When former vice president Joe Biden takes office in January, he will inherit a mixed economy with low inflation and high debt from President Donald Trump. It is better than what Bill Clinton and Barack Obama took over when they were elected, according to John Normand, JPMorgan’s head of cross-asset fundamental strategy, but still subdued enough to suggest economic and market recovery in the coming years.
Whether Biden will lead a unified or divided government may not be known until the January runoff for two Georgia Senate seats. But the stock market appears to be expecting—and liking—the prospect of a Biden presidency and Republican Senate. The S&P 500 rose 6% last week to achieve its best election-week gain since 1932.
Divided government has been historically thought of as good for markets. According to Yardeni Research, the S&P 500 rose 60% on average during periods when neither party had full control, beating the 56% return under Democratic control and 35% under Republicans.
But which party controls Congress is not the only factor that matters for the economy and markets. During the Clinton and Obama presidencies, both of which began their terms with Congressional control, market returns were extraordinarily high; while under George W. Bush, who also controlled Congress, returns were poor.
The economic legacy an incoming president inherits from his predecessor also plays a key role. “Initial conditions can determine the potential of the next administration, given the mean-reverting nature of the business cycle and some asset valuations,” wrote JPMorgan’s Normand in a Monday note.
A president who takes office during a recession or soon after one ends—when equities and credit are cheap compared with their long-run average—is more likely to preside over an economic expansion that delivers above-average gains in risky markets. On the other hand, a president who takes office in the twilight of an expansion—when markets are rich—is more likely to inherit a downturn.
Normand looked into the economic and market inheritance of incoming and re-elected presidents as of each November election, as well as the market performance over the subsequent four years of the next administration.
Obama in 2008 was dealt the “best” hand in 50 years, according to Normand, inheriting an economy still in a recession with extraordinarily cheap markets. “Whatever investors thought in 2008 about the path of regulatory and tax policy under a Democratic sweep was less relevant than the mean-reversion force from depressed levels,” he wrote.
Bush, on the other hand, probably had the toughest hand, Normand said. When he was elected in November 2000, the U.S. economy was peaking due to the Federal Reserve increasing its benchmark interest rates the prior year, and stocks were near-record expensive.
Biden’s inheritance is somewhat in between, according Normand, with the economic conditions today rather “mediocre.” On the one hand, unemployment rate is above average, and the country’s share in global GDP is at the low end of 24%. The U.S. is also highly indebted—both federal government and private sector debt are near record highs.
But Fed policy will likely remain ultra loose for extended periods and core inflation has stayed low, which has supported strong market gains over the past few months. That’s a combination “much less miserable than the stagflation Nixon/Ford handed to Carter in the 1970s,” wrote Normand.
From a valuation perspective, although stocks are trading at near-record high multiples, their return premium over Treasury yields are just above average for an incoming president. That means stocks are likely to continue outperforming bonds, according to Normand.
Treasury yields are near record lows. Given the semi-permanent loose monetary policy, they are unlikely to reverse in a substantial manner—unless there is a multiyear loose fiscal policy under a Democratic sweep, which could be inflationary and potentially make the bond market more attractive again.
The mixed economy inherited by Biden means it might matter more for his administration than previous ones whether Congress turns out to be divided or unified. After all, where the economy and market head from here depends heavily on the size of the next stimulus bill, infrastructure spending, and future tax policy.
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