Elections

Dear client, Along with an abbreviated report this week we are sending you this Geopolitical Strategy service report written by my colleague Matt Gertken, BCA’s Geopolitical Strategist. Matt argues that US social unrest is structural and therefore can still cause volatility, while the market’s recognition that Trump is an underdog is also a risk. I hope you will find this report both interesting and informative. Kind Regards, Anastasios   Portfolio Strategy While we remain constructive on the prospects in the broad equity market over the coming 9-12 month time horizon, a flare up in geopolitical risks and uncertainty around the upcoming election could serve as catalysts for a much needed breather in equities. Recent Changes Last week our rolling stop was triggered and we downgraded the S&P biotech index to neutral and booked gains of 5% since inception.1 Table 1 The SPX catapulted to fresh recovery highs last week, on the back of optimism surrounding the successful reopening of the economy along with the ongoing support of easy fiscal and monetary policies. Sentiment is not as extended as in February or during previous SPX tops in the past few years, as we highlighted in recent research.2 However, greed is slowly showing up on our radar screens as investors that have missed out on the rally are chasing performance. Additionally, the market action has an element of a short squeeze. Equity market internals signal that there is likely a bit more gas left in the tank, despite the roughly 1000 point rise since the March 23 lows. While the S&P transports index has neither made new all-time highs nor outperformed the SPX year-to-date, one economically hypersensitive sub-group, trucking, has been revving its engines. The S&P 1500 trucking index has stealthily joined the “new all-time highs” club. The highly fragmented trucking industry has an excellent track record in leading the S&P 500 and the current message is that the path of least resistance remains higher for the SPX (Chart 1). As large parts of the economy are reopening, this index seems to have priced in a full recovery and a return to normal in the back half of the year. The jury is still out on the economic recovery’s shape and the risk of a second viral wave is significant, but stocks continue to climb the proverbial "wall of worry". Chart 1Trucking As A Leading Indicator Importantly, another extremely pro-cyclical equity market indicator, the S&P deep cyclicals/defensives share price ratio, has also led the broad equity market bottom and continues to herald additional gains for the SPX (Chart 2). Deep cyclicals include tech stocks, but even if IT were excluded, the cyclicals ex-tech/defensives ratio still troughed prior to the SPX and is gaining steam. Chart 3 shows the GICS1 sector returns since the March lows and technology is similar to the overall market’s return. The deep cyclical trio (energy, industrials and materials) have outperformed the tech sector, and bested defensives by a wide margin. Chart 2Cyclicals Are Besting Defensives Chart 3GICS1 Sector (%) Returns Since The March Lows Our Global Trade Activity Indicator corroborates the message that the cyclicals/defensives ratio is emitting (Chart 4). The recent breakout in the JPM EM currency index along with budding evidence of China’s economic recovery and likelihood of a stimulus package (not as large as the GFC, but bigger than the early-2016 manufacturing recession one) suggest that global growth is slated to recover in the back half of the year. Chart 4Looming Global Growth Recovery Nevertheless, it is quite unnerving that the SPX has broken out to fresh recovery highs despite bleak economic fundamentals and rising political and geopolitical risks. One potential negative catalyst that could cause a healthy reset is the rise in the polls of Democratic presidential candidate Joe Biden ahead of the November elections. Chart 5 shows that over the past year, the S&P 500 has moved in lockstep with the relative odds of a Republican versus a Democrat getting elected President. But recently, a wide gap has opened warning that the SPX is vulnerable to a pullback. In truth, the online gambling community has been slow to react to the erosion of President Trump’s platform due to pandemic and recession – so his odds could fall further in the near term. At the margin, a Biden win should be negative for the stock market because his party is perceived as more hostile to businesses and the specter of higher taxes could trip up the SPX. Our Geopolitical Strategy service has highlighted this risk in recent reports, including on May 15.3 Tack on the persistently high reading in the Baker, Bloom and Davis Policy Uncertainty Index and the risk/reward tradeoff for the overall market tilts further to the downside at the current juncture (Chart 6). Chart 5Do Not Neglect (Geo)Political Risks Chart 6High Policy Uncertainty Is A Red Flag Bottom Line: While we remain constructive on the SPX over the coming 9-12 month time horizon, a flare up in geopolitical risks and uncertainty around the upcoming election could serve as catalysts for a much needed breather in equities.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com   Geopolitical Strategy Social Unrest Can Still Cause Volatility Highlights Social unrest in the US is driven by structural and cyclical factors as well as election-year opportunism. It can still cause volatility. Unrest will weigh on consumer and business confidence – adding to already ugly fundamentals. The market has come around to our view that Trump is an underdog in the election. This is a risk to equities since a Democratic victory will bring full control of government. President Trump has low legal or political constraints to deploying the military if violence gets worse in the streets. This increases tail risks of a civilian death that amplifies the unrest. A “silent majority” of voters could give Trump a polling boost as a “law and order” candidate later this year. This could require us to upgrade his odds of reelection. The US dollar faces long-term headwinds but we are unlikely to reinitiate our long EUR-USD trade until the US election cycle is complete. Feature Chart 1Markets Skyrocket On Stimulus & Reopening Economic reopening and stimulus are winning the day as investors continue to look forward to a time when growth and corporate earnings recover yet inflation and risk-free rates remain suppressed. Judging by the breakout of cyclical versus defensive stocks and risk-on versus risk-off currencies, the rally could continue and the gap between stock markets and macro fundamentals could widen further for some time (Chart 1). The market is looking through the most widespread social unrest since 1968 in the United States, which emerged due to the death in police custody of a black man, George Floyd, in Minneapolis. History suggests that over a one-year horizon, social unrest can be ignored – but in the near term it could yet provoke volatility. This risk is underrated because the market already believes that the unrest is a known quantity without material impact, yet this report shows otherwise. We see four new risks, the first three negative for the market. Chart 2US Consumer Sentiment Is Vulnerable Consumer confidence and activity could worsen in the face of historic national unrest. The slight uptick in improving consumer expectations could reverse (Chart 2). President Trump’s odds of reelection could fall permanently, triggering a downgrading of long-run earnings expectations. A mistake could cause unrest to reach an unknown critical threshold that strikes fear into investors about US stability. The US debate has moved on from racism to “fascism” as Trump’s opponents criticize him for his authoritarian rhetoric and deployment of military forces to secure parts of Washington, DC. Structural factors are driving the riots which means they may smolder and additional incidents could cause them to flare up throughout summer and fall. The deployment of troops to quell civil unrest – as in any country at any time – could easily lead to bloody mistakes. The upside risk is that Republican senators will capitulate even sooner on fiscal spending measures, seeing that their corporate power base is likely to feel more concerned about the collapse of society. The House Democrats and President Trump already share an interest in larding up the spending, so it was only a matter of time till the senate caved in anyway. If the next $2 trillion arrives without the June-July hiccup that we expect, then the market could power higher (Chart 3). Chart 3Global Fiscal Stimulus Continues To Grow In this report we show why US social unrest is structural and how it can still bring equity volatility. Also, the online betting market has caught up to our view that Trump is the underdog in the election. The prospect of full Democratic Party control could start to weigh on US equities. The upside risk to this view would be markets cheer Biden – which is unlikely for long – or if the violent protests create a “silent majority” that helps Trump win the swing states. If his polling improves in the wake of the riots – and the stock rally continues unabated – then we may upgrade his reelection odds from 35% to 50% or higher. Bottom Line: A pullback would be a buying opportunity, but a 10% correction could easily transpire given that a falling market reduces Trump’s odds greatly and could kill the market’s faith in Trump reflation policy from 2021-24. How Social Unrest Came To The United States The US was ripe for a major bout of unrest, as we have highlighted in past reports such as “Populism Blues” (2017), “Civil War Lite” (2019), and “Peak Polarization” (2020), as well as in our top five “Black Swans” report for this year. Our updated “Great Gatsby Curve” shows countries with high levels of income inequality and social immobility. The US is right in the danger zone, joined by other countries that have had unrest or political disruptions (Argentina, Chile, UK, Italy) or will soon (China) (Chart 4). African Americans suffer the worst of these ills and also have long-running grievances with the criminal justice system. Chart 4The US Is In The Danger Zone For Populism, Unrest Unrest was an easy prediction even before the pandemic and recession, which made matters worse. The US ranks last, among developed markets, just below Greece, in our COVID-19 Unrest Index (Table 1). This index combines four factors – economic fundamentals, vulnerability to COVID-19, household grievances, and governance indicators – to rank countries according to their susceptibility to social unrest. US unemployment has soared higher than that of other countries as it has less generous automatic stabilizers. Table 1US Ranks Worst In Our COVID-19 Social Unrest Rankings When it comes to the virus, the US is not any harder hit than most of its European peers (Chart 5). And the black community is not much harder hit than whites, although both have suffered more than their population share would imply, and more than the Hispanic community (Chart 6). Chart 5US No Different Than Western Europe On COVID-19 Deaths   Chart 6COVID-19 Least Deadly For Hispanics However, the lockdowns have caused the unemployment rate to soar and exacted a greater toll on the least educated and lowest paid members of society. The election is enflaming the situation. President Trump’s economy has now performed little better for households than President Obama’s economy, assuming they suffer an income and wealth shock at least equal to that of 2008-09 (Chart 7). Chart 7Households Suffer Massive Income Shock Given the collapsing economy, Trump is doubling down on “law and order,” taking an aggressive stance against rioting and looting and thus provoking a backlash. The media is also in a feeding frenzy as the pandemic and economic reopening narratives lose traction and yet Trump perseveres. Polarization is intensifying as a result. Trump’s rhetoric has been egregious as always. His threat to invoke the Insurrection Act of 1807 is not. President George Bush Sr invoked the act to suppress the LA riots in 1992. The act’s provisions, as well as the specific exceptions to the posse comitatus laws and norms, give the president broad discretion in matters precisely like these. The real constraint is not legal but political: any popular backlash from Trump and his advisers in trying to “dominate the battlespace” when it comes to civilians at home. Rioting and looting are also unpopular, so a larger crackdown could easily happen if more unrest takes place. Since the riots are driven by structural factors, they could still escalate, especially if another incident of police brutality occurs. Bottom Line: US unrest is driven by structural and cyclical factors and thus we are in for another “long, hot summer” like 1967. Negative surprises should be expected. The larger risks have to do with the impact on the election and sentiment. Trump’s Polling Was Dropping Even Before The Riots Trump’s approval rating has fallen to the lowest level this year and diverged from the historic average (Chart 8). This increases the risk that the market experiences volatility either in expectation of “regime change” in November or in reaction to Trump’s attempts to regain the initiative. Trump’s deviation from President Obama’s approval at this stage in 2012 is a warning sign (Chart 9). Chart 8Trump’s Polling Drops Below Average Chart 9Trump Falls Off Obama’s Pathway To Reelection Chart 10Trump’s Pandemic Bounce Turns Negative, Unlike Others Trump and the Republican Party received a smaller polling bounce from the pandemic – and year-to-date the bounce is not only gone but has turned negative, comparable only to Vladimir Putin and United Russia (Chart 10). At its peak it was smaller than that of previous US presidents in crisis situations (Table 2, see Appendix). These data come from before the George Floyd incident which will make matters worse for Trump, given that initial polls suggest 35% approve and 52% disapprove of his response to it. The presumptive Democratic nominee Joe Biden is narrowly leading in all major swing states (Chart 11A). Trump has dropped off in critical swing states of Florida, Wisconsin, and Arizona (Chart 11B). Biden is closer to Trump than he should be in states like Ohio and even Texas. Chart 11ATrump Trailing Biden In Swing States Chart 11BTrump Loses Critical Support In FL, WI, AZ Chart 12Biden Polling Better Than Clinton Did Against Trump Biden is tentatively outperforming Hillary Clinton’s showing in 2016 in head-to-head polls against Trump, including in swing states (Chart 12). He has not been on voters’ minds much during the crises. But he has strong support among African American voters, who primarily handed him the party’s nomination, so he may be able to exploit the unrest. Voters indicate they favor him on race relations as well as the coronavirus, though they still favor Trump on the economy. Bottom Line: Trump’s polling was deteriorating before the social unrest. It will suffer more in the near term. But there are still five months until the election. The Market Now Recognizes That Trump Is An Underdog Now, with the country’s biggest cities ablaze, the market is waking up to the fact that Trump and the Republicans have a much greater chance of entirely losing control of the government in just five months. Online gamblers have recently upgraded Biden and the Democrats substantially (Chart 13). Opinion polling has shown weakness but now it is likely to seep into the financial industry’s consciousness that US domestic political risks could still go higher. Policy uncertainty will not fall as sharply as otherwise expected during the economic reopening. Unrest typically reflects negatively on the ruling party, suggesting the status quo is unacceptable and driving voters to vote for change. This is one of the 13 keys to the presidency under the scheme of Professor Allan J. Lichtman, at American University, who has predicted every popular vote outcome since 1984. If one accepts this thesis, then at least five of the keys have now turned against Trump and the GOP. If the economy somehow continues to shrink in the third quarter, or if GDP per capita falls harder than estimated in Chart 7 above, Lichtman’s model will turn against Trump (Table 3, see Appendix). Our own argument has been that a health crisis and surge in unemployment alone are enough to undercut him given his thin margins of victory four years ago and low approval rating. The George Floyd incident reinforces this logic. Not only is voter turnout correlated with the change in unemployment over the president’s term in office, but the correlation holds in swing states and among African Americans. Here is where the devastating impact of COVID-19 among blacks may be relevant (Chart 14). Chart 13Online Bookies Now See Trump Is Underdog Chart 14Hardship For Blacks In Swing States Chart 15Unemployment Pushes Up Voter Turnout (For Blacks And All) If the pandemic and unemployment did not already provide sufficient motivation, then the George Floyd incident might rally this core Democratic Party constituency to turn up at the ballot box (Chart 15). That is a threat to President Trump given that Barack Obama is not on the ballot, so black turnout is unlikely to reach 2008 or 2012 levels. Bottom Line: An increase in African American voter turnout due to unemployment and poor race relations would broaden the electoral pathway to a Democratic victory in November. A Risk To The View: The Silent Majority Could the unrest help Trump? Possibly. Once the peaceful protests turned violent, the possibility emerged that Trump could benefit. The Democrats are not in a strong position whenever they link themselves to economic lockdowns and rioting and looting. It is clear from the police killings and unrest of 2014-15 that more and more people have lost confidence in police treating blacks and whites equally (Chart 16), but they do not make up a