Originally sent to VIXCONTANGO subscribers on November 1st, 2018 before the 2018 Election
2018 Election Prediction
I want to continue the discussion for the Election Scenarios from yesterday. Obviously, after the election I will write up a big guide once we have that very big information, but it is still good to have a model of what will happen and then judge the market’s reaction to the developments from a position of preparedness.
538 (Nate Silver) estimates the probabilities of the GOP keeping the Senate at 85% while the probabilities of the GOP keeping the House at only 15%. He is not alone in that view and polling from various outlets supports roughly tracks these percentages. So I am going to go with them. Polls in this cycle have the traditional oversampling of Democrats we saw in 2016 and thus there is a chance that the GOP will outperform in the House, but oversampling Democrats in 2018 makes more sense than 2016 simply because the GOP is in power. Voters of the minority party tend to be more enthusiastic and come out to vote in higher percentages. For example in 2010, 2012 and 2014, pollsters routinely underestimated GOP turnout and got blindsided by GOP wins 3 times in a row because their polls never accounted for minority party enthusiasm. They are biased only one way – the Democratic way. In 2018, however, they will get lucky because the Democrats are the minority party and enthusiasm skews that way. In other words, polls will accidentally work this year!
In the Senate I project the GOP will pick up seats. Only 3 current GOP seats are in question in Nevada and Arizona but the GOP has already basically ensured its majority with projected wins in Texas, Tennessee, North Dakota and Missouri 2 where their candidates hold massive polling leads far beyond the margin of error. If the GOP holds, Nevada and Arizona and gains in Florida, Indiana, Missouri 1 (McCaskill), Montana and a surprise win in New Jersey, you might have a 57 seat GOP Senate! I think the highest probability scenario calls for 54 seats, but recent developments have made me bump my estimates to 55 seats!
Senate Projection: 55 seats for GOP
I really don’t have enough knowledge to decipher the House, but official estimates have the Democrats winning by somewhere between 6-10 seats. If you think GOP will outperform because of Trump, you might think that the GOP would win, but I think Trump will galvanize more progressive Democrats just like Obama galvanized Tea Partiers and thus Democrats will outperform their estimates. I hope I am wrong, but this is what logic tells me.
House Projection: 235 seats for Dems
When you combine the probabilities, almost 75% the chances are for GOP Senate and Dem House. Only about 10% for the other scenarios and a GOP House and Democratic Senate is a practical impossibility. I will start by discussing the lower probability scenarios before I discuss the big one.
Originally sent to VIXCONTANGO subscribers on November 6th, 2018 before the 2018 Election
Key Democratic House Committee Chairs
Since my prediction is for a House win by the Democrats, I am going to start looking into the sector impact of such an event in preparation for my Election Guide email later on tonight and tomorrow morning. I hope I am wrong and the GOP holds the House, but that is a market scenario that does NOT merit a deeper look post-election since we remain on the current Trump-era policies which as we know favor XLF (financials), XLI (industrials), XLE (energy) and XLB (materials). If GOP holds the House, there will be a big market rally in the aftermath of the election. Period full-stop. What is interesting here is what will happen if Democrats take over the House since that represents a change from the status-quo.
The House has the following 2 powers:
- It has oversight powers over the executive branch
- It originates government spending bills
The Senate, by comparison, has “advice and consent” powers such approving treaties or approving executive branch appointments. In other words, the executive branch has to pass its people past the Senate, but then once they are in office, the House gets to investigate them if they don’t do a good job and “impeach” them. In addition, the ability to originate spending bills basically sets the Fiscal Policy agenda of the United States since Congress really is the one that prints the money (according to MMT). So the House is very, very important for the stock markets. Don’t let the TV pundits fool you. Who holds the House matters… a lot!
The most powerful members of the House sit on “Committees” that oversee various functions. The party that holds the majority selects the “Chair” of each House committee. The House minority party selects a “Ranking Member” which is the highest ranked party member in that committee and generally considered the 2nd in command of that Committee. Congressmen spend their entire careers angling to get a spot on these Committees and ideally one day they all want to become a “Chair” of a committee. These are some of the most important positions in the government of the US. When Congress changes hands, the Ranking Member is usually the one to be promoted and become a “Chair” of the committee in the next Congress. Here I will look through the Ranking Members of note on various important House committee and I will attempt to assess their market impact on select S&P 500 sectors.
