Investors Find Upside in Split U.S. Government

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My name is Sam Garza. I’m with DoubleLine Capital and I’m a portfolio manager.

It’s been a very interesting election. During the night of the election, it started feeling like 2016. I think as I look at what the market was expecting going into the election or wanted, the market, I think, wanted a decisive election that preferred a unified government of any colour. Here in the U.S. we call the Democrats blue and the Republicans red. The reason why the market was looking for a unified government is that it was hopeful that larger stimulus packages could be basically produced. The market didn’t want to be surprised and somewhere down the list, it was looking for a split government and at the very bottom, a tight election. I think so far, that’s what we’re looking at in the election is a split government and an election that looks very tight and there’s possibilities of litigation and recounts and whatnot.

So I think for markets, particularly like U.S. equity markets, there has been a lot of hedging done leading up into the election. If you look at the forward volatility curves, there’s a lot of buying of VIX futures and whatnot. It’s a little bit of, I think, buy-the-new, sell-the-rumor in that the day after the election, the market rallied. We started seeing certain assets do better and start to price out the potential for a split government —split government being Republican Senate and the potential for a Biden presidency, although it’s still going to be fluid.

And one of the interesting things that we’re already seeing is that interest rates have rallied, bank stocks have done worse, and tech stocks have done better. And my interpretation of that, is that having a split government reduces the odds for stimulus or makes the potential stimulus smaller than if it was a unified government, say Democrat presidency and Democratic Senate.

And that lower stimulus is less helpful for the economy during these periods of on and off restrictions. And so investors, at least in the early days after the election, are favouring growth and buying interest rates or buying bonds, I should say, with the outlook that there will be a little bit less growth going on in the economy, and so interest rates may not rise as much as folks had thought initially. So those are two interesting immediate outcomes.

And then I think just looking a little bit forward, looking like the results are getting a little clearer, but still going to take probably a few days. And I think the markets, the potential for the market to jump around if results change will be there. And it’s a lot to do, I think, with various equity sectors doing better in various outcomes — like I mentioned before, bank stocks down a little bit and tech stocks doing better as investors favor that growth.

The potential for there not being a blue wave or a split government with a Republican Senate and a Biden presidency, as I mentioned, one of the immediate implications is probably that stimulus won’t happen until January. It’s called the lame duck session; there probably won’t be stimulus. And there’s also potential for tax increases, I think, has gone down. And that’s something that was interesting as markets were contemplating a blue wave. One of the elements of a blue wave would probably have been tax increases, particularly corporate taxes. And with the split government, it’s in some ways, might actually represent a little bit of a sweet spot for assets in the sense that there will be probably a far less likely ability for taxes to go up — corporate or personal taxes.

Now, as I mentioned before, it’s still probably not the best outcome for the broader economy at large, but for risk assets, having a little bit of gridlock in Washington will probably prevent those tax increases. So it’s a bit of a mixed bag, I think: less potential for the economy, but also probably not going to see tax increases and a little bit more gridlock, which I think in normal cycles, markets would be quite comfortable with gridlock. It just so happens that being in the middle of a global pandemic, I think the markets are really focused on fiscal stimulus and what that might represent to the economy and how that translates to risk assets.