majority. Chart 16Over Time, Voters Losing Confidence In Police Fairness Chart 17Majority Sees Racism As Individual, Not Institutional Moreover, two-thirds of citizens, two-thirds of Hispanics, and almost half of blacks believed at that time that racism and discrimination stem from individual actions rather than institutional factors (Chart 17). Confidence and institutional trust will fall during today’s crisis moments but the above polls suggest limits to the protest movement. Generally Americans are satisfied with the work of their local police departments (Chart 18). This includes 72% of blacks. Only about a quarter of Americans report being harassed by the police at any time, according to a Monmouth University poll. Chart 18Silent Majority? Most Americans Satisfied With Local Police Almost 80% of people believe police funds should be increased or kept the same, versus 21% who agree with defunding the police. Only 39% of blacks support such a proposal (Chart 19). If House Democrats pass legislation characterized as taking funds away from police it will hurt them. Chart 19Silent Majority? Americans Don’t Want To Cut Police Funding Finally, regarding the use of the military, 58% of Americans approve of the US military supplementing city police forces, while 30% oppose (Chart 20). George Bush Sr deployed troops in a similar predicament, the LA riots of 1992, albeit with an invitation from the California governor. Chart 20Silent Majority? Americans Mostly Support Military Aid To Police Amid Unrest Legal constraints on Trump’s use of the military are low. Given that the political constraint is also low, a resurgence in violence will likely lead to a crackdown. Trump could benefit if it is managed successfully, but the risk of a bloody mistake that harms or kills civilians would also go up. Bottom Line: Trump could benefit from his pitch as the candidate of law and order if unrest continues, violence worsens, and his actions are deemed to restore order. We will upgrade Trump’s reelection odds if his polling improves and the stock market and economy continue to rebound. Investment Takeaways Historic bouts of unrest show that market volatility occurred in the wake of the 1965-69 disturbances, the 1992 LA riots, the breakdown of order in New Orleans after Hurricane Katrina in 2005, and the protests and riots against police brutality in 2014-15. Unrest did not prevent the market from rallying in all of these cases, but it did in some, and pullbacks also followed unrest periods. In every case presidential approval suffered – and in 1968, 1992, 2006, and 2014 the ruling party suffered losses in the election (Charts 21 A-D). Chart 21AThe ‘Long, Hot Summer’ Saw Inflation, Volatility Chart 21BLA Riots Saw Unemployment, Volatility Chart 21CKatrina Saw Volatility, Presidential Approval Drop Chart 21DFerguson Saw Volatility Amid Falling Unemployment Chart 22Confidence Suffers Amid Social Unrest Furthermore, consumer and business confidence generally suffered in these periods (Chart 22). Trump’s reelection bid could fail to recover, which would make him a lame duck and heighten political risks dramatically. Our longstanding view that the party that wins the White House will also win the senate is reinforced by this year’s polls. The market is reacting to stimulus now but policies look to turn a lot tougher on business. The election puts a self-limiting factor into the equity rally. Either the market sells off in the short run to register the currently likely victory of Joe Biden, who will hike taxes, wages, and regulation, or the market rallies all the way till the election, increasing the chances of President Trump’s reelection, which would revolutionize the global system, especially on trade, and would require a selloff around December. The US dollar faces near-term headwinds as global growth recovers and uncertainty related to COVID-19 abates, but the near term is murky, whereas the major headwinds are over a cyclical time horizon. Our theme of “peak polarization” in the US contrasts starkly with our theme of “European integration” and implies that the euro can continue to advance. However, we are unlikely to reinitiate our long EUR-USD trade until the US election cycle is complete. The risk of a Trump victory is still substantial and we view Europe as a marginal loser in that scenario. We still expect investors to flee to the dollar in the event of any global crisis, even if it originates in the United States.   Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com Appendix Table 2Trump’s Crisis Polling Bounce Compared To Previous Presidential Bounces Table 3Lichtman’s 13 Keys To The Presidency Likely Turning Against Trump … Economy Critical   Footnotes 1     Please see BCA US Equity Strategy Insight Report, “Housekeeping” dated June 4, 2020, available at uses.bcaresearch.com. 2    Please see BCA US Equity Strategy Weekly Report, “There’s No Limit” dated May 26, 2020, available at uses.bcaresearch.com. 3    Please see BCA Geopolitical Strategy Weekly Report, “Michelle, Amash, Trump, Biden” dated May 15, 2020, available at gps.bcaresearch.com

Highlights Social unrest in the US is driven by structural and cyclical factors as well as election-year opportunism. It can still cause volatility. Unrest will weigh on consumer and business confidence – adding to already ugly fundamentals. The market has come around to our view that Trump is an underdog in the election. This is a risk to equities since a Democratic victory will bring full control of government. President Trump has low legal or political constraints to deploying the military if violence gets worse in the streets. This increases tail risks of a civilian death that amplifies the unrest. A “silent majority” of voters could give Trump a polling boost as a “law and order” candidate later this year. This could require us to upgrade his odds of reelection. The US dollar faces long-term headwinds but we are unlikely to reinitiate our long EUR-USD trade until the US election cycle is complete. Feature Chart 1Markets Skyrocket On Stimulus & Reopening Economic reopening and stimulus are winning the day as investors continue to look forward to a time when growth and corporate earnings recover yet inflation and risk-free rates remain suppressed. Judging by the breakout of cyclical versus defensive stocks and risk-on versus risk-off currencies, the rally could continue and the gap between stock markets and macro fundamentals could widen further for some time (Chart 1). The market is looking through the most widespread social unrest since 1968 in the United States, which emerged due to the death in police custody of a black man, George Floyd, in Minneapolis. History suggests that over a one-year horizon, social unrest can be ignored – but in the near term it could yet provoke volatility. This risk is underrated because the market already believes that the unrest is a known quantity without material impact, yet this report shows otherwise. We see four new risks, the first three negative for the market. Chart 2US Consumer Sentiment Is Vulnerable Consumer confidence and activity could worsen in the face of historic national unrest. The slight uptick in improving consumer expectations could reverse (Chart 2). President Trump’s odds of reelection could fall permanently, triggering a downgrading of long-run earnings expectations. A mistake could cause unrest to reach an unknown critical threshold that strikes fear into investors about US stability. The US debate has moved on from racism to “fascism” as Trump’s opponents criticize him for his authoritarian rhetoric and deployment of military forces to secure parts of Washington, DC. Structural factors are driving the riots which means they may smolder and additional incidents could cause them to flare up throughout summer and fall. The deployment of troops to quell civil unrest – as in any country at any time – could easily lead to bloody mistakes. The upside risk is that Republican senators will capitulate even sooner on fiscal spending measures, seeing that their corporate power base is likely to feel more concerned about the collapse of society. The House Democrats and President Trump already share an interest in larding up the spending, so it was only a matter of time till the senate caved in anyway. If the next $2 trillion arrives without the June-July hiccup that we expect, then the market could power higher (Chart 3). Chart 3Global Fiscal Stimulus Continues To Grow In this report we show why US social unrest is structural and how it can still bring equity volatility. Also, the online betting market has caught up to our view that Trump is the underdog in the election. The prospect of full Democratic Party control could start to weigh on US equities. The upside risk to this view would be markets cheer Biden – which is unlikely for long – or if the violent protests create a “silent majority” that helps Trump win the swing states. If his polling improves in the wake of the riots – and the stock rally continues unabated – then we may upgrade his reelection odds from 35% to 50% or higher. Bottom Line: A pullback would be a buying opportunity, but a 10% correction could easily transpire given that a falling market reduces Trump’s odds greatly and could kill the market’s faith in Trump reflation policy from 2021-24. How Social Unrest Came To The United States The US was ripe for a major bout of unrest, as we have highlighted in past reports such as “Populism Blues” (2017), “Civil War Lite” (2019), and “Peak Polarization” (2020), as well as in our top five “Black Swans” report for this year. Our updated “Great Gatsby Curve” shows countries with high levels of income inequality and social immobility. The US is right in the danger zone, joined by other countries that have had unrest or political disruptions (Argentina, Chile, UK, Italy) or will soon (China) (Chart 4). African Americans suffer the worst of these ills and also have long-running grievances with the criminal justice system. Chart 4The US Is In The Danger Zone For Populism, Unrest Unrest was an easy prediction even before the pandemic and recession, which made matters worse. The US ranks last, among developed markets, just below Greece, in our COVID-19 Unrest Index (Table 1). This index combines four factors – economic fundamentals, vulnerability to COVID-19, household grievances, and governance indicators – to rank countries according to their susceptibility to social unrest. US unemployment has soared higher than that of other countries as it has less generous automatic stabilizers. Table 1US Ranks Worst In Our COVID-19 Social Unrest Rankings When it comes to the virus, the US is not any harder hit than most of its European peers (Chart 5). And the black community is not much harder hit than whites, although both have suffered more than their population share would imply, and more than the Hispanic community (Chart 6). Chart 5US No Different Than Western Europe On COVID-19 Deaths   Chart 6COVID-19 Least Deadly For Hispanics However, the lockdowns have caused the unemployment rate to soar and exacted a greater toll on the least educated and lowest paid members of society. The election is enflaming the situation. President Trump’s economy has now performed little better for households than President Obama’s economy, assuming they suffer an income and wealth shock at least equal to that of 2008-09 (Chart 7). Chart 7Households Suffer Massive Income Shock Given the collapsing economy, Trump is doubling down on “law and order,” taking an aggressive stance against rioting and looting and thus provoking a backlash. The media is also in a feeding frenzy as the pandemic and economic reopening narratives lose traction and yet Trump perseveres. Polarization is intensifying as a result. Trump’s rhetoric has been egregious as always. His threat to invoke the Insurrection Act of 1807 is not. President George Bush Sr invoked the act to suppress the LA riots in 1992. The act’s provisions, as well as the specific exceptions to the posse comitatus laws and norms, give the president broad discretion in matters precisely like these. The real constraint is not legal but political: any popular backlash from Trump and his advisers in trying to “dominate the battlespace” when it comes to civilians at home. Rioting and looting are also unpopular, so a larger crackdown could easily happen if more unrest takes place. Since the riots are driven by structural factors, they could still escalate, especially if another incident of police brutality occurs. Bottom Line: US unrest is driven by structural and cyclical factors and thus we are in for another “long, hot summer” like 1967. Negative surprises should be expected. The larger risks have to do with the impact on the election and sentiment. Trump’s Polling Was Dropping Even Before The Riots Trump’s approval rating has fallen to the lowest level this year and diverged from the historic average (Chart 8). This increases the risk that the market experiences volatility either in expectation of “regime change” in November or in reaction to Trump’s attempts to regain the initiative. Trump’s deviation from President Obama’s approval at this stage in 2012 is a warning sign (Chart 9). Chart 8Trump’s Polling Drops Below Average Chart 9Trump Falls Off Obama’s Pathway To Reelection Chart 10Trump’s Pandemic Bounce Turns Negative, Unlike Others Trump and the Republican Party received a smaller polling bounce from the pandemic – and year-to-date the bounce is not only gone but has turned negative, comparable only to Vladimir Putin and United Russia (Chart 10). At its peak it was smaller than that of previous US presidents in crisis situations (Table 2, see Appendix). These data come from before the George Floyd incident which will make matters worse for Trump, given that initial polls suggest 35% approve and 52% disapprove of his response to it. The presumptive Democratic nominee Joe Biden is narrowly leading in all major swing states (Chart 11A). Trump has dropped off in critical swing states of Florida, Wisconsin, and Arizona (Chart 11B). Biden is closer to Trump than he should be in states like Ohio and even Texas. Chart 11ATrump Trailing Biden In Swing States Chart 11BTrump Loses Critical Support In FL, WI, AZ Chart 12Biden Polling Better Than Clinton Did Against Trump Biden is tentatively outperforming Hillary Clinton’s showing in 2016 in head-to-head polls against Trump, including in swing states (Chart 12). He has not been on voters’ minds much during the crises. But he has strong support among African American voters, who primarily handed him the party’s nomination, so he may be able to exploit the unrest. Voters indicate they favor him on race relations as well as the coronavirus, though they still favor Trump on the economy. Bottom Line: Trump’s polling was deteriorating before the social unrest. It will suffer more in the near term. But there are still five months until the election. The Market Now Recognizes That Trump Is An Underdog Now, with the country’s biggest cities ablaze, the market is waking up to the fact that Trump and the Republicans have a much greater chance of entirely losing control of the government in just five months. Online gamblers have recently upgraded Biden and the Democrats substantially (Chart 13). Opinion polling has shown weakness but now it is likely to seep into the financial industry’s consciousness that US domestic political risks could still go higher. Policy uncertainty will not fall as sharply as otherwise expected during the economic reopening. Unrest typically reflects negatively on the ruling party, suggesting the status quo is unacceptable and driving voters to vote for change. This is one of the 13 keys to the presidency under the scheme of Professor Allan J. Lichtman, at American University, who has predicted every popular vote outcome since 1984. If one accepts this thesis, then at least five of the keys have now turned against Trump and the GOP. If the economy somehow continues to shrink in the third quarter, or if GDP per capita falls harder than estimated in Chart 7 above, Lichtman’s model will turn against Trump (Table 3, see Appendix). Our own argument has been that a health crisis and surge in unemployment alone are enough to undercut him given his thin margins of victory four years ago and low approval rating. The George Floyd incident reinforces this logic. Not only is voter turnout correlated with the change in unemployment over the president’s term in office, but the correlation holds in swing states and among African Americans. Here is where the devastating impact of COVID-19 among blacks may be relevant (Chart 14). Chart 13Online Bookies Now See Trump Is Underdog Chart 14Hardship For Blacks In Swing States Chart 15Unemployment Pushes Up Voter Turnout (For Blacks And All) If the pandemic and unemployment did not already provide sufficient motivation, then the George Floyd incident might rally this core Democratic Party constituency to turn up at the ballot box (Chart 15). That is a threat to President Trump given that Barack Obama is not on the ballot, so black turnout is unlikely to reach 2008 or 2012 levels. Bottom Line: An increase in African American voter turnout due to unemployment and poor race relations would broaden the electoral pathway to a Democratic victory in November. A Risk To The View: The Silent Majority Could the unrest help Trump? Possibly. Once the peaceful protests turned violent, the possibility emerged that Trump could benefit. The Democrats are not in a strong position whenever they link themselves to economic lockdowns and rioting and looting. It is clear from the police killings and unrest of 2014-15 that more and more people have lost confidence in police treating blacks and whites equally (Chart 16), but they do not make up a majority. Chart 16Over Time, Voters Losing Confidence In Police Fairness Chart 17Majority Sees Racism As Individual, Not Institutional Moreover, two-thirds of