if equities returns are flat for 10 years and entitlements are cut, reduced, or co-pays increased 300%, etc, there are going to be a lot of sick, starving, homeless old people in the streets. I am still waiting for the populace to get pissed off. The entitlement programs might be that moment.

      We can’t know what’s going to happen with the courts. There is a bias toward Koch-type politics now. Point is, we are all assuming a linear trend (more of the same into the foreseeable future) from the courts. Could be linear, but probably not. A lot can happen. 500,000 dead from COVID in the US would be an example of scarring that results in generational change in outlook. The attitude of the populace could reach a tipping point where we are driven together by our own suffering rather than driven apart by politiicians.

  3. I think the market is pricing in a Biden President, GOP Senate, Dem House. Which would be the worst of all worlds, in terms of getting more stimulus or almost any other action. Looking at prediction markets, the odds of a Dem Senate are in the 60%-ish range, which is basically a coin flip. Some forecasters have it higher, but I think investors’ expectations often lean closer to prediction markets.

    1. Yeah, I tend to agree with this.

      But really, there’s no telling what Trump is doing right now. One part of me thinks he’s tired of it all, another part of me thinks he’s scared of being prosecuted for financial crimes if he’s not president, another part of me thinks he actually might be excited about the possibility of losing and then starting his own TV channel (or something), and then still another part of me thinks he is all-in on his own narrative and may try to stay in power even if he losses by a landslide.

      1. H- That is a lots of parts of you! Anyway, I do not think there is anyway that a blue wave will NOT happen. People have had enough of this shit show. tRUMP has ruined the GOP for at least the rest of this decade.

        I know collectively as a nation we are a pretty stupid people. But are we really that stupid to not punish all of the GOP for enabling this dufus?

  4. High election turnout is probably going to be an electoral washout for the GOP. This election’s closest brush with 20th-21st century history is 1932. If this is correct, you can say goodbye to the fillibuster or at least have it markedly reduced in usage. The Supreme Court can throw out laws, but Congress and the President can pass new ones. It takes time to get to the Court. And don’t forget Thomas is nearing retirement and Roberts has heart problems. If this election happens it is going to take the Republicans time to regroup and reform, or the party splits apart completely. There are probably 10 or more GOP Senate seats at risk, and only 2 Democratic ones. A sweep at the presidential level is going to take out some Republicans you might not expect to go….

    1. All potential 2nd terms are a referendum on the incumbent. Biden is fairly irrelevant in all of this. With that, I tend to agree as I think the few undecideds will probably break to Biden. I’m also envisioning an absolutely massive gender gap this cycle. IF this happens, I agree with you 100%, there are Republican senators (and Representatives) who are going to go down.

  5. what a looney day… trump telling his rallies “you think I wanna be here in the rain? I just want to go back home where it’s warm” and Gundlach weighing in: “i think trump will win. I hate both parties. I think we’ll have a revolution over inequality within two more cycles”. And the USPS is now being managed on a daily basis by a DC district court judge – to speed up service. Not sure why he’s bothering since no sane voter would be sticking a ballot in the mail at this point and insane people can be ruled ineligble to vote, so… (though, prima facie, insane people can run for high office)

  6. … part of me wonders how many Sanders and Warren supporters don’t vote for Biden/Harris because they don’t want 8-years of Harris (and do want another bite at the progressive-apple in 4-years)

  7. MM I really think there are no Sanders and Warren supporters who won’t vote for Biden/Harris because they absolutely want to get the tRUMP and hopefully the GOP out.

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