What a Change in Legislative Control Means for You and Your Portfolio

One common question we hear from our clients focuses on what the new administration will truly mean for their portfolios – and their ideas of living richly – over the next four years.

Despite how on point our market insights may seem at times, we don't have a crystal ball.  But we'd like to remind you that you can rest assured we are always keeping our eye on the markets to gather data and monitor trends that may impact our clients. While our data views politics with an impartial eye, changes in policy may lead to changes in the economic outlook. We will continue to closely follow the trajectory of new federal legislation in the coming weeks, months and years – we’re dedicated to serving as your eyes and ears for the long haul.

Here, we will unpack some of the projected federal policy changes we might expect in 2021.

A Small Margin of Control in Government

Although we now have a Democratic president and Senate majority, keep in mind that Democratic Party control is extremely narrow.  With the exception of a handful of years, the current congressional construct is the smallest margin of control in recent history.  This raises the question of our government’s ability to pass legislation and get things done in an efficacious manner.

Source: Cembalest, M. (January 6, 2021). Eye on the Market. J.P. Morgan.

In order for Democrats to pass legislation, they’ll have to keep every one of their members in line, meaning if even one vote switches to the Republican side, it will no longer be possible for Vice President Kamala Harris to act as the tiebreaker.

This delicate balance could translate to good news for the economy. It may mean that Congress will focus on legislation that is widely supported, such as an enhanced stimulus package for individual Americans and direct payments to struggling businesses. At the same time, Republicans may rally, and find support amongst centrist Democrats, to prevent less popular and arguably more economically negative measures from passing, like raising tax rates. As we examine some of President Biden’s proposals, whether they seem daunting or exciting, it’s important to keep in mind that most of the proposed measures will be tempered in some form by Congress.

Here are some of the most anticipated policy changes:

• Increased taxes – Although initial reports on Biden’s proposed policy changes focus on increasing the corporate and personal tax rates, we will likely see a much smaller increase than promised, due to the tenuous nature of control just described and probably not until 2022.

• Green New Deal, student debt forgiveness, and free health care – With the narrow margin of control and a heavy reliance on centrist support, we are unlikely to see the passage of policies viewed as extremely progressive and left-wing. We’re more likely to see other less controversial progressive agenda items, such as additional subsidies for renewable energy production, transportation, and/or drug price controls for expanded health care access.

• New fiscal support and the potential for the Federal Reserve to raise rates – We might see the Fed react to massive economic support bills coming out of a Democrat-led government by raising rates or cutting back some of their own supports if inflationary price pressures begin to build. There may be a surprise in store for 2021, as many people expect the Fed to wait to raise rates and/or curtail its economic programs for years to come.

• Improvements to U.S. and China relations – Foreign trade improvements have long been expected under a Biden presidency. As with any complex relationship, it’s still unclear what exactly his next move will be, or whether import tariffs put in place by the Trump administration will be removed.

While there’s no guarantee to any of the predictions outlined above, they do align with the expectations of many industry experts. With such a small margin of control by one party, it is possible that the country avoids any large market moving policy changes for the foreseeable future, especially when it comes to unpopular items like tax hikes. Regardless of legislative outcome, a key concern remains: the all-time-high valuations of the stock market.

High Market Valuations

Stock markets have reacted to the good news around COVID-19 vaccinations and improvements to the economy by rising, by many different measures, to all-time high levels. Essentially, the markets have taken into account all of this good news, which is now priced-in as if nothing could go wrong in the future (a.k.a. priced for perfection). As we learned in 2020 however, many things can go wrong, and often do in quite unpredictable ways; we should always be prepared for this possibility. This is one reason why the CWM team has been slowly building into conservative portfolio positioning in our risk-managed clients’ accounts over recent months, despite ongoing market positivity and promises by the new Biden administration for a more robust vaccine rollout and economic support.

As we discussed previously in our Thirdly series, another reason stock market valuations have been high is initial federal fiscal support in 2020, along with the effects of slashed interest rates contributing to cheaper mortgages (“Should I Refinance My Home During the Pandemic?”).

Although government support was necessary for many individuals and our overall economic outlook, the aid did not affect people equally which is where we see in a K-shaped recovery. Some people at the top of the K are doing well financially despite the economic carnage of 2020, and have been able to invest and borrow easily. This is, at least, partially why speculative investable assets are seeing a great deal of interest, increasing concerns about rising risks of inflation. Market speculation leads to all-time high valuations and market fragility; in relation, higher inflation could result in the Fed pulling back from its support mechanisms and effectively bringing an end to a euphoric market.

As I like to say, the stock market currently appears to be a bug looking for a windshield—what goes up must come down, and eventually, that windshield will have a new critter.

Focusing on the future

The story of humanity is one of progress over time. We will see these turbulent times through, although maybe not without some rough riding for the stock market or other areas of our society. As always, the CWM team will keep a close eye on market metrics and trends to inform our recommendations and ideally help keep that ride as smooth as possible.

Without a crystal ball, we can only make educated guesses about the future based on our data and past comparison. Past periods of economic fragility demonstrate that one thing going wrong can result in sharp market selloffs, especially when valuations are high, as we saw last March. Current all-time-high valuations, combined with other market insights, show us that we have a higher probability of securing more favorable long-term outcomes with safer investments right now.

Like early last year, our current data suggests that clients will likely be able to better weather potential market selloffs, and perhaps even see some gains, in more conservative investments. For now, we’re following our disciplines and waiting to see how events unfold in the coming months before making any significant changes.

If you’re interested in learning more about CWM’s approach or how recent world events may have an effect on your plans to live richly, please contact us.