citizens, two-thirds of Hispanics, and almost half of blacks believed at that time that racism and discrimination stem from individual actions rather than institutional factors (Chart 17). Confidence and institutional trust will fall during today’s crisis moments but the above polls suggest limits to the protest movement. Generally Americans are satisfied with the work of their local police departments (Chart 18). This includes 72% of blacks. Only about a quarter of Americans report being harassed by the police at any time, according to a Monmouth University poll. Chart 18Silent Majority? Most Americans Satisfied With Local Police Almost 80% of people believe police funds should be increased or kept the same, versus 21% who agree with defunding the police. Only 39% of blacks support such a proposal (Chart 19). If House Democrats pass legislation characterized as taking funds away from police it will hurt them. Chart 19Silent Majority? Americans Don’t Want To Cut Police Funding Finally, regarding the use of the military, 58% of Americans approve of the US military supplementing city police forces, while 30% oppose (Chart 20). George Bush Sr deployed troops in a similar predicament, the LA riots of 1992, albeit with an invitation from the California governor. Chart 20Silent Majority? Americans Mostly Support Military Aid To Police Amid Unrest Legal constraints on Trump’s use of the military are low. Given that the political constraint is also low, a resurgence in violence will likely lead to a crackdown. Trump could benefit if it is managed successfully, but the risk of a bloody mistake that harms or kills civilians would also go up. Bottom Line: Trump could benefit from his pitch as the candidate of law and order if unrest continues, violence worsens, and his actions are deemed to restore order. We will upgrade Trump’s reelection odds if his polling improves and the stock market and economy continue to rebound. Investment Takeaways Historic bouts of unrest show that market volatility occurred in the wake of the 1965-69 disturbances, the 1992 LA riots, the breakdown of order in New Orleans after Hurricane Katrina in 2005, and the protests and riots against police brutality in 2014-15. Unrest did not prevent the market from rallying in all of these cases, but it did in some, and pullbacks also followed unrest periods. In every case presidential approval suffered – and in 1968, 1992, 2006, and 2014 the ruling party suffered losses in the election (Charts 21 A-D). Chart 21AThe ‘Long, Hot Summer’ Saw Inflation, Volatility Chart 21BLA Riots Saw Unemployment, Volatility Chart 21CKatrina Saw Volatility, Presidential Approval Drop Chart 21DFerguson Saw Volatility Amid Falling Unemployment Chart 22Confidence Suffers Amid Social Unrest Furthermore, consumer and business confidence generally suffered in these periods (Chart 22). Trump’s reelection bid could fail to recover, which would make him a lame duck and heighten political risks dramatically. Our longstanding view that the party that wins the White House will also win the senate is reinforced by this year’s polls. The market is reacting to stimulus now but policies look to turn a lot tougher on business. The election puts a self-limiting factor into the equity rally. Either the market sells off in the short run to register the currently likely victory of Joe Biden, who will hike taxes, wages, and regulation, or the market rallies all the way till the election, increasing the chances of President Trump’s reelection, which would revolutionize the global system, especially on trade, and would require a selloff around December. The US dollar faces near-term headwinds as global growth recovers and uncertainty related to COVID-19 abates, but the near term is murky, whereas the major headwinds are over a cyclical time horizon. Our theme of “peak polarization” in the US contrasts starkly with our theme of “European integration” and implies that the euro can continue to advance. However, we are unlikely to reinitiate our long EUR-USD trade until the US election cycle is complete. The risk of a Trump victory is still substantial and we view Europe as a marginal loser in that scenario. We still expect investors to flee to the dollar in the event of any global crisis, even if it originates in the United States.   Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com Appendix Table 2Trump’s Crisis Polling Bounce Compared To Previous Presidential Bounces Table 3Lichtman’s 13 Keys To The Presidency Likely Turning Against Trump … Economy Critical

Highlights There are no atheists in foxholes, and no Austrians ahead of this election: Republican senators and White House staffers may grumble about giveaways, but they cannot risk being painted as the Grinch who Stole Essential Services in the homestretch of the campaign. A Biden victory will mean a leftward swing: Our geopolitical strategists believe markets are underestimating the extent to which a Biden victory would lead to a less friendly backdrop for investment capital. Tensions with China are likely to escalate: China-bashing is popular with the electorate, and a desperate White House may turn up the heat to recover its standing in the polls. The battle for great-power supremacy remains unresolved. The pandemic is causing the retreat from globalization to accelerate before our eyes: Curtailing offshoring and building new redundancies into supply chains will weigh on corporate profit margins and undermine earnings growth. Feature We had the pleasure of sitting down with Matt Gertken, the leader of BCA’s Geopolitical Strategy service, for a webcast last week. The timing could not have been better, as the pandemic has thrust Washington into the spotlight and the campaign will keep it there until Election Day. This report blends the US Investment Strategy and Geopolitical Strategy teams’ takes on the broad themes we discussed and is a starting point for thinking about the 2020 election and its financial market implications. We will return to the topic throughout the summer and early fall as developments unfold. Republicans in the Senate can talk tough now, but they will have to knuckle under if they want to keep their majority (and the White House). Future Fiscal Largesse Though the scale of the CARES Act was huge, powering the United States to the head of the global class in terms of fiscal stimulus (Chart 1), both parties were discussing the next phase of COVID-19 relief before the ink on the bill was dry. Two months later, that momentum has stalled as Republicans have begun to push back against a fifth wave of spending (the CARES Act was the third). Senator Lindsey Graham (R-SC) has taken direct aim at the $600 weekly federal unemployment benefit supplement, scheduled to expire at the end of July, calling unemployment benefits in excess of pay an “aberration,” and pledging that the program will be extended “over [his] dead body.” Chart 1A Massive Amount Of Fiscal Stimulus That benefit may be generous on a Scandinavian scale,1 but along with the direct $1,200 payments sent to nearly two-thirds of households, it is helping the economy withstand deleterious social distancing measures. Shoring up the finances of vulnerable households will help them stay current on their auto loans and rent or mortgage payments, staving off a wave of repossessions, evictions and foreclosures, and preventing a cascading chain of defaults that would intensify the economic pressure. Table 1The Battleground States Need Help Graham’s rhetorical flourishes aside, Republicans cannot hand the Democrats an opening to cast them as Scrooge when the campaign intensifies in late summer. Trump’s 2016 victory turned on flipping Florida and Rust Belt stalwarts Pennsylvania, Ohio, Michigan and Wisconsin from the Democrats, and all those states are in play again except Ohio (Chart 2). Unemployment is elevated in the battleground Rust Belt states, and we think it must be higher than the official measure in a state as dependent on tourism as Florida (Table 1).2 Channeling the Grinch by taking unemployment benefits and essential workers away from put-upon voters in pivotal states3 is not a winning electoral strategy. Caught between an aid proposal that both Democrats and the White House want, Republican senators will ultimately have to concede. Chart 2The Midwest And Florida Are Crucial Rounding Out The Democratic Ticket Chart 3A New Obama-Biden Ticket? Presumptive Democratic nominee Biden is considering the pool of candidates to fill the number two spot on the ticket. Vice-presidential picks generate a lot of discussion when they’re made, but they typically have little influence on election outcomes. Among this year’s crop of contenders for the presidential nomination, only Senator Amy Klobuchar (D-MN) could fulfill the typical VP function of helping to land a swing state. Klobuchar would likely appeal to soccer moms and suburban independents capable of being swayed back to the Democrats, but her moderate sensibilities wouldn’t expand Biden’s appeal to the party’s progressive wing or inspire younger voters. Senator Elizabeth Warren (D-MA) could help attract progressives and younger voters who see Biden as the status quo, but her antipathy toward big business could turn off swing voters and she would come at the cost of a senate seat.4 Voters have an unfavorable view of Kamala Harris (D-CA) and her contentious exchanges with Biden in the early debates could make for an awkward pairing. Stacey Abrams has recently entered the picture and would be an asset if she were able to increase African-American voter turnout, but she has a thin government resume. Michelle Obama is the only choice who would make a splash and significantly boost Biden’s prospects. She is viewed way more favorably than the rest of the field (Chart 3), would solidify Biden’s connection with Barack Obama, and increase turnout among the progressive, female, and minority voters the ticket needs to tip the scales in its favor. Unfortunately for the Democrats, she has unequivocally indicated that she does not wish to run. Biden has said he’d welcome her onto the ticket in a second, and he will likely put off his choice until efforts to draft her definitively fail. Michelle Obama could shake up the race if the Democrats can convince her to join the ticket. Investors should keep an eye on the Democratic ticket. Joe Biden will turn 78 in November. He will be a one-term president if he wins, and his public appearances suggest that he’s slower on the draw than he used to be. He may rely on his second-in-command much more than the average president and she will immediately become the odds-on favorite for the 2024 nomination. If the Democrats gain control of the Senate alongside a Biden victory, as our Geopolitical Strategy service projects, financial markets may have to begin discounting a future with materially less friendly regulatory and tax policy. China Tensions Will Not Go Away Chart 4The Middle Kingdom Is Out Of Favor Our geopolitical strategists have long flagged US-China tensions as the paramount geopolitical flashpoint. The only standalone nations with superpower potential are engaged in a long-term struggle for hegemony. The trade tensions that waxed and waned across all of 2019 were only one act of a longer-running play. Investors should not have been lulled into thinking the Phase 1 trade agreement would end the friction between the two countries. Politicians can be counted upon to give their constituents what they want, especially during election campaigns. China’s unpopularity with US voters has reached a new high in the wake of the pandemic (Chart 4), and candidates are likely to compete with one another to appear tougher on China. Between now and the election, there is a possibility that tensions could ramp up considerably. If the president finds his re-election prospects suffering from the COVID-19 outbreak and soaring unemployment, he may look to transform himself into a wartime president, boldly asserting American interests globally, and serially baiting an unpopular foe like China. Profit Margin Pressures Are Coming Except when interrupted by recessions, S&P 500 profit margins have climbed steadily higher since the early ‘90s (Chart 5). Several factors contributed to the increase in corporate profitability: the PC revolution, outsourcing, China’s entry into the WTO, the declining power of labor unions and, punctuating the rise in 2018, the 40% cut in the top marginal corporate tax rate (from 35% to 21%). If the Democrats take the White House and the Senate, we expect that corporate tax rates will swiftly rise. The top marginal rate may not go all the way back to 35%, but it has room to rise from its lowest level since before the US entered World War II (Chart 6), and any increase will represent a profit headwind. Re-configuring supply chains will reduce margins. Higher taxes will, too, if Democrats can take the White House and the Senate. Chart 5Corporate Profit Margins Are Vulnerable Chart 6A Democratic Sweep Will Lead To Higher Taxes Our Geopolitical Strategy service identified peak globalization as an important theme not long after it began publishing in 2012. The outbreak of the pandemic seems as if it will accelerate the retreat from globalization (Chart 7), and any reduction in outsourcing is likely to weigh on profit margins until automated inputs can supplant more expensive domestic labor. Onshoring is not the only factor likely to increase corporate costs after the pandemic, however. Companies are likely to seek to diversify their supply chains so that they are not so reliant on a single country or supplier. Building up redundancies within supply chains will make those chains more stable, but it will also increase costs. Chart 7The Pandemic Is Accelerating The Trend Away From Globalization A Biden victory is not the only source of election downside. If the president wins re-election, the odds of tariff conflicts with Europe will rise significantly. Unconstrained by having to contest another election, the administration could ratchet up the pressure on Europe, prompting certain retaliation from Brussels. Our strategists see a greater chance for trade peace, ex-China, if Biden captures the White House. Investment Implications The overriding questions on investors’ minds are why the stock market and the economy have parted company so decisively and how long they can continue to diverge. Our explanation turns on policy: the Fed has intervened mightily to hold down Treasury yields and keep financial markets functioning, while Congress has thrown open the federal coffers to keep laid-off workers and suddenly teetering businesses afloat. The social distancing measures imposed to slow the spread of COVID-19 caused economic activity to crater. Monetary and fiscal policy have been deployed to build a bridge over that crater, lest capital, people and businesses disappear into it like the Union troops at Petersburg. Ever since they began to rally in late March, financial markets have focused exclusively on the bridge. The Fed has the capacity and the will to install more monetary planks should the crater prove to be wider than initially estimated. Congress’ commitment is shakier, but the election will compel Republicans to provide more funding should it become necessary to prevent a dire outcome. The virus alone will dictate how long the bridge will have to be in place and investors can only guess at the virus' future course. Given the stock market’s pattern of surging on positive preliminary data for potential treatments or vaccines and barely easing when those data are shown to hold far less promise, it appears that its expectations are skewed to the right-hand side of the distribution. There appears to be considerable room for disappointment on the public health front. The possibility that markets are giving short shrift to a robust second wave of infections, or overestimating the speed with which a vaccine can be developed and distributed, is not a reason to short equities or be underweight them in balanced portfolios, though. The rally has been too strong, and there is a subset of right-tail outcomes that could well come to pass. We continue to expect a correction, and are carrying excess cash to prepare for it, but we are maintaining a neutral tactical outlook in the event of a positive surprise. We are optimistic about equities’ prospects over a twelve-month timeframe. Our rationale is that easy monetary policy and generous fiscal spending will outlive the social distancing measures they were prescribed to treat. Low interest rates, ample liquidity and pumped-up aggregate demand form a highly supportive backdrop for equities and should help them handily outperform bonds. The difference between our outlook and the equity market’s may simply be a matter of timing; the resurgent S&P 500 seems to be skipping ahead to the twelve-month conclusion and looking through the uncertainties that will arise along the way. The bears face daunting odds if Congress approves a meaningful fifth phase of fiscal stimulus: every trillion dollars extends the dark US bar in Chart 1 by another five percentage points. TIPS will eventually be the asset of choice when the debt has to be repaid but, in the meantime, equities have undeniable appeal.   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1 According to a new working paper, the median unemployed worker is eligible for benefit payments equivalent to 134% of his/her pre-layoff compensation. https://www.nber.org/papers/w27216 Accessed May 26, 2020. 2 Nevada, home to the Magic Kingdom for adults, has the nation’s highest unemployment rate (28.2%). 3 Most state constitutions mandate balanced budgets. In the absence of federal aid, local school, fire, police and public hospital payrolls will have to be pared in response to declining sales and income tax revenues. 4 Massachusetts’ Republican governor would get to appoint her replacement until a special election could be held.

