“Under democracy one party always devotes its chief energies to trying to prove that the other party is unfit to rule — and both commonly succeed, and are right.”
— H.L. Mencken

When it comes to party politics, I’ve long agreed with the Sage of Baltimore: a pox on both their houses.

Sadly, however, someone has to win every election.

Whether you agree with the winner or not, the fact is that their policy choices will have a big impact on the stock market. You might as well prepare for it.

Right now, the odds-on favorite to win the White House is Joseph Biden.

That’s not my opinion. It’s the stock market’s.

The chart below shows the PredictIt political futures market and a basket of long and short bets on stocks related to a Biden victory. Not a pretty picture for the president:

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Of course, they say that a week in politics is a lifetime — and we’ve got three until the election. Nothing is set in stone.

But it’s worth taking a closer look at the blue line in that chart above … specifically, the sectors and stocks driving its march to the top.

The market is rapidly waking up to the possibilities. Let’s get ready to vote with our investment dollars … not for the politicians, but for ourselves.

Stimulus Goes Big Time

If the Democrats sweep Washington in November — as PredictIt says they are likely to do — the conversation about fiscal stimulus will change dramatically. Investors should be ready to change with it.

The case for federal government spending is clear.

The COVID-19 pandemic has caused an insufficiency of demand. Millions have lost jobs. Millions more are fearful of borrowing and spending. Facing weak consumer markets, companies are unwilling to invest. Even though we’ve seen a gradual recovery over the summer, we can expect a downward spiral in the next few quarters.

Economic history proves that in a situation like this, government spending can substitute for consumer demand and kick-start the economy back to life. Increased economic activity generates tax revenues that pay for required borrowing, especially at today’s ultra-low interest rates.

The endless bickering over a stimulus package has focused on short-term measures to help wage earners and vulnerable industries like the airlines. It’s not meant to address bigger problems in the U.S. economy.

There is almost no chance now that such a package will be passed before the election.

But if the Democrats sweep Washington, we’re looking at the possibility of massive stimulus in key economic sectors, including health care, infrastructure and education.

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But this spending wouldn’t really be stimulus. It would be active government policy that addresses issues that have been left to fester since 2010.

Divided government in Washington has meant that Congress has done nothing for years except pass a massive, deficit-busting tax cut in 2017.

More than anything else, the market is pricing in the possibility of an active federal government for the first time in more than a decade.

Like it or not, unified Democratic control of Washington would unleash a flurry of legislative activity that’s been pent up for years.

That means government money will flow to certain parts of the economy … and investor money will flow to stocks in those sectors.

Winners and Losers

The blue line in that chart up top is the Nomura-Wolf Long-Short Biden Election Basket. It tracks 30 pair trades across various sectors.

Companies expected to do well under Democrats are long positions. Those expected to suffer are short positions.

Here’s a sample of its hypothetical trades:

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Since early September, the Nomura-Wolfe Democrat long trades have gained 10% relative to the short trades. The Dow Jones Industrial Average, by contrast, is up about 3%.

That suggests U.S. equity markets are already pricing in a higher probability of a Democratic sweep.

Similar action is taking place in bond markets. Yields on 10-year Treasurys, which have seen some of the lowest levels on record this year, have increased by over 16% over the last month:

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Rising long-term bond yields mean markets are pricing in faster economic growth, higher inflation and rising government deficits over the next decade.

Hold Your Nose and Place Your Bets

As a kid growing up with a dad who was an ambitious Republican politician, I often heard the phrase “hold your nose and vote.”

He meant that sometimes, it was worth casting a ballot for a politician you didn’t agree with on many things, but whose victory would help achieve something you were for.

Don’t get me wrong, I’m not advising you to vote for one party or the other in November.

But I am strongly suggesting that if you place your investment bets carefully now, you could see big windfalls in the coming quarters!

Kind Regards,

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Ted Bauman

Editor, The Bauman Letter