|Ranking Member||Sector Impact|
|Adam Schiff, Intelligence Committee||He will have the power to subpoena Trump’s tax returns and then leak them to the media and cause all kind of trouble for the President. He doesn’t have a particular sector impact, but broad market impact because he will have access to the Holy Grail of modern politics – The Trump Tax Returns. Worth a Bear Market all by himself!|
|Maxine Waters, Financial Services||She really needs no introduction. She has been around since the Rodney King riots in the early 90s. Lately she has been inciting the Democratic base to physically intimidate Republican officials everywhere – where they eat, where they sleep, etc. She is one of the more extreme members of the Progressive Left and is often a staple of strong financial regulation. She is a big opponent to Stephen Mnuchin because he didn’t pay her off when he was Chairman of OneWest and she worked really hard to derail his nomination. They are both from LA. Look for her to go after Mnuchin hard (launch an oversight investigation) after the election. In addition, she will be shaking banks for bribes to avoid strong regulatory action. Basically the female Al Sharpton. Banks may pay her off and survive but it is all coming off from the bottom line. Financials (XLF) goes down minimum -10% from current levels. Banks are not expensive on historical basis but if they are regulated by Waters, they could go down below book value. Massive continuous shakedowns are coming.|
|Al Green, Financial Services,
Oversight and Investigations Subcomittee
|He has already drafted Trump articles of impeachment and is in the key Oversight position on the Financial Services committee. He is the tip of the spear and he is going after Mnuchin and banks hard. He is going after Trump hard. I don’t think Mnuchin survives as a Treasury Secretary if Democrats win the House. I think he will be gone before the year turns over. But get ready to see a lot of this guy and his brand of extremism.|
|Elijah Cummings, Oversight and Government Reform||He has been discussed in this newsletter as an author of the Sanders-Cummings Drug Price Control bill which Trump at some point considered. If Democrats win the House, that bill will gain big traction. As I mentioned in the past newsletters passing that bill is a $500 billion boost to the US economy as lower drug prices directly benefit US consumers. However, it affects the Health Care (XLV) industry negatively as it crimps their record profitability. This bill is worth at least -20% loss for the XLV at the expense of higher GDP growth in the US. XLY (consumer) and XLP (staples), XRT (retail) are the sectors to benefit disproportionately from this bill. I personally like Elijah Cummings a lot, he is a great American.|
|Stacey Plaskett, Oversight, Energy and Environment Subcomittee||This is going to be the lady trying to make Rick Perry (Secretary of Energy) and Scott Priutt (Environmental Protection Agency) lives miserable. In particular, there is no doubt that oversight investigation of Scott Priutt will be launched. Big Energy has a lot to lose here and this is going be costing them at least -10% in market cap for the XLE (energy), if not more. If oil prices continue to tumble, a Democratic held house is not going to help Big Energy names like Exxon Mobil or Chevron at all. Plaskett is a long time New York lawyer who worked in a high position bringing down Big Tobacco in her past. Her boss Larry Thompson was replaced by James Comey at the Department of Justice. Taking down big old-school industries is her specialty. Her only private job has been at the United Health Group. Long story short, she will be a pain for Big Energy because she is not dependent on them.|
|Jan Schakowsky, Energy & Commerce, Digitial Commerce Subcomittee
|Famous for saying during the Facebook interrogations that “It is clear the self-regulation at social media does not work”. Strong proponent of having at least the European GDPR regulation passed in the US. She is expected to come down hard on social media. Social media has been selling off and will continue to selloff as there is more or less bipartisan consent that social media is now important enough to be regulated by the government. This lady is a Chicago hard-liner on the issue and she might fight herself with much backing from Trump Republicans in the new Congress. She takes off at least -10% from the XLC (media) market cap. Probably affects Apple and the XLK (technology) market cap as well.|
|Richard Neal, Ways and Means Subcomittee||Hard to get a read on this guy. He is a Massachusetts liberal who doesn’t like the AMT (alternative minimum tax). He is totally in the “what the f—“ category. Voted against the Bush tax cuts because they would put more people in the AMT category?!? He is in favor of simplifying the tax code and getting the rich to pay their fair share. But not through AMT, apparently. He voted against NAFTA and voted against bill that would give the President more authority on Trade. So he could be a key person that would block Trump’s trade deals if there are any with China, Mexico and other countries. His market impact is across the board and if he goes after preferential treatment of dividends and interest payments in the tax code, watch the market selloff fast. He doesn’t have a sector impact, he has broad market impact. If Trump “simplifies” the tax code the way Democrats want, watch stocks knock go into a bear market fast.|
|John Lewis, Ways and Means, Oversight Committee||This is the guy that is going to ask where the repatriations are – which is about $250 billion in SPX profits which are still unreported. He is in position to launch an investigation into the IRS and Treasury to determine why they aren’t collecting repatriations and who issued the rule that delayed repatriations. Trump insulted him and his payback could be to go after Mnuchin hard and then whoever comes after Mnuchin. Whenever you hear the word “oversight”, that means able to launch investigations of the executive branch. In any case, he has the ability to knock off about $10 per share of GAAP EPS for the SPX. Or roughly 250 points.|
As we can see here, the promotion of these folks will have significant negative impact for XLK (technology), XLF (financials), XLV (health care), XLC (media), XLE (energy) and XLB (materials). The only sectors to benefit are potentially XLY (consumer discretionary) and XLP (consumer staples). Unfortunately, the negatively affected sectors represent about 65% of the SPX. If we assume a -10% move in those post-election while the other 35% gain some on rotation, it is not hard to come up with an additional -7% in the SPX which will send us right at the 2450 target that I have for 2018. Democratic House led investigations and anti-business (but very popular among Americans) spending bills will help contract the SPX multiple right to where it should be. Below 20. For sub 10% growth next year, we definitely should not be trading at above 21 GAAP PE trailing multiple like we are today, but much lower.
Long story short, it is very hard for me to envision a big market rally into year-end if the Democrats win the House. As the market discovers the agenda and the background of the new Committee Chairs, I don’t think investors will be happy at all. At the very least, they won’t be willing to overpay for a dollar of earnings the way they did with a Trump led total GOP control of the US government.