Highlights At 50% Trump’s reelection odds are too high, flagging a risk to equity markets of policy discontinuity. The virus, unemployment, and wages will weigh on him over the year. Trump’s polling is firm because the crisis is still acute. If it remains firm when the dust settles then we will reassess. Trump is competitive in swing states, but not clearly leading. The stock market, as a single variable, is an excellent gauge of reelection odds for ruling parties in US elections going back to 1896. It gives Trump a 16% chance as of today. This is too low, but unemployment and wages also suggest he is an underdog. Michelle Obama and Justin Amash are potential spoilers flying under the radar. The Senate will follow the White House, signaling an understated risk of a total policy reversal and hard left turn in US policy. Massive stimulus motivates our long run risk-on trades: cyber security, infrastructure, Fed-backed corporate bonds, and China reflation plays. Europe and European industrials stand to benefit on a relative basis if Biden wins. Feature Chart 1Recent Poll Shows Trump Leads In Swing States President Donald Trump’s reelection bid is holding up better than we expected so far this year. Trump leads former Vice President Joe Biden in swing states by 52% to 45%, according to a poll taken by CNN from May 7-10 (Chart 1). Our poll of polls below are not as supportive, but this is a strong sign of competitiveness for a sitting president in the midst of a pandemic, recession, social unrest, and controversy over reopening the economy. Naturally several clients have pushed back against our decision to downgrade Trump’s chances of victory from 55% to 35% back in March. We don’t mind the heat – we took the heat for two years while we favored Trump for reelection. Moreover we are not dogmatic. If the facts change, we will change our minds. So far, we are sticking to our view. It is a view that implies risk to corporate earnings and hence supports a tactically bearish or short positioning on the S&P 500. If Trump maintains and builds on his popular support, particularly by August when the Republican and Democratic parties hold their conventions, then we will upgrade his odds, assuming that the economy is improving and the pandemic is abating. At present the market is underrating the challenges facing the president, as we outline in this report. Reopening Poses Downside Risks To Trump Chart 2US Follows The Swedes So far reopening is helping Trump, but it poses a major risk to him down the line this year. The election is five months away – a world away. The new “whistleblower’s complaint” against the Trump administration argues that America faces its “darkest winter in modern history” due to the impending second wave of the virus. However, we rely on the testimony of Anthony Fauci to the Senate this week. Fauci said that states can continue to reopen as long as they adhere to federal guidelines that require 14 days of declining cases in the first phase. June 1 is an acceptable time for most states to open. The trajectory of US deaths per million is deviating from the path of the European Union and moving toward the path charted by Sweden. Swedes have adhered strictly to looser guidelines; Americans have adhered loosely to stricter guidelines. The US death count per million people, a lagging indicator, will rise or at least remain flat in the coming months if states and individuals are not vigilant and compliant (Chart 2). One should assume, however, that governments and individuals will alter their behavior for the sake of self-preservation and in light of new information. Interior American states – those not included in the “COVID confederacy” of western and eastern Democratic states – have seen a tentative drop in deaths (Charts 3A & 3B). While looser restrictions will lead to higher deaths than otherwise, it is not a foregone conclusion that it will be unmanageable for the health system. Chart 3AInterior US Sees Rising COVID Cases … Chart 3B… And Deaths Could Rise From Here From an Electoral College perspective – an absurd way to look at a pandemic, but such are the times – the red states will see an accelerating case count and death toll if they do not actively manage the reopening process (Charts 4A & 4B). This is a political liability. Chart 4ARed States Stable In Case Count … Chart 4B… Yet Deaths Could Tick Up Expectations that Trump is a slam dunk for reelection neglect the obvious fact that interior states shut down before they suffered the full brunt of the pandemic. If new outbreaks spiral out of control, it will have a negative political ramification for those pushing for a quick reopening. That will eventually accrue to the president, with whom the buck stops. A resurgence of infections, whether this summer or this fall, will be met with better preparedness, in terms of non-pharmaceutical intervention (social distancing) and likely pharmaceutical intervention as well (anti-virals, probably not yet a vaccine). But the virus is now underrated as a political risk since President Trump is fully identified with the decision to “liberate” the states yet his polls are firm and online gamblers on sites like PredictIt are giving him a roughly 50% chance of winning reelection. Bottom Line: If outbreaks spiral out of control in swing states then the incumbent president and ruling party will be punished. The evolution of cases and deaths is critical in the near term. Uncertainty over reopening, and understated risks of political change, call for a higher equity risk premium and hence more downside for share prices. Trump’s Approval Gains Are Slight Americans are hitting “peak polarization” this year and the coming years. It is well known that partisanship is affecting voters’ views on objective reality. But notice that all consumers are getting more optimistic about the future, not just Republicans (Chart 5). Chart 5Sentiment Is Polarized But Everyone Sees Improvements On Horizon Uncertainty over reopening and understated risks of political change, call for more downside for share prices. There is a clear bifurcation in voter’s opinions of Trump’s handling of the economy as against the pandemic. Voters approve less and less of his pandemic response; they disapprove less and less of his handling of the economy (Charts 6A & 6B). Chart 6ATrump’s Approval Falling On COVID-19 … Chart 6BYet Supported On Economy Chart 7Voters Wary Of Reopening Too Fast The implication is that if the economy is the single biggest issue in November, then Trump made the right electoral call to reopen fast and focus on presiding over the biggest stimulus in history. Yet a clear majority feels the country is lifting restrictions too quickly. Only a slight majority of Republicans agree with him (Chart 7). Recent Emerson and Marist polls reinforce the point that the economy is the most important issue. Biden is leading Trump on the coronavirus – and notably leading older voters on both issues (Charts 8A & 8B). Chart 8AVoters Still Most Concerned About The Economy Chart 8BYet One Poll Says Biden Gaining Lead On Both Economy And Pandemic Trump’s national approval rating remains underwater, but it has gradually converged with the average of American presidents (Chart 9). A major incident of social unrest – which is possible given active protest movements amid high polarization – would hurt him. The lowest point in his approval rating occurred in August 2017 during the Charlottesville, Virginia protests against taking down a statue of Confederate General Robert E. Lee that turned bloody. Incidents of social unrest will be exploited by both political extremes, but a rise in unrest in general would cause anxiety among middle-of-the-road voters and tend to hurt the ruling party. Chart 9Trump Rising – But Social Unrest A Risk Chart 10Trump Not Yet Clearly On Obama Trajectory Chart 11Trump Gaining Among Hispanics, But Slight Dip Among Elderly Comparing Trump’s approval rating to his immediate predecessors is more realistic because general presidential approval has declined over time due to polarization. On this front, Trump is falling short of President Obama at this stage in 2012. Of course, he could still rally in the lead-up to the campaign, as is typical of sitting presidents (Chart 10). An important caveat is that Trump is making headway in unexpected voting groups. His support is surging among Hispanics, who are disproportionately hurt by economic lockdowns due to the sectoral concentration of their labor, yet less likely to die of COVID-19 (most likely because they are a younger cohort relative to blacks and whites). Moreover this trend began before the coronavirus and coincides with a rise in approval among electorally vital Midwesterners, as well as young people (Chart 11). The implication is that Democrats’ decision to impeach Trump has helped him, just as we argued it would last year, and yet COVID-19 has not reversed his gains. Older people, as mentioned, are a very important exception. They are the critical voting bloc and most susceptible to the virus. They are tentatively becoming less approving of the president. This is according to this Gallup poll, to the CNN poll highlighted at the top of this report, and the aforementioned poll in Chart 8 above. The right-leaning pollster Rasmussen – a proxy for those trying to avoid anti-Trump skews in polling due to any self-censorship or methodological biases – shows that Trump’s approval rating bottomed at a slightly lower level than it did when the Zelensky call appeared last fall, but not as low as during the market plunge and political controversies of late 2018 (Chart 12). This is good news for Trump. Chart 12Trump Reviving From Virus Hit, Shows Rasmussen Polling Chart 13Trump’s Polling Bounce Small Relative To Peers Yet Trump’s polling “bounce,” as the nation rallies around his leadership amid crisis, is small at two percentage points. Other leaders have gotten bigger boosts (Chart 13). More importantly, Trump’s polling bounce is miniscule compared to the average bounce for American presidents during crises that assail the US from the outside (Table 1). Table 1Trump’s Crisis Polling Bounce Compared To Previous Presidential Bounces Bottom Line: Trump is holding up surprisingly well with voters amid the crisis given his past polling. This is an important signal. But it is important to see if it is sustained after the acute phase passes. His polling gains are small relative to US history and contemporary peers. His consistent strong marks on the economy only matter if the economy is the chief issue of the election, but the pandemic creates a major risk that this election could be one of the unusual elections in which a non-economic issue is the most salient. Trump Isn’t Winning In Head-To-Head Polls Earlier we highlighted Trump’s lead in swing states, according to the latest CNN poll. But in our aggregate of polls, Biden is leading in all swing states except Ohio (Chart 14A). Chart 14ABiden Leads Swing State Poll-Of-Polls Except Ohio The lead is within the margin of error in Wisconsin, Florida, and Arizona, meaning the candidates are effectively tied. But that reflects negatively on the sitting president, since incumbents have an advantage over challengers, and Biden is widely known to be a deeply flawed challenger. Trump has taken a big hit in head-to-head polls in critical states. Moreover the year-to-date change in these head-to-head polls suggests that Trump has taken a big hit in critical states: Florida, Arizona, and even Ohio, which should be rock solid for him (Chart 14B). Chart 14BTrump Suffered Blow From Virus In Swing State Poll-Of-Polls The consolation for Trump is that Biden, “Sleepy Joe in the basement,” who is fending off mounting accusations of sexual misconduct against Tara Reade, has either lost ground or made negligible gains. Clients often tell us they do not trust the polls. But post-WWII history shows that polls are fairly accurate and more accurate for sitting presidents than their challengers. Incumbents have averaged 55% of the popular vote, versus 49% for challengers, a clear indication of the incumbent advantage (Chart 15A). Chart 15ASitting Presidents Usually Win The Popular Vote Voter intentions in October and November ahead of the election are usually only 0.8% lower than the sitting president’s actual vote share. However, the same polls tend to underrate challengers by 2.2% (Chart 15B). Chart 15BPolling Is Accurate – Yet Underrates Challengers More Than Incumbent Presidents Chart 16Trump’s Favorability Less Negative, Biden’s Turns Negative Favorability polling is of limited relevance, given that the candidates for president in 2016 and 2020 are the least favorable of all politicians. Polarization makes it so that being hated by the other party is an asset. But it is notable that Trump’s net favorability is not half as negative as it was in 2016, and that he is tied with Biden, whereas Biden has fallen a great distance since the last economic crisis, when he had greater favorability than Barack Obama (Chart 16). Bottom Line: The candidates are virtually tied in the swing states and Biden’s slight lead in our poll-of-polls has not benefited from the crisis. Incumbents tend to outperform their polling by one point, but challengers tend to outperform by two. Biden is manifestly a weak challenger but taking all the evidence together he has a slight lead at present in the swing states. Stock Market And Recession Are Worrisome For Trump Table 2Trump’s Odds 50% At Most Based On Historic Recession/Election Probabilities US elections are a referendum on the incumbent party. Recessions tend to destroy sitting presidents. This is true, but there are important exceptions. A close look at the odds of sitting presidents, as well as sitting parties, and the timing of when the economy resumes expansion, suggests that Trump’s odds of winning are at best 50/50 (Table 2). Our own quantitative election model shows the same thing, and has hovered at 51% all along, although it will flip key states against him once state-level data are updated for the collapse in the economy. Fernando Crupi, of BCA Research Commodity & Energy Strategy, shows what a simple and straightforward look at the S&P 500 implies about Trump’s odds. Together we looked at two variables in elections since 1896: the market performance year to date on October 31 of the election year, and the result of the election for the incumbent party, i.e. victory if the incumbent party is reelected or loss if the new president hails from the opposing party. To estimate the probability of victory we use a logistic model, a widely used statistical tool designed to predict probabilities which can only range between zero and one, never hitting them.1 It is virtually impossible for an election outcome to be certain. The results are as follows: The year-to-date performance of the S&P 500 is a statistically significant variable (at the 5% level) in determining the fate of an incumbent party and has a positive correlation with it. Out of 31 elections, the model correctly predicted the outcome of 77% of the elections in-sample. While this is far from perfect it is remarkable given that we are using the market performance as the only explanatory variable. The effect of an additional percentage point of stock market performance is not linear on the incumbent party’s re-election odds, so two numbers are worthwhile expressing. At the mean S&P 500 YTD performance of the 31 elections, an additional percentage point increase in the market would increase the incumbent party’s odds of winning by 2.8 percentage points, and a decrease would decrease it by the same. By comparison, for all possible values of market performance, the average effect of an additional percentage point increase (or decrease) of the market would increase (or decrease) the probability of an incumbent party re-election by 2.1 percentage points. Chart 17 helps to visualize the model – for any percentage of market performance YTD as of October 31, it shows Trump’s odds of reelection this fall. With the S&P down by 13% this year, Trump’s odds would be 16%. A 10ppt recuperation in the S&P 500 from here would increase his chances to 40% and a 15ppt recuperation would bring him to 55%. Chart 17The Stock Market Says Trump’s Reelection Odds Are 16% Obviously the stock market is likely to rally or sell off for various reasons, for instance, if it thinks that the economy will get worse and the incumbent will lose. A change of government introduces policy uncertainty. Our own electoral model, explained in previous reports, is more robust than this back-of-the-envelope experiment and produces a more favorable outcome for Trump. So while the S&P may be low-balling Trump at 16%, we have no basis either in history or in formal modeling to give him more than a 50% chance as things stand today. And subjectively we think 50% is too high. Presidential approval follows the unemployment rate in the final innings of the campaign. Trump is doomed by this measure. Lastly, to reiterate and update key points we have made in the past: Presidential approval tends to follow the unemployment rate in the final innings of the campaign. Trump is obviously doomed by this measure, as it is the net change over time that matters most (Charts 18A & 18B). Chart 18AUnemployment Rate A Huge Chart 18B… And Tends To Predict Voter turnout is one of the hardest variables to predict, but it follows pretty closely with the change in unemployment over the preceding four years in the swing states. High turnout amid a deep recession is negative for the incumbent president (Chart 19). Chart 19Surge In Unemployment Positive For Turnout, Yet Hurts Incumbent Our subjective probability of reelection, at 35% as of March 24, holds up pretty well in this light. We will adjust this as new evidence comes to light. Bottom Line: To claim that Trump’s odds of reelection are substantially higher than 50% is to argue that “this time is different.” The market should keep falling from its April 29 peak around 2950 not only because of uncertainty about the pandemic and economy but also because of the risk that Trump’s troubles lead to market-negative outcomes. Michelle And Justin As Spoilers With multiple overlapping crises and high polarization, we have highlighted the high potential for extreme events, black swans, and spoilers. These do not include any move of the election date – that would make Trump look weak and would require House Democrats to agree to change a key 1845 statute.2 But they include almost everything else: violent incidents, disputes over voting methods amid the virus, vote recounts, judicial interventions, Electoral College irregularities, congressional intercession, refusals to concede, you name it. We would not be surprised if the Supreme Court took an opportunity currently before it to rule in favor of punishments against “faithless electors” or even to prohibit electors from voting contrary to the popular will in general. On a much less important note, we would also not be surprised if the high court enables President Trump’s personal accounts and tax records to be subpoenaed. Another possible spoiler: Michelle Obama. Chart 20Michelle Obama Objective Best Pick For Vice President Biden is currently mulling his pick for the vice presidential candidate. None of the candidates are magical: Senator Amy Klobuchar makes the most sense of the conventional options as she could improve his standing among women, Midwesterners, white voters, and suburbanites. She hails from Minnesota, he from Pennsylvania, creating a potential pincer movement in the Electoral College. Klobuchar’s favorability is stronger than that of Senators Elizabeth Warren and Kamala Harris, neither of whom can