The models are broken
The market is trying to get back to the pre-Covid and pre-war times, but that model is broken. A new dawn is here and the financial world needs to adapt.
Chief Investment Officer
Summary: Joe Biden becoming the 46th president of the US marks the end of a remarkable four years of Trump and will bring a pronounced change of presidential style, if not a complete change in some of policies initiated during the Trump era. In this post, we run down ten top policy priorities for the incoming Biden administration, five domestic and five foreign, as 2021 is set to be a volatile year, especially once we get to the other side of the Covid pandemic.
US President Joe Biden’s Top Ten list of Policy Priorities
On January 20, 2021, Joseph Robinette Biden was sworn in as the 46th president of the United States of America. The policy shift to the new president may be somewhat less jarring than was the shift from Obama to Trump, but like Trump, the Biden administration will launch a similar rush to unwind his predecessor’s policies. A very divided America means that when the one side gets the power, it moves to erase the policies of the former office-holder. Biden has promised a blitz of executive orders from the get-go, but here we will outline ten key areas of policy focus for the incoming administration, five domestic and five foreign.
Biden’s domestic policy agenda
1. Killing Covid: Job One from Day One
Biden’s most important job from “Day One”, as he likes to say, was always to come out swinging in fighting the Covid crisis, appealing for the 100 days of restrictions and mask-wearing he has promised in order to allow the roll-out of vaccines time to start winning the race against new, more contagious Covid variants as well as mortality and the overall strain on US hospitals. Biden will likely mount an enormous federal push to establish vaccination centers nationwide in coordination with state authorities. Ensuring a fair and rapid distribution of the vaccine to everyone will be critical for establishing any popular mandate beyond the first half of this year. If the vaccine effort succeeds this could mean a weak Q1 and early Q2, but a likely boom for the second half of this year. We could even see a destabilizing “crack-up boom” as both pent up demand from lockdowns and pent-up savings from the huge pandemic-inspired fiscal cash splash into the economy combine to see a huge surge in activity and inflation. This would position the Fed and the government for a policy mistake by having over-goosed the stimulus, only to trigger massive volatility as it is likewise withdrawn too quickly.
Such a scenario could see wildly diverging performance for our themed equity baskets, as our “misery index” stocks linked to energy, travel and leisure at first soar, as do value stocks relative to growth on rising inflation, but with everything risking a rough ride if inflation spikes too aggressively later this year.
2. Social stability: in the driver’s seat
Modern cycles of bailing out the economy when it dips into a recession have tended to focus on the financial markets, where the pain is felt most quickly and where stabilizing the financial system is seen as a prerequisite for stabilizing the economy. But the Covid recession is different because inequality is greater than ever and the traditional policy response to keep financial markets functioning has only aggravated inequality, as small businesses fail and tens of millions of especially low paying jobs were lost while the fiscal stimulus has super-charged the success of online behemoths and perhaps stimulated the Chinese economy as much as the US economy through demand for manufactured imports. This time, stabilizing the economy will mean stabilizing society to prevent whatever passes these days for an armed insurrection – and we have seen glimpses of what this might looks like in 2020 and in the Capitol Hill riots two weeks ago.
Above all, the Biden administration will focus in this area on a safety net for the most vulnerable through prevention of evictions, raising the minimum wage and increasing medical coverage and lowering health costs. Inevitably, raising the minimum wage quickly will price some low wage jobs out existence, which will require more income support for the out of work – so we could potentially see a continuation of what has amounted to the introduction of a de facto Universal Basic Income (UBI) via stimulus checks. Post-covid, UBI policies may be more difficult to continue due to Republican resistance, but there is no “fiscal responsibility” party any longer, and there will be no sudden turn to austerity like we saw in the wake of the 2008-09 crisis. Meaning? Fiscal deficits driven by MMT like policies are set to continue until tamed by inflation. Higher wages, especially for those likely to spend nearly every penny of what they earn, will mean inflation and margin pressures on businesses that are unable to raise prices as quickly as costs rise. The Biden administration is likely find support from across the aisle on large infrastructure projects, which are likely the most productive use of fiscal stimulus, especially if investments upgrade blighted communities in cities big and small across the US. One are to watch for here is the degree to which a serious attempt is made to encourage relocation of manufacturing back into the US.
Social media and elections – after the 2020 election cycle, it is more clear than ever that the US must improve its election infrastructure, including everything from the wild mix of voting methods to the speed of tallying the results. The country can’t afford a repeat of the 2020 election disaster that took far too long to call, given the margin of Biden’s victory, and must ensure a rapid and transparent result on Election Night 2022. Let’s hope the US gets it right at that election and in 2024, possibly introducing blockchain technology and other tech to ensure we don’t see slow election counts, and conspiracy theories flourishing on social media.
