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Markets Can Kiss Goodbye to the Blue Wave

Points of Return

Midnight in Manhattan

As I write, it has just turned midnight on the eastern seaboard of the U.S., and there is much more counting to be done before the results of the elections are known. But several very important things are now clear:

  • There is no "Blue Wave." That is true politically, but also in the economic sense that that phrase has come to take on: There will be no big game-changing shift toward fiscal policy and away from monetary domination;
  • The reason for this is that the Republicans now seem close to certain to hold on to the Senate;
  • There will not be clarity for a while, probably not until Friday;
  • The risk of protracted legal challenges is very real.

There is also some very good news, in that there was a high turnout, with minimal stories of voter intimidation from around the country. For all the fears of riots and insurrection when Tuesday dawned, nothing like that has happened, at least so far. 

The most important point for markets concerns fiscal policy. The mathematics behind Senate control were that the Democrats needed to win three states, if Biden took the presidency, and four if Trump prevailed. So far, they have lost a seat in Alabama, and gained one in Colorado. They  look likely to win Maine and Arizona. That leaves them one short, and at the time of writing it looks like they aren't going to pick up another state. Hoped-for pickups in Georgia, Iowa and North Carolina didn't materialize.

With a Republican Senate, we either have the economic status quo, dominated by monetary policy, under President Trump; or a Biden versus Mitch McConnell dynamic in which fiscal policy would become even more frugal. A blue wave of infrastructure spending looks very unlikely at this point. As a result, many market assumptions that have endured for months need to be changed.

This leads to some excitement, as both the stock and bond markets made a strangely emphatic bet on a Blue Wave during Tuesday's Wall Street trading. Action in the 10-year Treasury bond was spectacular, with yields topping 0.9% for the first time since the March implosion, and then tanking by 15 basis points as the results came in:

As for the equity market, there was a bizarre replay of the excitement on election night in 2016, when the stock market rallied on the assumption that Hillary Clinton would win, reversed as it grew clear that she wouldn't, and then rallied massively. Exactly the same pattern has played out four years later:

The reasons are slightly different this time. The initial setback reflected worries about the waning possibility of a Blue Wave. The subsequent rally is more defensive than the surge four years ago. It appears to be led by Big Tech, with Nasdaq-100 futures gaining 4.8% at one point. Big Tech benefited most from the conditions of the six months since the Covid shock, and at this point it is regarded as a defensive play.

The bad news for markets is that the uncertainty will probably persist. Biden appears to have taken Arizona, and Trump looks unlikely to win any of the states that went to Clinton four years ago. This means that the election will come down to the Rust Belt states of Wisconsin and Michigan (which will announce results Wednesday at the earliest), and Pennsylvania (unlikely to announce until Friday). If Biden wins all of them, he will be president. At this point, that is plausible. Indeed, the scenario I mentioned in the newsletter a few days remains open, in which the electoral college could come down to a tie. Here it is:

At the time of writing, Trump hasn't gone through with his threat to make a premature declaration of victory, which is probably wise politics, although he did send out a tweet alleging that an attempt to steal the election was under way. But if the scenario in this map or anything much like it does come to pass, there is virtually no doubt that the result would be contested legally. That would amp up the uncertainty.

Other things matter a lot. The country is as divided as ever, and it hasn't repudiated the Trump era in the way that many outside the U.S. desperately wanted. But for markets, the key points are that the Blue Wave won't break, and that the uncertainty will endure.


Betting Markets 1 Pollsters 0

It's clear that this isn't a Biden landslide. Democrats have performed worse than pollsters predicted, and beyond their margin for error. The betting markets look better.

They were always skeptical of the emphatic odds on a Biden victory produced by the main poll-based models. Predictit and the main betting markets agreed on the eve of Election Day that Biden's chances were only 63%, not the 90%-plus called by the likes of FiveThirtyEight and The Economist. That leaves them looking clever.

But this isn't an unqualified victory for the prediction markets. On Predictit, the afternoon saw a swath of bets on Biden to win battleground states. Then, shortly before polls closed on the eastern seaboard, the website crashed. Many bettors who had suddenly decided to bet on Biden won't be happy. This screenshot I took before the site crashed shows that Predictit was moving sharply toward Biden in late afternoon:

The betting markets that remain open may have overstated Trump's chances of victory. London-based Betfair at one point gave Trump an 87% chance. That number has already come down to 58%. But the markets, incorporating the angst of liberals and the confidence of conservatives that this election wasn't going to be a landslide for Biden, and with money at stake, have done a better job than the polling models.