help bring a swing state (Chart 20).3 Yet Warren is well known and could help mend the gap with the progressive wing of the party. Picking her highlights the understated risk to the market of a progressive turn in Biden’s platform. Stacey Abrams could help bring over the black vote but she is sorely lacking in credentials and is reminiscent of the GOP’s desperate and failed bid to reconnect with its base by nominating Sarah Palin in 2008. The obvious choice is Michelle Obama. She has the highest favorability by far, including when her detractors are netted out. She solidifies Biden’s connection with Barack Obama, helps energize progressives, women, and minorities who are needed to turn out. And her power base is in the Midwest. One little problem … Michelle has repeatedly said she does not wish to run. Others have confirmed she has no interest. And a Machiavellian political adviser could advise her to wait until later when there is no incumbent president and then run directly for the top job, free of Biden’s baggage. We held the latter view, until the corona crisis. Trump was heavily favored prior to recession. Now the tables have turned. And a vice presidential role would improve her chances of being the first woman president later. The fact that she apparently does not want to run is obviously a huge problem. But her party needs her and this fact may become increasingly evident as Biden’s weaknesses are exposed. Vice presidential picks seldom make a difference in the campaign. At best they can help bring a swing state. But this election is different. Biden would turn 78 immediately after being elected; he is more likely than the average president to depend upon his VP while ruling, and to pass the baton to the VP early. COVID-19 underscores this risk. In other words, this year is the rare case where the Veep pick is important enough to matter and a charismatic candidate exists who could materially improve the odds of the opposition party’s victory. Would Michelle really help? An argument could be made that the Obama legacy is tarnished and that Trump would relish the chance to run against the Obama brand. However, our reasoning is based on Electoral College scenarios drawn from the best demographic data available, which suggest that the strongest challenge the Democrats can mount in 2020 is to reproduce the 2012 Obama/Biden ticket (Chart 21). Chart 21Electoral College Scenarios Say Biden/Obama 2012 Redux Best Shot For Dems To Beat Trump Chart 22Amash Is Small, But Significant Another important potential spoiler is Justin Amash. Amash is a former Republican who defected from the party due to his opposition to Trump and has since become the nation’s first congressman of the Libertarian Party. Amash could be important because he hails from Michigan, a key swing state, and is a splinter from the right-wing rather than the left-wing, thus potentially threatening President Trump’s thin margins in the battleground states. Currently Amash is winning 3%-5% of the popular vote, according to polls (Chart 22). Historically an extremely elevated third party vote is a threat to the incumbent president and ruling party, regardless of ideological affiliation. This is because it bespeaks general popular discontent, which in turn reflects negatively on the status quo and ruling party. However, so far Amash is not popular enough to hit the extremely elevated threshold. Looking at third party candidacies that have drawn more than 2% of the vote over history, the incumbent party wins 50% of the time. So the historical results are indecisive, but they do show potential for Amash to play the spoiler (Table 3). Table 3How Do Sitting US Presidents And Their Parties Fare When Voters Turn To Third Parties? Furthermore a larger group of Democrats and Democratic-leaning voters are determined not to vote for Biden than Republican and Republican-leaning voters are determined not to vote for Trump (Chart 23). The Republican Party rank and file support Trump enthusiastically, more so than Democrats support Biden, especially in the swing states (Chart 24). This suggests that Amash will fail to get traction among Republicans. Chart 23Left-Leaners Reject Biden More Than Right-Leaners Reject Trump Chart 24GOP More Zealous For Trump Than Dems For Biden We would not rule him out, however. The context of pandemic, deep recession, and extreme polarization is fertile for a third party candidate, as was the case in 2016. If support for Trump wanes due to the mounting death toll and unemployment rate, the weakness of Biden might point to defections from Trump’s camp to Amash. Again, this could be particularly relevant in swing states. Amash may not garner more votes than Gary Johnson, his Libertarian predecessor in 2016, since that year saw an “open election” favorable to third parties, whereas this year there is an incumbent running. But Amash has flown entirely under the radar. He is therefore underrated by markets. And his impact, in the final analysis, will likely prove more negative for the ruling party than Biden, who is very far from a libertarian. Bottom Line: Peak polarization and a historic national crisis will produce black swans. But some spoilers are identifiable. Biden picking Michelle Obama, and a small but significant margin of Republicans defecting to Amash in swing states, are non-negligible risks to Trump’s reelection odds. What About The Senate? Democrats are likely to retain the House of Representatives, unless the positive trends for Trump that we have highlighted start to snowball into massive momentum. Hence the Senate will be decisive to the legislative success of the next administration. It is especially relevant if a Democrat wins, since the implication would be single party control of both legislative and executive branches. By contrast, Trump’s reelection would imply a continuation of today’s balance of power. Online gamblers have finally come around to our long-held view that the Senate will go the way of the White House: currently PredictIt gives the Democrats a 52% chance, up substantially from last year. Republican Senate leaders have openly aired their fears as the election cycle picks up. The risk to Republican control is not merely because the crisis has erased the uptick in Republican Party affiliation (Chart 25), nor is it due to the break in Republican momentum in generic voter party support (Chart 26), though these developments are unwelcome to Republicans. Chart 25Republican Affiliation Of Voters Rolls Over Chart 26Democrats Tick Up Slightly In Generic Congressional Ballot Rather, politics have increasingly become nationalized and more Republican senators are at risk than Democrats due to the windfall Republican senate victory in 2014. Current polling reinforces that the Senate stands on a knife’s edge, as all races are virtually tied, except Colorado, which is a likely shoo-in for Democrats. Arizona is almost as good for them (Chart 27). Democrats need to take four seats plus the White House to win the chamber. Chart 27Close Races In Senate Will Follow The White House Bottom Line: The Senate will go the way of the White House, which means the market is not only underrating a Biden victory but also underrating the probability that he is unconstrained. With peak polarization, and full Democratic control, Biden would not prove a center-left president in office. He would end up governing to the left of the Obama administration. Investment Takeaways Why does the election matter? If Trump loses, the United States will most likely see another total reversal of national policy, as in 2016 and 2008. Yet this time the macroeconomic, political, and demographic backdrop will make it harder for Republicans to stage as effective of resistance as in 2010-16. This is positive for aggregate demand, due to fiscal policy, but negative for corporate earnings. Biden will be pushed to the left by the progressive wing of his party and will face relatively few legislative or judicial constraints. The Democrats will also surprise the market with a tough stance toward China to steal back the mantle of fighting for American workers. Big business will face higher taxes, sweeping re-regulation, and trade restrictions, all at the same time. The S&P 500 has fallen 4% since we recommended investors step back from the rally. We see more downside due to sluggish recoveries, viral outbreaks, hiccups in providing stimulus, and political and geopolitical risks. The S&P’s next support levels are at 2670 and 2250. Chart 28China Faces Protectionism Either Way, But Europe Only With Trump In the short term, Trump’s odds are overrated. We will upgrade him if the stock market, economy, and political indicators improve substantially from what we are seeing today by August when the two parties hold their conventions. What about our view that Trump will crack down on China? A crackdown will cause the S&P to sell. Yet a dramatic selloff that destroys his reelection hopes, or a rally based on massive stimulus, both encourage him to escalate the crisis. Politically, confronting China is positive for him and he cannot let Biden outmaneuver him on workers, trade, and China. This entire dynamic leaves us inclined to be risk-averse. For investors with a long time horizon we recommend selective risk-on investments such as cyber-security, infrastructure, China reflation plays, and investment grade corporate bonds, the latter now backed by the Federal Reserve. A parting thought on industrials. Gargantuan stimulus is positive for cyclical stocks over the long run. But Trump’s reelection raises the prospect of trade war not only with China but also with Europe. It also increases the substantial risk of an expanding conflict with Iran that sows unrest in the Middle East over the next five years. Whereas Biden would seek a united front with Europe against China and would reduce Middle Eastern risks to Europe. Hence over the long run European industrials can benefit disproportionately from a Biden win, on a policy-oriented basis, compared to a Trump win (Chart 28).     Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com Fernando Crupi Research Associate fernandoc@bcaresearch.com Footnotes 1 Compared to a simple regression line, the effect of the explanatory variable on the predicted probabilities varies along the curve. An increase (or decrease) in our explanatory variable by one unit has a smaller and smaller effect on the probability of victory as we approach our upper and lower probability bounds of 0 and 1. Obviously this model cannot fully explain the outcome of an election nor establish causality, but it gives us a good indication of how important the market performance is for an incumbent party to be re-elected. 2 Please see Acts of the Twenty-Eight Congress of the United States, Statute II, Library of Congress. www.loc.gov. 3 The only superior scenario mathematically, in which Biden aims solely at winning back the Democrats’ old blue collar white voter base, is much less likely to succeed given that these voters have drifted to the GOP in recent decades and have been galvanized by Trump.

Highlights The collapse in oil prices supercharges the geopolitical risks stemming from the global pandemic and recession. Low oil prices should discourage petro-states from waging war, but Iran may be an important exception. Russian instability is one of the most important secular geopolitical consequences of this year’s crisis. President Trump’s precarious status this election year raises the possibility of provocations or reactions on his part. Europe faces instability on its eastern and southern borders in coming years, but integration rather than breakup is the response. Over a strategic time frame, go long AAA-rated municipal bonds, cyber security stocks, infrastructure stocks, and China reflation plays. Feature Chart 1Someone Took Physical Delivery! Oil markets melted this week. Oil volatility measured by the Crude Oil ETF Volatility Index surpassed 300% as WTI futures for May 2020 delivery fell into a black hole, bottoming at -$40.40 per barrel (Chart 1). Our own long Brent trade, initiated on 27 March 2020 at $24.92 per barrel, is down 17.9% as we go to press. Strategically we are putting cash to work acquiring risk assets and we remain long Brent. The forward curve implies that prices will rise to $35 and $31 per barrel for Brent and WTI by April 2021. We initiated this trade because we assessed that: The US and EU would gradually reopen their economies (they are doing so). Oil production would be destroyed (more on this below). Russia and Saudi Arabia would agree to production cuts (they did). Monetary and fiscal stimulus would take effect (the tsunami of stimulus is still growing). Global demand would start the long process of recovery (no turn yet, unknown timing). On a shorter time horizon, we are defensively positioned but things are starting to look up on COVID-19 – New York Governor Andrew Cuomo has released results of a study showing that 15% of New Yorkers have antibodies, implying a death rate of only 0.5%. The US dollar and global policy uncertainty may be peaking as we go to press (Chart 2). However, second-order effects still pose risks that keep us wary. Chart 2Dollar And Policy Uncertainty Roaring Geopolitics is the “next shoe to drop” – and it is already dropping. A host of risks are flying under the radar as the world focuses on the virus. Taken alone, not every risk warrants a risk-off positioning. But combined, these risks reveal extreme global uncertainty which does warrant a risk-off position in the near term. This week’s threats between the US and Iran, in particular, show that the political and geopolitical fallout from COVID-19 begins now, it will not “wait” until the pandemic crisis subsides. In this report we focus on the risks from oil-producing economies, but we first we update our fiscal stimulus tally. Stimulus Tsunami Chart 3Stimulus Tsunami Still Building Policymakers responded to COVID-19 by doing “whatever it takes” to prop up demand (Chart 3). Please see the Appendix for our latest update of our global fiscal stimulus table. The latest fiscal and monetary measures show that countries are still adding stimulus – i.e. there is not yet a substantial shift away from providing stimulus: China has increased its measures to a total of 10% of GDP for the year so far, according to BCA Research China Investment Strategy. This includes a general increase in credit growth, a big increase in government spending (2% of GDP), a bank re-lending scheme (1.5% of GDP), an increase in general purpose local government bonds (2% of GDP), plus special purpose bonds (4% of GDP) and other measures. On the political front, the government has rolled out a new slogan, “the Six Stabilities and the Six Guarantees,” and President Xi Jinping said on an inspection tour to Shaanxi that the state will increase investments to ensure that employment is stabilized. This is the maximum reflationary signal from China that we have long expected. The US agreed to a $484 billion “fourth phase” stimulus package, bringing its total to 13% of GDP. President Trump is already pushing for a fifth phase involving bailouts of state and local governments and infrastructure, which we fully expect to take place even if it takes a bit longer than packages that have been passed so far this year. German Chancellor Angela Merkel has opened the way for the EU to issue Eurobonds, in keeping with our expectations. Germany is spending 12% of GDP in total – which can go much higher depending on how many corporate loans are tapped – while Italy is increasing its stimulus to 3% of GDP. As deficits rise to astronomical sums, and economies gradually reopen, will legislatures balk at passing new stimulus? Yes, eventually. Financial markets will have to put more pressure on policymakers to get them to pass more stimulus. This can lead to volatility. In the US the pandemic is coinciding with “peak polarization” over the 2020 election. Lack of coordination between federal and state governments is increasing uncertainty. Currently disputes center on the timing of economic reopening and the provisioning bailout funds for state and local governments. Senate Majority Leader Mitch McConnell is threatening to deny bailouts for American states with large, unfunded public pension benefits (Chart 4A). He is insisting that the Senate “push the pause button” on coronavirus relief measures; specifically that nothing new be passed until the Senate convenes in Washington on May 4. He may then lead a charge in the Republican Senate to try to require structural reforms from states in exchange for bailouts. Estimates of the total state budget shortfall due to the crisis stand at $500 billion over the next three years, which is almost certainly an understatement (Chart 4B). Chart 4AUS States Have Unfunded Liabilities Chart 4BUS States Face Funding Shortfalls Could a local government or state declare bankruptcy? Not anytime soon. Technically there is no provision for states to declare bankruptcy. A constitutional challenge to such a declaration would go to the Supreme Court. One commonly cited precedent, Arkansas in 1933, ended up with a federal bailout.1 A unilateral declaration could conceivably become a kind of “Lehman moment” in the public sector, but state governors will ask their legislatures to provide more fiscal flexibility and will seek bailouts from the federal government first. The Federal Reserve is already committed to buying state and local bonds and can expand these purchases to keep interest rates low. Washington would be forced to provide at least short-term funding if state workers started getting fired in the midst of the crisis because of straightened state finances – another $500 billion for the states is entirely feasible in today’s climate. Constraints will prevail on the GOP Senate to provide state bailout funds. This conflict over state finances could have a negative impact on US equities in the near term, but it is largely a bluff – McConnell will lose this battle. The fundamental dynamic in Washington is that of populism combined with a pandemic that neutralizes arguments about moral hazard. Big-spending Democrats in the House of Representatives control the purse strings while big-spending President Trump faces an election. Senate Republicans are cornered on all sides – and their fate is tied to the President’s – so they will eventually capitulate. Bottom Line: The global fiscal and monetary policy tsunami is still building. But there are plenty of chances for near-term debacles. Over the long run the gargantuan stimulus is the signal while the rest is noise. Over the long run we expect the reflationary efforts to prevail and therefore we are long Treasury inflation-protected securities and US investment grade corporate bonds. We recommend going strategically long AAA-rated US municipal bonds relative to 10-year Treasuries. Petro-State Meltdown Since March we have highlighted that the collapse in oil prices will destabilize oil producers above and beyond the pandemic and recession. This leaves Iran in danger, but even threatens the stability of great powers like Russia. Normally there is something of a correlation between the global oil price and the willingness of petro-states to engage in war (Chart 5). Chart 5Petro-States Cease Fire When Oil Drops When prices fall, revenues dry up and governments have to prioritize domestic stability. This tends to defer inter-state conflict. We can loosely corroborate this evidence by showing that global defense stocks tend to be correlated with oil prices (Chart 6). Global growth is the obvious driver of both of these indicators. But states whose budgets are closely tied to the commodity cycle are the