3. The climate agenda: taking it easy
While climate ranked high during the campaign season and was particularly aimed at satisfying the progressive wing of the Democratic party, virtue signaling will be the name of the game more than heavy spending for the balance of at least 2021. The $7 trillion Green Tech Infrastructure idea that Biden campaigned on will not pass a thinly divided Congress. But green spending will be on the agenda and will come out of the general budget and only add to inflation risks, both by undercutting investment in cheaper fossil fuel energy and because green energy infrastructure is very expensive to build out. Read our latest 'green transformation' theme analysis for inspiration about which green energy stocks could benefit positively from Biden's energy policy. But look for popular pushback against the green agenda in 2022 if, as is likely, that underinvestment in black energy (fossil fuels) results in hefty price rises for consumers, who will still mostly still be driving petrol-powered cars. Never underestimate the impact of the retail price of gasoline on the American psyche.
Our most ardent hope for the longer term is that some of the energy spending will be diverted towards next generation nuclear power, both new fission reactors, but also into basic research and demonstration projects for nuclear fusion energy. Shortly put, alternative energy cannot replace fossil fuel energy on a system wide basis, as the energy production is of too low density, and only nuclear energy can ever offer a credible replacement if we want to maintain anything approaching our standard of living and the related energy intensity of our modern economy.
4. The big internet monopolies: regulatory fangs for the FAANGs?
The giant info-tech monopolies, from Facebook and Google, to Amazon and Alphabet were already cropping up on the regulatory radar before Covid hit. And then came the pandemic response, which not only didn’t hold these companies back, but actually supercharged their share prices on valuation multiples from interest rate cuts and as lockdowns encouraged a boom in online activity and purchases on the shutting down and reduction of activity at physical stores and restaurants and other entertainment venues.
Monopolies extract far too much excess profit from an economy, far beyond any productivity they ever provided in the bargain. They have no grown to world-eating monstrosities as 2021 gets under way. Increasingly, both of the US political parties are recognizing this and are ready to do something about it. A bipartisan committee in Congress in 2020 made significant findings that cast a negative light from lawmakers on the major infotech companies, and the US Federal Trade Commission and multiple state attorneys general have already filed a case against Facebook. 2021 will be the year when US regulators finally start to catch up with the threat these monopolies present to the economy, other businesses and even social stability. Stricter regulation on content, breaking up and disintermediation of their use of user data could all be on the agenda. As the top handful of companies has provided the majority of the growth in US equity market cap in recent years, the implications for US-bound investment are vast.
5. Taxation: hitting the snooze button
With the urgency of the pandemic and virus response this year, the issue of tax policy will take a back seat for the Biden administration for at least 2021, even if Biden campaigned loudly on rolling back some portion of the Trump tax cuts for corporate America and other tax reforms that he vowed would only hit the top 1% of income earners. One issue that is underappreciated about Trump’s tax reform is that it brought a vicious tax rise for higher earners in areas of the country – generally highly Democratic states on the coasts – with the highest state and local taxes, as the limits for deductions were chopped. It was a brutally partisan ploy. If Biden is unable to roll back these portions of the Trump tax code changes and then adds new federal taxes on top of state- and local taxes, coastal cities and states could turn into ghost towns of the elite, which erode the local tax bases there even further, leaving a negative spiral for the underfunded local public sector.
Biden's foreign policy agenda
While presidents often run on very domestic-policy driven agendas, the nature of the executive branch, which the president heads, is that it has very little sway in establishing any domestic policy agendas without a solid control of Congress, which retains the “power of the purse”. Six of Obama’s eight years as president, for example, were spent with little ability to do anything on the domestic front and Biden only has the slimmest margin of control over Congress. On the foreign policy front, however, presidents can largely do what they please, and Biden will establish a very new style in US foreign relations, even if some of the tendencies under Trump will be continued, particularly in the case of China. Five major areas of policy focus will be on:
6. China relations: Change of style more than substance
An increasingly anti-China stance is a bipartisan phenomenon in the US, and Biden may roll back very little, if any of the measures Trump enacted against China, from the Trump administration’s banning Chinese telco equipment maker Huawei from selling its tech in the US and generally demanding its national security allies do the same, to moves limiting funding of Chinese companies listed in the US due to auditing standards and purported links to the military.
Of course, the style of communication with China will be very different for Biden: don’t expect brash tweets threatening sudden tariff moves or Biden’s great personal affinity with Xi Jinping. Rather, expect a slow tightening of measures like the ones already established that will deepen the divide between the two countries, make it clear to US companies that they will need to scramble to find alternative sources of production outside of China. This will inevitably set off a rivalry for influence among trading partners globally, at worst risking a slow descent into a kind of cold global financial and trade war, one certainly hopefully without the brutal, kinetic proxy wars of the cold war, but one that could be pointing toward a bifurcation of the global monetary system and the global economy itself. Whether and to what degree the US can draft major trading partners and traditional allies in Asia and Europe into their aggressive stance on China will be critical in the first two years of the Biden presidency.