Should we even bother with trying to map political probabilities? This piece in The Atlantic suggests not. Meanwhile, this 5,000-word article arguing that if Trump were to win, "the entire polling industry, and quite possibly empiricism itself, would be in a nearly unfathomable crisis" reads very interestingly with the benefit of hindsight. Even if Biden does eke out a narrow victory, results so far mean the unfathomable crisis is here. 


What Nigel Did Next

Nigel is making plans for us. The politician who did more than anyone else to force Britain's government to hold a referendum on whether to exit the European Union, and then to win a vote for Brexit, is planning a new populist attack on the financial services industry.

The podcast and website will be called Fortune & Freedom with Nigel Farage. Nigel is casting the attempt to democratize finance, and to save people from being ripped off, in much the same language that he once used to persuade the British to leave the EU. Here is a sample:

there is another powerful institution we need to free ourselves from…

I'm talking about the bloated and self-serving mainstream financial industry.

Simply put:

Your money is in the hands of someone else…

And that is very dangerous.

Because it means you could be heading for a very disappointing future.

I'm going to show you how to make your own financial decisions – and not to rely entirely on people who may not have your best interests at heart, in the long run.

The stakes could not be higher.

I am torn. I disagreed strongly with Farage over Brexit. I have more sympathy with him when it comes to demonizing the "mainstream financial industry," particularly in the U.K. Financially naive investors have a strong tendency to get short-changed. I started my career 30 years ago reporting on aggrieved British pensioners who had been tricked by unscrupulous sales reps into abandoning copper-bottomed defined-benefit pension plans and buying products with excessive charges instead. Twenty years ago, I reported on the frenzy as 401(k) sponsors allowed savers to switch between different funds from day to day. That also ended in tears. Saving for retirement is difficult, and there is a large industry keen to cheat people. 

But the lesson of those experiences is harder to discern. Yes, the financial industry will take advantage of people. But giving people more discretion, when they don't have the financial knowledge to avoid the rip-off merchants, is a recipe for disaster. Farage is setting himself up to provide them with the education they need, which is laudable. It would be better, though, to redesign saving products to give people default options that work well, letting them opt out only when they are sure they can do better.

The financial services industry should take note, though. If one of the canniest and most successful populist politicians in the world is coming after you, it may be a portent of things to come. 


False Consciousness

Finally, I'd like to share an insight from the Opinion live election blog, which you can follow here. Earlier in the evening, I posted this chart from Gallup, which with hindsight helps to explain why Trump has done much better than the polls predicted:

Gallup has regularly asked voters the famous Ronald Reagan question: "Are you better off now than you were four years ago?" When Americans were surveyed in late September, a majority said yes. Trump is the first incumbent to be able to say this at the end of his first term since Reagan. My attempted explanation:

If Reagan was right that this is such an important question, why is Trump not winning clearly in all the polls? And as this survey was conducted in September, with the country still barely starting to recover from the Covid-19 economic shock, how could so many people possibly feel better off?

One answer lies in polarization; people are so determined to back their side these days that supporters of the president determinedly told pollsters that they were better off, regardless of the truth.

Another may be what Karl Marx called "false consciousness" – the Trump salesmanship has been so successful that people think they are better off, even if they aren't.

Or maybe, just maybe, there really are that many people who are better off than they were four years ago. Whatever the explanation, if Trump has performed better than the pollsters predicted, this particular survey answer could come to seem very important.

That brought the following fascinating answer from my colleague Karl Smith, who found it easy to explain:

First, median household income was way up in 2019. Indeed, the rise of the last five years is the largest on record, beating out even the increase of the 1990s. Second, even though unemployment has exploded because of the pandemic, personal income has actually risen even more since the end of 2019. That's because the unemployment benefits of the CARES Act were so generous that they more than made up for the loss in income from joblessness.

These factors help explain President Donald Trump's otherwise perplexing improved performance with minorities, particularly men. On the other hand, his former stronghold of older White voters is collapsing. The most obvious answer is Covid.

The results so far suggest that this was a great piece of punditry. Macroeconomics don't always tell all the story. If Biden does hang on to win, it will be because Covid-19 has weakened Trump's hold on the white working class in the Rust Belt. 


Survival Tips


I'll keep it brief. If you feel the way many of my neighbors in New York City do, you'll want to listen to one of my favorite songs of all time: Heaven Knows I'm Miserable Now by the Smiths. It's great when you have a hangover. For those who trusted in the polls, it may be just what you need.

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