most likely to cut defense spending. Chart 6Global Growth Drives Oil And Guns Russia is case in point. Revenues from Rostec, one of Russia’s largest arms firms, rise and fall with the Urals crude oil price (Chart 7). The Russians launch into foreign adventures during oil bull markets, when state coffers are flush with cash. They have an uncanny way of calling the top of the cycle by invading countries (Chart 8). Chart 7Oil Correlates With Russian Arms Sales Chart 8Russian Invasions Call Peak In Oil Bull Markets Chart 9Turkish Political Risk On The Rise In the current oil rout, there is already some evidence of hostilities dying down in this way. For instance, after years of dogged fighting in Yemen, Saudi Arabia is finally declaring a ceasefire there. Turkey, which benefits from low oil prices, has temporarily gotten the upper hand in Libya vis-à-vis Khalifa Haftar and the Libyan National Army, which depends on oil revenues and backing from petro-states like Russia and the GCC. Of course, Turkey’s deepening involvement in foreign conflicts is evidence of populism at home so it does not bode well for the lira or Turkish assets (Chart 9). But it does highlight the impact of weak oil on petro-players such as Haftar. However, the tendency of petro-states to cease fire amid low prices is merely a rule of thumb, not a law of physics. Past performance is no guarantee of future results. Already we are seeing that Iran is defying this dynamic by engaging in provocative saber-rattling with the United States. Iran And Iraq The US and Iran are rattling sabers again. One would think that Iran, deep in the throes of recession and COVID-19, would eschew a conflict with the US at a time when a vulnerable and anti-Iranian US president is only seven months away from an election. Chart 10US Maximum Pressure On Iran Iran has survived nearly two years of “maximum pressure” from President Trump (Chart 10), and previous US sanction regimes, and has a fair chance of seeing the Democrats retake Washington. The Democrats would restart negotiations to restore the 2015 nuclear deal, which was favorable to Iran. Therefore risking air strikes from President Trump is counterproductive and potentially disastrous. Yet this logic only holds if the Iranian regime is capable of sustaining the pain of a pandemic and global recession on top of its already collapsing economy. Iran’s ability to circumvent sanctions to acquire funds depended on the economy outside of Iran doing fine. Now Iran’s illicit funds are drying up. This could lead to a pullback in funding for militant proxies across the region as Iran cuts costs. But it also removes the constraint on Iran taking bolder actions. If the economy is collapsing anyway then Iran can take bigger risks. Furthermore if Iran is teetering, there may be an incentive to initiate foreign conflicts to refocus domestic angst. This could be done without crossing Trump’s red lines by attacking Iraq or Saudi Arabia. With weak oil demand, Iran’s leverage declines. But a major attack would reduce oil production and accelerate the global supply-demand rebalance. Iran’s attack on the Saudi Abqaiq refinery last September took six million barrels per day offline briefly, but it was clearly not intended to shut down that production permanently. Threats against shipping in the Persian Gulf bring about 14 million barrels per day into jeopardy (Chart 11). Chart 11Closing Hormuz Would Be The Biggest Oil Shock Ever Iran-backed militias in Iraq have continued to attack American assets and have provoked American air strikes over the past month, despite the near-war scenario that erupted just before COVID. Iranian ships have harassed US naval ships in recent days. President Trump has ordered the navy to destroy ships that threaten it; Iranian commander has warned that Iran will sink US warships that threaten its ships in the Gulf. There is a 20% chance of armed hostilities between the US and Iran. Why would Iran be willing to confront the United States? First, Iran rightly believes that the US is war-weary and that Trump is committed to withdrawing from the Middle East. But this could prompt a fateful mistake. The equation changes if the US public is incensed and Trump’s election campaign could benefit from conflict. Chart 12Youth Pose Stability Risk To Iran Second, the US is never going to engage in a ground invasion of Iran. Airstrikes would not easily dislodge the regime. They could have the opposite effect and convert an entire generation of young, modernizing Iranians into battle-hardened supporters of the Islamic revolution (Chart 12). This is a dire calculation that the Iranian leaders would only make if they believed their regime was about to collapse. But they are quite possibly the closest to collapse that they have been since the 1980s and nobody knows where their pain threshold lies. They are especially vulnerable as the regime approaches the uncharted succession of Supreme Leader Ali Khamanei. Since early 2018 we have argued that there is a 20% chance of armed hostilities between the US and Iran. We upgraded this to 40% in June 2019 and downgraded it back to 20% after the Iranians shied from direct conflict this January. Our position remains the same 20%. This is still a major understated risk at a time when the global focus is entirely elsewhere. It will persist into 2021 if Trump is reelected. If the Democrats win the US election, this war risk will abate. The Iranians will play hard to get but they are politically prohibited from pursuing confrontation with the US when a 2015-type deal is available. This would open up the possibility for greater oil supply to be unlocked in the future, but sanctions are not likely to be lifted till 2022 at earliest. Russia Russia may not be on the verge of invading anyone, but it is internally vulnerable and fully capable of striking out against foreign opponents. Cyberattacks, election interference, or disinformation campaigns would sow confusion or heighten tensions among the great powers. The Russian state is suffering a triple whammy of pandemic, recession, and oil collapse. President Vladimir Putin’s approval rating has fallen this year so far, whereas other leaders in the western world have all seen polling bounces (even President Trump, slightly) (Chart 13). Putin postponed a referendum designed to keep him in office through 2036 due to the COVID crisis. In other words, the pandemic has already disrupted his carefully laid succession plans. While Putin can bypass a referendum, he would have been better off in the long run with the public mandate. Generally it is Putin’s administration, not his personal popularity, that is at risk, but the looming impact on Russian health and livelihoods puts both in jeopardy (Chart 14) and requires larger fiscal outlays to try to stabilize approval (Chart 15). Chart 13Putin Saw No COVID Popularity Bump Chart 14Russian Regime Faces Political Discontent Moreover, regardless of popular opinion, Putin is likely to settle scores with the oligarchs. The fateful decision to clash with the Saudis in March, which led to the oil collapse, will fall on Igor Sechin, Chief Executive of Rosneft, and his faction. An extensive political purge may well ensue that would jeopardize domestic stability (Chart 16). Chart 15Russia To Focus On Domestic Stability Chart 16Russian Political Risk Will Rise Russian tensions with the US will rise over the US election in November. The Democrats would seek to make Russia pay for interfering in US politics to help President Trump win in 2016. But even President Trump may no longer be a reliable “ally” of Putin given that Putin’s oil tactics have bankrupted the US shale industry during Trump’s reelection campaign. The American and Russian air forces are currently sparring in the air space over Syria and the Mediterranean. The US has also warned against a malign actor threatening to hack the health care system of the Czech Republic, which could be Russia or another actor like North Korea or Iran. These issues have taken place off the radar due to the coronavirus but they are no less real for that. Venezuela We have predicted Venezuela’s regime change for several years but the oil meltdown, pandemic, and insufficient Russian and Chinese support should put the final nail in the regime’s coffin. Hugo Chavez’s rise to power, the last “regime change,” occurred as oil prices bottomed in 1998. Historically the Venezuelan armed forces have frequently overthrown civilian authorities, but in several cases not until oil prices recovered (Chart 17). Chart 17Venezuelan Coups Follow Oil Rebounds The US decision to designate Nicolas Maduro as a “narco-terrorist,” to deploy greater naval and coast guard assets around Venezuela, to reassert the Monroe Doctrine and Roosevelt Corollary, and to pull Chevron from the country all suggest that Washington is preparing for regime change. Such a change may or may not involve any American orchestration. Venezuela is an easy punching-bag for President Trump if he seeks to “wag the dog” ahead of the election. Venezuela would be a strategic prize and yet it cannot hurt the US economy or financial markets substantially, giving limited downside to President Trump if he pursues such a strategy. Obviously any conflict with Venezuela this year is far less relevant to global investors than one with Iran, North Korea, China, or Russia. Regime change would be positive for oil supply and negative for prices over the long run. But that is a story for the next cycle of energy development, as it would take years for government and oil industry change in Venezuela to increase production. The US election cycle is a critical aggravating factor for all of these petro-state risks. Shale producers are going bankrupt, putting pressure on the economy and some swing states. The risk of a conflict arises not only from Trump playing “wag the dog” after the crisis abates, but also from other states provoking the president, causing him to react or overreact. The “Other Guys” Oil producers outside the US, Canada, gulf OPEC, and Russia – the “other guys” – are extremely vulnerable to this year’s global crisis and price collapse. Comprising half of global production, they were already seeing production declines and a falling global market share over the past decade when they should have benefited from a global economic expansion. They never recovered from the 2014-15 oil plunge and market share war (Chart 18). Angola (1.4 million barrels per day), Algeria (one million barrels per day), and Nigeria (1.8 million barrels per day) are relatively sizable producers whose domestic stability is in question in the coming years as they cut budgets and deplete limited forex reserves to adjust to the lower oil price. This means fewer fiscal resources to keep political and regional factions cooperating and provide basic services. Algeria is particularly vulnerable. President Abdelaziz Bouteflika, who ruled as a strongman from 1999, was forced out last year, leaving a power vacuum that persists under Prime Minister Abdelaziz Djerad, in the wake of the low-participation elections in December. An active popular protest movement, Hirak, already exists and is under police suppression. Unemployment is high, especially among the youth. Neighboring Libya is in the midst of a war and extremist militants within Libya and North Africa would like to expand their range of operations in a destabilized Algeria. Instability would send immigrants north to Europe. Oil production will be reduced involuntarily as well as voluntarily this year due to regime failures. Brazil is not facing the risk of state failure like Algeria, but it is facing a deteriorating domestic political outlook (Chart 19). President Jair Bolsonaro’s popularity was already low relative to most previous presidents before COVID. His narrow base in the Chamber of Deputies got narrower when he abandoned his political party. He has defied the pandemic, refused to endorse social distancing or lockdown orders by local governments, and fired his Health Minister Luiz Henrique Mandetta. Chart 18Petro-States: 'Other Guys' Face Instability Chart 19Brazilian Political Risk Rising Again Brazil has a high number of coronavirus deaths per million people relative to other emerging markets with similar health capacity and susceptibility to the disease. This, combined with sharply rising unemployment, could prove toxic for Bolsonaro, who has not received a bounce in popular opinion from the crisis like most other world leaders. Thus on balance we expect the October local elections to mark a comeback for the Worker’s Party. The limited fiscal gains of Bolsonaro’s pension reform are already wiped out by the global recession, which will set back the country’s frail recovery from its biggest recession in a century. The country is still on an unsustainable fiscal path. Bolsonaro does not have a strong personal commitment to neoliberal structural reform, which has been put aside anyway due to the need for government fiscal spending amid the crisis. Unless Bolsonaro’s popularity increases in the wake of the crisis – due to backlash against the state-level lockdowns – the economic shock is negative for Brazil’s political stability and economic policy orthodoxy. Bottom Line: Our rule of thumb about petro-states suggests that they will generally act less aggressive amid a historic oil price collapse, but Iran may prove a critical exception. Investors should not underestimate the risk of a US-Iran conflict this year. Beyond that, the US election will have a decisive impact as the Democrats will seek to resume the Iranian nuclear deal and Iran would eventually play ball. Venezuela is less globally relevant this year – although a “wag the dog” scenario is a distinct possibility – but it may well be a major oil supply surprise in the 2020s. More broadly the takeaway is that oil production will be reduced involuntarily as well as voluntarily this year due to regime failures. Investment Takeaways Obviously any conflict with Iran could affect the range of Middle Eastern OPEC supply, not just the portion already shuttered due to sanctions on Iran itself. Any Iran war risk is entirely separate from the risk of supply destruction from more routine state failures in Africa. These shortages have been far less consequential lately and have plenty of room to grow in significance (Chart 20). The extreme lows in oil prices today will create the conditions for higher oil prices later when demand recovers, via supply destruction. Chart 20More Unplanned Outages To Come Chart 21European Political Risk No Longer Underrated An important implication – to be explored in future reports – is that Europe’s neighborhood is about to get a lot more dangerous in the coming years, as the Middle East and Russia will become less stable. Middle East instability will result in new waves of immigration and terrorism after a lull since 2015-16. These waves would fuel right-wing political sentiment in parts of Europe that are the most vulnerable in today’ crisis: Italy, Spain, and France (Chart 21). This should not be equated with the EU breaking apart, however, as the populist parties in these countries are pursuing soft rather than hard Euroskepticism. Unless that changes the risk is to the Euro Area’s policy coherence rather than its existence. Finally Russian domestic instability is one of the major secular consequences of the pandemic and recession and its consequences could be far-reaching, particularly in its great power struggle with the United States. We are reinitiating a strategic long in cyber security stocks, the ISE Cyber Security Index, relative to the S&P500 Info Tech sector. Cyberattacks are a form of asymmetrical warfare that we expect to ramp up with the general increase in global geopolitical tensions. The US’s recent official warning against an unknown actor that apparently intended to attack the health system of the Czech Republic highlights the way in which malign actors could attempt to capitalize on the chaos of the pandemic. We also recommend strategic investors reinitiate our “China Play Index” – commodities and equities sensitive to China’s reflation – and our BCA Infrastructure Basket, which will benefit from Chinese reflation as well as US deficit spending. China’s reflation will help industrial metals more so than oil, but it is positive for the latter as well. Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com   Footnotes 1 John Mauldin, "Don't Be So Sure That States Can't Go Bankrupt," Forbes, July 28, 2016, forbes.com.   Section II: Appendix : GeoRisk Indicator China Russia UK Germany France Italy Canada Spain Taiwan Korea Turkey Brazil Appendix Table 1 The Global Fiscal Stimulus Response To COVID-19 Section III: Geopolitical Calendar

Highlights Over the past year we have discussed “peak polarization” for the United States with many clients. We have held the contrarian view that political animosities within the US are nearing their peak. Feature Prior to COVID-19 we argued that polarization would either peak this year, with the US election, or in roughly two years – a scenario in which President Donald Trump won reelection and an epic partisan battle ensued with House Democrats over his second-term policy priority (probably the southern border wall). The global pandemic and recession have changed things. They are accelerating the peaking process, as a domestic consensus is forming on Big Government, border controls, and protectionism against China. It is also less likely that President Trump will scrape through with a narrow victory in November – rather, he will win or lose decisively. Policy consensus and a decisive electoral outcome should reduce polarization in the coming years. The risk to this view is that President Trump is reelected for a second time without a majority of the popular vote and then attempts major cuts to social spending to correct the country’s gargantuan budget deficits. This risk is vastly overrated. A corollary of our view is that US polarization will hit a boiling point in this election year. Polarization will remain extreme until the election results are confirmed, settled, and done. The conflict between Trump and the Democratic governors over when to reopen the virus-plagued economy is case in point. For investors, this view implies that, in the very near term, the dollar and global safe-haven flows will remain strong, defensive plays have further to run, and US equities will continue to outperform global. But over the long run, the dollar is already at extreme highs and global equities outside the US offer better value. The COVID Confederacy When we chose our theme for this year’s presidential election, “Civil War Lite,” we argued that the US faced a host of social and political challenges that would come to head by November 3. These challenges could manifest in violent social unrest or in an electoral or constitutional crisis that harmed government legitimacy. We did not expect COVID-19, but it has created exactly what our Civil War Lite theme implies: a clash between federal and state governments over who has the final say in the American system. Specifically, the Democratic-led states on the east and west coast are quarreling with the Trump administration over how and when to reopen their economies in the wake of tough “shelter in place” measures that have ground the economy to a halt in order to stem the pandemic. For the first time since the great realignment of US politics in the 1930s, the US is having an historic nationwide crisis in which the Republicans are asserting an overriding federal government and the Democrats are insisting on states’ rights. United States governors have formed two coalitions to determine when and how to