7. Taiwan: a global tech lynchpin
Taiwan is a global economic pressure point as it is the only place where chip fabs are able to produce the most high-end chips in volume, and is responsible for fully half of global semiconductor output and a staggering 90% of the most advanced chip production, by some industry estimates. It is also a geopolitical pressure point at the heart of the ongoing face-off between the US and China over tech dominance, after the US moved to prevent some Chinese companies, particularly Huawei, from taking delivery of chips containing US technology, even if manufactured in Taiwan or elsewhere.
How will China deal with this challenge, when it has so far failed to produce its own fabs and its key companies are reliant on Taiwanese output with and without US intellectual property for at least the next two years? Any supply disruptions from Taiwan, regardless of the reason, would prove enormously disruptive for the tech industry and nearly every aspect of the economy if this golden goose is prevented from laying its golden eggs. Geopolitically and economically, Taiwan is mission critical.
8. Russia: shield your eyes?
While there was plenty of talk over the last few years of a Trump-Putin bromance, the Trump administration actually proved quite tough on Russia at most turns when given a chance to enact sanctions, and even moved specifically against the Russia-German Nordstream 2 natural gas pipeline project meant to connect Russian natural gas exports directly to Germany and circumvent Ukraine. But Russia could be in for a new level of pressure from the Biden administration, partly as the Democrats still believe Russia was heavily involved in the disruption and disinformation in the 2016 election cycle, and possibly as well on the recent cyberattack many accuse Russian operatives of having perpetrated. A cold relationship could get that much colder and make it increasingly difficult for Russia to access the USD-based financial system and attract inbound capital investment. This could weigh on the ruble and Russian assets. But more importantly, given Russia’s heavy reliance on exporting to Europe, the issue of Russia will represent perhaps the greatest test of the strength of traditional US-Europe alliances, as well as he EU’s own resolve in creating a euro-based financial system that is sufficiently robust to exist independently as well.
9. The Middle East: no good choices
No ability (or desire) to predict outcomes here, but the Middle East traditionally hosts a cauldron of dangerous issues, made more dangerous by food insecurity of parts of the region at a time when food prices are soaring. Many credit the start of the Arab Spring and even the Syrian civil war to destabilizing food shortages and drought, in the case of Syria. The focus on shifting away from fossil fuels in the developed world potentially doubles down on the risks, as oil and gas exports are the economic underpinning of the region. The shift by Biden back to less hostile stance on Iran could likewise set the region on edge, and China’s increasingly heavy reliance on imported Middle East-sourced oil relative to the US will mean that it will inevitably deepen its involvement in the region after seeing its oil imports more than double over the last 10 years. China is far and away the largest importer of oil now.
Turkey is another key regional player with many irons in many fires and a President Biden will unlikely prove as friendly an ally to Turkish President Erdogan as Trump, after the Turkish president bought a Russian missile defensive system. Can Turkey retain its nominal membership as a member of NATO and would a Biden administration want to exercise further leverage on Turkey via sanctions?
10. Europe and multilateral institutions: lip service at best.
Trump’s presidency was a massive problem for the EU, as the Trump presidency marked the most significant weakening of the diplomatic relationship between the US and its chief allies there since the end of World War II. Four years of Trump leave Europe feeling isolated and even militarily insecure on the threats from Trump to withdraw military protection and weaken NATO commitments, not to mention the possible financial impact of protectionist US trade policy. What will be the change under Biden? In the beginning, we’ll likely see a helpful lack of urgency on any new protectionist trade policies together with plenty of lip service on the friendly traditional relationships, which will buy some short-term relief. But there are plenty of areas where the US and EU can get into trouble, from policy on Russia noted above, to whether the EU is willing to take sides in a deepening US-China rivalry. Also, the increasingly inwardly focused US voter doesn’t give a hoot about Europe.
Elsewhere, Biden will also make a show of normalizing US involvement with multilateral institutions like the UN, WHO and initiatives linked to the international fight against climate change. But these are not broadly popular – particularly the WHO and its PR disaster in not declaring Covid a pandemic - and could prove surprisingly limited. Expect the economic populism angle to constantly creep into the picture and become a risk in the polls for nearly any non-nationalistic, “globalist” policy initiative. The Biden presidency could show that a left populist agenda can drive a protectionist US agenda just as much as right populism can. For example, the climate agenda can be used to sanction Brazil for its rain-forest destruction. And left populism can also deepen the US-China divide on the political left’s criticism of China on human rights and its status as world’s largest CO2 emitter due to its heavy use of coal.
The market is trying to get back to the pre-Covid and pre-war times, but that model is broken. A new dawn is here and the financial world needs to adapt.
Chief Investment Officer
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