reopen. On the West Coast, California Governor Gavin Newsom joined with the governors of Oregon and Washington states to set up a working group. On the East Coast – the epicenter of the pandemic in the US – Andrew Cuomo, Governor of New York, joined with his counterparts from New Jersey, Massachusetts, Connecticut, Delaware, Rhode Island, and Pennsylvania to set up a similar working group. Governor Cuomo fought a war of words with President Trump over who has the authority to invoke and revoke emergency health and security actions. President Trump declared, “When somebody is the president of the United States, the authority is total.” Cuomo rebuked him by saying, “we have a constitution … we don’t have a king.” Trump replied by suggesting that Cuomo and his fellow governors were engaging in “mutiny” and implied that he could use his enormous powers and funds as head of the federal government to decide the conflict. The conflict between President Trump and the “COVID Confederacy” heightens uncertainty in the near term. All parties have since softened their tone. Cuomo said he did not want confrontation, President Trump said that he would “authorize” all fifty governors to reopen their economies, and Newsom asserted his executive authority over California without addressing Trump’s comments directly. This conflict may be overrated from the point of view of long-term American stability – President Trump is not about to impose a naval blockade like Abraham Lincoln. But it is not overrated in the near term for financial markets. That is because the reopening plan remains undecided. The “COVID Confederacy,” as we facetiously call it, makes up a combined 38% of US gross domestic product (Table 1), which is shown here in our flow-based cartogram of the United States (Map 1). Each state is colored red or blue according to its Republican or Democratic Party Electoral College vote in 2016, and it is sized proportionally to its economic output. Map 1The COVID Confederacy: States That May Break With Federal Government Over Quarantines Table 1The COVID Confederacy As Share Of GDP We think this conflict matters because it heightens the uncertainty over the duration of quarantine measures, and hence the sufficiency of fiscal stimulus and the length of time until economic normalization. Markets do not like uncertainty. Second, the conflict could still escalate, given that President Trump could still try to push for an earlier economic opening than the Blue States are ready for. Third, even assuming that all sides recognize they need to cooperate amid crisis, the US election still hangs in the balance and the decision to open the economy will increase the death count and thus hypercharge the political contest. Bottom Line: We expect US politics to weigh on US and hence global equities in the near term, as they have already rallied by 24% since their trough in March. When And How Will The US Reopen? How will Trump’s conflict with the Democratic governors be resolved? President Trump is in an impossible situation. Reopening the economy earlier will lead to an increase in deaths – the US will move toward or past Sweden in Chart 1. This is in an election environment in which each death will be heavily politicized while the dangers of deeper recession will be more abstract. Not reopening the economy will add to the US’s historic losses in employment, production, and retail sales (Chart 2). Chart 1Reopening Will Improve Economy But Increase Deaths Per Million Chart 2Delayed Reopening Will Weigh On Stocks Even in the best-case scenario, in which the economy starts to reopen in May, mitigation efforts succeed, and deaths are limited, Trump will still be left with large-scale unemployment and recession. Historically unemployment is the best indicator for which direction the president’s approval will ultimately go (Chart 3). And bear in mind that interior Republican states will be at risk of subsequent outbreaks because they are on a later time frame for the virus peak and yet are most likely to comply with Trump’s reopening plan. The implication is that Trump is constrained and will ultimately decide to maintain the lockdowns longer than he is implying (May 1), and longer than the market expects. He would not want to be seen as losing the fight to the virus. As we go to press, Trump is finalizing “Opening Up America Again” guidelines. Leaving decisions to governors could mean accepting longer lockdowns. Chart 3AUnemployment Rate Leads The Way For Presidents Chart 3BUnemployment Rate Leads The Way For Presidents Meanwhile the Democratic governors who make up the COVID confederacy have a perverse incentive to hold out longer in maintaining strict social distancing. If they reopen too soon, deaths go up and they suffer the political consequences. Yet in normalizing the economy they risk helping Trump get reelected. To be sure, the governors cannot cut off their own economies to spite Trump. But they can continue to drag their feet. First, to show that they are “more competent” leaders who “rely on science” and thus ensure that Trump takes the blame for the increase in deaths. Second, because Trump’s declaration of “total authority” forces them to defend their power and prerogative as governors – this is a constitutional constraint on President Trump. A major problem for Trump is that, unlike Abraham Lincoln, he is asserting total authority over the states not to fight and win the war (in this case, against the virus), but to ease the recession. This is a risky position because subsequent outbreaks will hurt him. Public opinion polling suggests that 64% of voters think the government should prioritize fighting the virus while 29% think it should prioritize rebooting the economy – and this split is 51% versus 43% among Republicans (Chart 4). Chart 4Voters More Afraid Of Virus Than Recession Business leaders at the first meeting of Trump’s “Great American Economic Revival Industry Groups” testified that premature opening is counterproductive if virus testing is inadequate. It is risky for their employees, threatens dire legal consequences down the road, and may need to be reversed. To be sure, economic pressure will change voters’ and business leaders’ minds eventually. The Democratic governors will capitulate as demand for loosening grows. They may be bickering over a one or two week difference in reopening timelines. Testing is improving markedly, and New York is on track to be much better equipped to handle the required testing in the month of May. Still, there is a great risk that the governors delay at least two weeks beyond Trump’s timeline. And a two-week delay with these states costs, at minimum, $237 billion, or 3% of their GDP this year. There is also a risk that the dispute escalates and Trump resorts to coercion to pressure the states to reopen sooner, creating more uncertainty. If the federal government loosens guidance and Trump uses the “bully pulpit” to speed up reopening, the overall effectiveness of the state lockdowns will decline. This could cause the governors to tighten controls before they loosen them, or it could even cause the federal government to reverse course. House Democrats have cooperated on fiscal stimulus (see Appendix) with President Trump and Senate Republicans because they would not dare delay relief for households merely to undermine the president. But the political logic works differently for Democratic state governors when it comes to reopening the economy – they benefit politically from saving lives and opposing President Trump. Bottom Line: Ultimately the COVID confederacy of Democratic states will suffer immense pressure to reopen, so their contest with Trump may only amount to one or two weeks’ difference. But this “Civil War Lite” can get worse before it gets better. Investors face rising uncertainty over the coming month over the pace and extent of US reopening. Peak Polarization Chart 5Why We Called 2020 ‘Civil War Lite’ We chose our election theme because of the extreme levels of polarization in US politics. These will come to a head with the November 3, 2020 general election. It cannot be overstated that today’s polarization is empirically extreme – this is not subjective. Our quantitative election model shows that more and more states have a near-certain probability of sending their Electoral College votes to the party they already favor – meaning that these states are uncompetitive in the election due to the fixed opinion of voters (Chart 5, top panel). The difference in Republican and Democratic approval of the president is soaring far above the high points of the past forty years (Chart 5, bottom panel), a very simple sign of polarization. The most rigorous measure of polarization in American political science shows that polarization is the highest since the Civil War in the 1860s (a time when these data lose applicability). It is comparable to the Reconstruction era in the 1870s and the populist era in the early 1900s (Chart 6). Our quantitative model relies on leading economic indicators as of February and thus still gives President Trump victories in New Hampshire and Wisconsin. It predicts him winning the White House with 273 Electoral College votes, only a three-seat margin over the required 270 to win the Oval Office.1 The economic collapse will hurt his odds as data come in, as is clear when we “shock” our model with a 2008-sized slowdown (Chart 7). Chart 6US Polarization The Highest Since The Civil War Chart 7Our US Election Quant Model Shows A Tight Race The clearest and simplest sign of polarization is the long-term decline in presidential approval ratings and increase in disapproval ratings. Approval has not hit the low point, when George W. Bush presided over a financial meltdown on top of a foreign military quagmire, but it is near Truman and Nixon-era lows (Chart 8A). Chart 8AA Very Simple View Of US Political Polarization The lesson from this last chart is that Americans most approve of their presidents during times of prosperity at home and peace abroad, such as the late 1950s and early 1960s, the late 1980s (as the Soviets collapsed), and the late 1990s, during the post-Cold War “peace dividend.” Yet Trump’s first three years in office, despite peace and prosperity, did not witness a huge increase in approval. Extreme polarization will come to a head with the November election. Disapproval is even more telling. Historically, the disapproval rating peaks at a crisis point and then dramatically subsides – with a series of lower and lower peaks – in the subsequent years. This was true after the Korean War and Truman administration scandals, the Watergate scandal and Nixon’s resignation, and the first Iraq war and 1990-91 recession. But in the case of the Great Recession, polarization only briefly declined before it rapidly began mounting again, reaching a post-2008 peak under President Trump (Chart 8B). Chart 8BA Very Simple View Of US Political Polarization The last point suggests that the US was building toward a new crisis point and COVID-19 has created that moment. The question is whether Trump’s approval ultimately goes up or down as a result, and whether the nation bands together in the wake of the election as it did after past crisis elections (e.g. 1932, 1952, 1968, 1976). House Democrats and Republicans have cooperated on stimulus packages, as mentioned, but this cooperation will give way to cut-throat competition as the acute crisis subsides and the election approaches. Bottom Line: US polarization is historically extreme and will intensify ahead of the election. Election And Reconstruction Prior to COVID there were three main scenarios for polarization to escalate further in the 2020-22 period: Trump Narrowly Reelected: It is inherently rare for a president to win the Electoral College vote without winning the popular vote. It happened in 2000 and 2016, marking the polarized times. If it happened again it could easily be accompanied with vote recounts or Supreme Court intervention, like in 2000, or foreign meddling. Such a crisis would push polarization higher, once again emphasizing the parallel with the 1870s, such as the 1876 “Stolen Election.” Trump Narrowly Defeated: The same could be said if Trump were to lose narrowly. Disputed vote recounts, or faithless electors in the Electoral College, or other unexpected incidents would give rise to accusations of a Deep State coup d'état against President Trump, leaving his supporters disaffected. Wag The Dog: It is also conceivable that an international crisis could occur in which the President is accused of “wagging the dog,” orchestrating a rally-around-the-flag effect to get reelected. Our top contenders for such an event are Venezuela, Iran, or North Korea. The crisis has Iran even closer to the brink and it is continuing to spar with the US in the Gulf and in Iraq (Charts 9A & 9B). A war of choice would heighten polarization, particularly at a time when the public is war-weary. (Obviously a genuine, non-manipulated war could also occur, but it would reduce not heighten polarization.) Chart 9AIran Was Extremely Vulnerable … Chart 9B… Even Prior To COVID-19 COVID-19 has changed the outlook because it is much more likely now that Trump loses the election – yet it is also more likely that if he wins, he wins the popular vote. Chart 10Public View Of Trump’s Handling Of Pandemic Unclear Thus Far Trump is more likely to lose because he faces recession and charges of mishandling the pandemic. The “bounce” in his approval rating has already subsided (Chart 10). The bounce in his and Republican support have subsided faster than that of other comparable world leaders and ruling parties. Trump’s polling bounce was also extremely small relative to other major presidential bounces in modern history – especially bounces derived from an exogenous crisis that was not the president’s fault, like COVID. “Enemy” shocks tend to create a 20%-30% boost to approval (Table 2). This is especially worrisome evidence for Trump. Table 2Trump’s Crisis Polling Bounce Compared To Previous Presidential Bounces And yet Trump is more likely than he was prior to COVID to see his approval rise above 50% and win the popular vote. He briefly polled above 50% during the bounce. Look at Chart 10 again – his approval bounce is bottoming at 45%, higher than last year’s lows. There is still a 35% chance that Trump guides the country through the crisis and is rewarded at the voting booth. There are four reasons we still give Trump a 35% chance of winning. First, COVID itself is obviously not Trump’s fault (nor is it Xi Jinping’s). Second, the economy is going to benefit from historic stimulus. Third, COVID reinforces Trump’s major policy themes: tighter borders and more domestic manufacturing. Fourth, Biden is a weak challenger. Most importantly, a new national consensus is forming regardless of the US election outcome. The crisis has led to border shutdowns and highlighted the risk of globalization and border insecurity. Note that US policy on immigration first tightened under President Obama (Chart 11). In the post-COVID environment, candidate Biden will not be willing to be accused of wanting open borders. So this likely is an abiding theme in US politics – Biden will be more pro-immigration than Trump, but he will have to have some limits to protect against any future Trumpian populists. Chart 11AUS Will Tighten Immigration Laws One Way Or Another Chart 11BUS Will Tighten Immigration Laws One Way Or Another The COVID crisis has also exacerbated US-China tensions, urging “decoupling” and calling attention to US reliance on China to make testing kits, protective equipment, and key pharmaceuticals (Chart 12). As we have argued before, the US containment policy toward China began under President Obama’s “Pivot to Asia” and is likely to continue under a Biden administration, particularly in the wake of COVID. Biden will be less tariff-happy than Trump, but he cannot win the Rust Belt, and keep it, if he is soft on China. What about fiscal policy? The great debate is over taxes and spending. And yet COVID has laid the starkest divisions to rest. Trump was never a “limited government” Republican, but if he wins reelection on this basis there is very little chance that he will revert to a pre-COVID Republican position of slashing social spending and taxes. First, Democrats may still keep the House. Second, like Boris Johnson in the UK, Trump would need to solidify the new conservative beachhead among the working class. This would require fiscal accommodation, i.e. limited spending retrenchment, despite the extraordinary stimulus of the pandemic. Biden, for his part, will raise taxes but not as much as Democrats may desire due to the need for economic recovery. Thus polarization is much more likely to fall in the wake of COVID and the US election on a new policy consensus of more secure borders, trade protectionism, and greater government spending. This new consensus will be reinforced by the more left-leaning ideology of the Millennial generation, which will reinforce the shift toward Big Government that is occurring under a Baby Boomer Republican president (Chart 13). Chart 12US Will Diversify Supply Chain Away From China Chart 13The Democratic Party Ascendancy In the meantime the election conflict, rather than this new consensus, will dominate the national scene. Bottom Line: If Trump loses because of his handling of the pandemic and recession, it will likely be a landslide. Polarization will decrease, just as after earlier boiling points. His followers will be discouraged, leaving only a rump of loyalists. A new Democratic consensus is likely to emerge that incorporates policies that Obama and Trump had in common on borders and manufacturing. Polarization is likely to fall on a new policy consensus of more secure borders, trade protectionism and greater government spending.  If Trump wins because of his handling of the crisis, he is not likely to squeak by narrowly in the election. In this scenario he has by definition received a swell of support for his conduct amid a historic crisis. He would grow his mandate. This will reduce polarization under a new Big Government Republican consensus. Investment Takeaways Tactically we remain long defensive plays. We see no immediate end to dollar strength, safe haven flows, and US equity outperformance until the US pandemic stabilizes and a clear path for economic reopening begins to unfold. Even if US equities fall because of US political uncertainty this year, they can outperform international equities at least until Chinese and global growth stabilize and turn up. Strategically, we remain overweight global equities relative to US equities on the basis of relative valuations and looming US policy headwinds arising from more government intervention, more redistribution, and more on-shoring. China’s stimulus should help lift international equities over a one-year horizon. Note that in the near term this US equity underweight may continue to be offside. Housekeeping We are throwing in the towel on our long EUR-USD trade, which has lost 2% since inception, and our long German consumer services trade, which is down 6%. We are also closing our long Thai bonds trade relative to Malaysia for a miniscule gain of 1.4 basis points. We still recommend both of these markets as strong emerging market plays. Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com Footnotes 1 Over the past several months the model showed a tie, 269-269, which would have given Trump the victory through an arcane congressional process for selecting the president. Appendix: The Global Fiscal Stimulus Response To COVID-19

Highlights The near-term is fraught with risk for US equities and global risk assets. Investors concerned over uncertainty, a slow recovery, and economic aftershocks must also guard against geopolitics. COVID-19 is not a victory for dictatorship over democracies. Democracies face voters and will ultimately improve government effectiveness. President Trump is likely to lose the US election. As this becomes increasingly likely, his policy will turn more aggressive, increasing geopolitical risks – particularly in US-China relations. Stay short CNY-USD. Stay long defense stocks. Feature Chart 1Another Downdraft Is Likely US equity prices have risen 26% since their March 23 low point, but our review of systemic global crises suggests that a re-test of the bottom would not be surprising (Chart 1). A range of mitigating health policies – plus still-growing policy stimulus – will most likely prevent a depression. But a longer than expected economic trough, due to some persistent level of social distancing pre-vaccine, and negative second-order effects, such as emerging market crises, could trigger another wave of selling. Moreover we expect another shoe to drop: geopolitics. A Light At The End Of The Tunnel Governments are starting to get a handle on the COVID-19 pandemic. The number of daily new cases in the European Union, which is most clearly correlated with global equities, has subsided (Chart 2). Chart 2Any Setbacks Will Hit Equity Market Hard The US is also seeing new cases crest. To be safe one should count on a subsidiary spike that could easily set back US equities after a notable stock market rally (Chart 2, second panel). But Europe has shown that social distancing works, which US investors will recognize. Italy’s Prime Minister Giuseppe Conte is expected to begin the gradual loosening of social controls to restart the economy. Since Italy is the hardest hit of the western nations (second only to Spain), its leaders will not relax lockdown measures unless they are sure they can do so safely (Chart 2, bottom panel). Still, if governments loosen controls too soon, they may have to tighten them again. Uncertainty will therefore persist regarding the pace of economic normalization, which is bound to be slow due to the fact that discretionary spending will remain suppressed, as it is today in China, and the special precautions that at-risk populations like the elderly will have to take. Economic stimulus measures are still growing in size. Japan’s stimulus, which we count at 16% of GDP, is smaller than the headline 20% but still very large. We have long argued that Japan was on the forefront of the move toward debt monetization among developed markets, but COVID-19 has accelerated the paradigm shift. The United Kingdom has now explicitly stated that the Bank of England will directly finance government debt. The Spanish government is proposing Universal Basic Income (UBI), which it hopes to make permanent, rather than merely for the duration of the pandemic. The jury is still out on whether the weak Pedro Sanchez government will be able to pass it but the current is in favor of “whatever it takes.” Italy’s Five Star Movement has long advocated universal basic income and is part of a ruling coalition that has received a wave of popular support to combat the crisis. At present only a more limited “income of emergency” is being legislated, in keeping with the more centrist Democratic Party, a coalition partner. But Italy’s devastation creates the impetus for bolder moves, either by this government or a subsequent government in 2021 or after. The European institutions are backstopping these states, at least for now, so any deeper disagreements about climbing down from stimulus will have to wait until the coming years. The EU itself is likely to announce additional fiscal measures, via the European Stability Mechanism, whose austerity requirements will be waived, and the European Investment Bank. We can see a token agreement on “coronabonds” (joint debt issuance by the Euro Area), but investors should not fixate on the eurobond debate. These would require a new mechanism, which is inexpedient, whereas the existing mechanisms are already sufficient to bankroll the huge deficit spending plans that the member states are already rolling out. The United States is negotiating an additional “phase four” package that could range between $500 billion and $2 trillion, meaning anywhere from 2.5% to 10% of GDP in new measures (Chart 3). Our estimate would err on the high side because it will largely consist of the same key elements as the “phase three” $2.3 trillion package: unemployment benefits and cash to households, plus a larger dollop for local governments than in the last package. Chart 3Fiscal Tsunami Is Still Building Congress is scheduled to return to vote the week of April 20, but an early return is entirely possible if the pandemic worsens. If the infection curve is flattening, then Republican Senators may hold out longer in negotiations. Squabbling would cause temporary agitation in equity markets. The Democrats and the Republicans still have a mutual interest in spending profusely: the Republicans to try to salvage their seats through economic improvement by November; the Democrats to prove their election proposition that a larger role for government is necessary. Finally, China is preparing to announce more stimulus. So far Chinese measures amount to only 3% of GDP but this is insufficient given the weakness in China’s economic rebound thus far. The expansion in quasi-fiscal spending (government-controlled credit expansion) is an open question, but we would guesstimate a minimum of 3% of GDP. Dramatic measures should be expected because China is undergoing the first recessionary environment since the Cultural Revolution and President Xi Jinping risks a monumental economic destabilization if he hesitates to shore up aggregate demand, which would ultimately threaten single-party rule. We see little chance of him making this mistake. The problem is that animal spirits and external demand will remain weak regardless, an occasion for disappointments among bullish equity investors. Moreover US-China geopolitical risks are rising again, as discussed below. Our updated list of fiscal measures for 25 countries can be found in the Appendix. Bottom Line: The pandemic is peaking in the US and EU, while more stimulus is coming. This is positive for equity investors with a 12-month time frame but the near-term remains vulnerable to another selloff. Democracies Are Not Less Effective Than Dictatorships The pandemic has given rise to wildly misleading narratives in the financial community and mainstream media about the political ramifications for different nations. Getting these narratives right is important for one’s investment strategy. The most popular is that China “won” – is expanding its global influence – while the United States “lost” – is failing at global leadership. More broadly the authoritarian eastern model is said to be triumphing over the western democratic model. The real distinction among states is whether they were familiar with pandemics emanating from China, the unreliability of China’s transparency and communications, and the need to track and trace infections from the beginning. Thus South Korea, Taiwan, Singapore, Vietnam, and Japan have all had relatively benign experiences and all but Vietnam are democracies, with varying degrees of representation and contestation. Nor is COVID-19 an “eastern” versus “western” thing. Germany did an effective job testing, tracking, and tracing infections as well. Germans are relatively law-abiding and trust Chancellor Angela Merkel and the state governments to “do the right thing.” Canada, with its experience of SARS, has also reacted effectively. Denmark, Austria, and the Czech Republic are already tentatively reopening their economies. Yet the number of new confirmed cases per million people shows that Germany is not wildly different from the US and Italy (Chart 4). The truth is that Italy’s bad fortune alerted the US and G7 states to take the threat more seriously – the US has had good outcomes in Washington State but bad outcomes in highly populated New York. Nor is it true that the American health care system is uniquely terrible in treating patients, as is so widely claimed. US deaths per million are worse than Germany but better than Italy (Chart 5) – and Italy’s health system is also not to blame. Failure of ruling parties to spring into decisive action is the main differentiator. Chart 4US In Line With Italy In New Cases … Chart 5… But Better In Limiting Deaths Chart 6Dictatorships Good At Halting Freedoms Dictatorships have had fewer cases and deaths, if their statistics can be trusted – which is a big if.1 This does not suggest that their governance model is better, but rather that they are better at halting freedoms, such as free movement (Chart 6). North Korea has zero cases of COVID-19. People were already under lockdown. Variation within the dictatorships stems from their policy responses and experience fighting pandemics. China, the origin of several recent outbreaks, has extensive experience. It also has a functional health system, fiscal resources, and a heavily centralized power structure. Iran, however, has less experience and capability. The question now is Russia, which was slow to react and has a growing outbreak, yet has a heavily centralized power structure to flatten the curve. Incidentally domestic risk is an important reason for Russia to cooperate with OPEC on oil production cuts, as we have argued. These points can be demonstrated by comparing COVID-19 deaths per million to each nation’s health capabilities and underlying vulnerability to the disease. Note that our intention is to highlight the role of policy in outcomes, not to attempt a full explanation of an epidemiological phenomenon. In Chart 7A, we judge health capacity by health spending per head and life expectancy at the age of 60. Nations that spend a lot per person, and whose people live longer, have better health systems. Yet many of these states are seeing the highest number of deaths because they are European and Europe was the epicenter of the outbreak. Chart 7ARich, Healthy Countries Got Hit Hardest Because Unprepared The US ranks right along with Germany and Sweden.2 Policy responses – early testing, tracking, and tracing – explain why South Korea has far fewer deaths than Italy and Spain on a population-weighted basis. However, the underlying conditions still matter, as the US’s health system, travel bans, and distance from the crisis produced better outcomes than its other policy responses would have implied. These data will be more accurate once the infection curve has flattened across the world. The situation is changing rapidly. If the US rises up in deaths per capita, it will be because of its slow responses, or subsequent policies. The same goes for emerging market economies that are ranking low in deaths but either have not seen the full effect of the pandemic, or had more time to adjust policy due to the crisis in Europe. Emerging market economies have lower health capacity, but also younger and hence healthier populations. The older the society, and the higher proportion of severe illnesses like heart and lung disease, the more susceptible to COVID-19 deaths, as Chart 7B shows. But yet again, the policy response still proves decisive. China has more deaths than some countries that are more vulnerable, because it got hit first. If Brazil and Turkey rise higher and higher above China in deaths, as is likely, it is because of policy failure, not basic vulnerability. Chart 7BEurope And US: Vulnerable Populations, Governments Slow To React Russia stands out as especially vulnerable in this Chart 7B. Here is where authoritarian measures may pay off, as with China, but only in the short term – since Russia will still be left with an elderly population highly prone to severe illness and a creaking health system. As mentioned above, the risk to Russian stability is a factor pushing for geopolitical cooperation in oil market cartel behavior to push prices up and improve the fiscal outlook to enable better domestic stability management. Bottom Line: Government policy, particularly preparedness and rapid action, have been the decisive factors in containing COVID-19, not dictatorial or democratic government types. The richest countries have the most freedoms and the most vulnerable elderly demographics. Within the rich countries, southern Europe reacted slowly and got hit hardest, with some exceptions. The US’s incompetence has been overrated, based on deaths, probably because of President Trump’s general unpopularity. These results are preliminary but they suggest that the US and EU will experience political change to address their lack of rapid action. Non-democracies will still have to deal with the recession and the consequences on social stability. Democracies Face Voter Blowback Democracies will face the wrath of voters once the immediate crisis dies down. The crisis has driven people to rally around the flag, creating polling bounces for national leaders and ruling parties. In some cases the trough-to-peak increase in popular support is remarkable – President Trump's approval reached 10 percentage points briefly, and he rose over 50% approval in some polls for the first time in his presidency (Chart 8A). Yet these initial bounces are already subsiding, as in Trump’s case (Chart 8B). Chart 8ADemocracies Are Accountable To Voters Chart 8BAnd Polling Bounces Are Fading By this measure, the US, Italy, France, and Spain all face serious political reckonings going forward. Trump is the first in the firing line. Our quantitative election model relies on state-level leading economic indicators that are lagging and show him still winning with 273 Electoral College votes (Chart 9A). However, if we introduce a 2008-magnitude economic shock to these indexes, the Democrats flip Michigan, Wisconsin, Pennsylvania, and New Hampshire, yielding 334 Electoral College votes for former Vice President Joe Biden (Chart 9B). This is assuming Trump’s approval rating stays the same, which, at 46%, is strong relative to the whole term in office. Chart 9AOur Quant Election Model Will Turn Against Trump When Data Catches Up Chart 9BA 2008-Style Shock To States Gives Democrats The White House Our qualitative judgement reinforces our election model. Historically, US elections are referendums on the ruling party. An incumbent president helps the party win reelection. But a recession is usually insurmountable. George Bush Sr lost in 1992 despite a shallow recession that ended the year before. While Joe Biden is a flawed candidate in numerous ways, the question voters face in November is whether they are better off than they were four years ago. With thousands of deaths and an unemployment rate at or above 20%, it is hard to see swing state voters answering “yes.” Not impossible, but we subjectively put the odds at 35%, and that could easily be revised downward if Trump’s polling falls back down to the 42% range. Trump will also be responsible for the handling of the pandemic itself. His administration obviously made several policy mistakes. A paper trail will highlight intelligence warnings as early as November, and warnings from his inner circle as early as January, that will hurt him.3 Objectively, the Republican Party’s greatest policy flaw, prior to COVID-19, was health care – and this will connect with COVID-19 even if the Affordable Care Act (Obamacare) has little to do with crisis response. Bottom Line: The first and most important political casualty of the pandemic will be Trump’s presidency. Not because the US is uniquely incompetent in the face of the pandemic – although it obviously could have done better, judging by several of the other democracies – but because this year happens to be an election year and democracies hold governments accountable. Major Risk Of Clash With China Chart 10China Likely To Depreciate The Renminbi There are two downside geopolitical risks that follow directly from the above. First, while the Democratic candidate Joe Biden is a “centrist,” his position will move to the left of the political spectrum. This is to energize the progressive faction of the party – which is already energized. The market will be taken aback if Biden produces major leftward shifts, in the direction of Senator Bernie Sanders, on taxes, regulation, health care, pharmaceuticals, banks, energy, or tech. This is not a problem when the market is down 36%, but as the market rallies, it becomes more relevant. While US taxes and regulation will go up, Biden will still have to win over the Midwestern Rust Belt voter through trade protectionism, a la Trump and Bernie. This will be exacerbated by the pandemic, which has supercharged American popular enmity toward China and fear of supply chain vulnerability toward China. When Biden reveals that he is protectionist too, US equities will react negatively. Second, more immediately, the clash with China may happen much sooner. As President Trump comes to realize he is losing his grip on power, he will have an incentive to retaliate against China for its mishandling of the pandemic, shift the blame, and achieve long-term strategic objectives as well. This makes Trump’s approval rating a critical indicator – not only of his reelection odds, but of whether he determines he has lost and therefore adopts more belligerent foreign or trade policy. We view the danger zone as anything less than 43%. If Trump becomes a lame duck, he could target China, or other countries, such as Venezuela. The advantage of the latter is that it could have the desired political effect without threatening the economic restart. A conflict with Iran would have bigger consequences – particularly negative for Europe. But in the COVID-19 context, Venezuela and Iran are not relevant to American voters. A conflict with North Korea, however, is part of the strategic conflict with China and would be hard to keep separate from broader tensions. This is only likely if Kim Jong Un stages a major provocation. At present, Washington and Beijing are keeping a lid on tensions. Presidents Trump and Xi are in communication. Beijing has rebuked the foreign minister who accused the US military of bringing COVID-19 to Wuhan. Trump has stopped using inflammatory rhetoric about the “Chinese virus.” China is not depreciating the renminbi, it is upholding other aspects of the trade deal, and it is sending face masks and ventilators to assist the US with the health crisis. But this could change. With its economy under extreme pressure, Beijing must take greater moves to stimulate. An obvious victim will be the renminbi, which is arguably stronger than it should be, especially if China cuts interest rates further, no doubt in great part because of the “phase one” trade deal with the United States (Chart 10). If and when Beijing decides that it must ease the downward pressure on exports and the economy, the renminbi will slide. This will provoke Trump. If he is convinced he cannot salvage the economy anyway, then he has an incentive to channel American anger toward China into new punitive measures over currency manipulation. Finally, the ingredients for our “Taiwan black swan” scenario are falling into place. Taiwan has long attempted to gain representation in the World Health Organization but has been blocked by Beijing’s assertion of the One China principle. However, Taiwan is now caught in an escalating tussle with the WHO leadership that involves both Washington and Beijing. Taipei warned the WHO as early as December that COVID-19 could be transmitted by humans and that the pandemic risk was high.4 Both China and the WHO leadership are simultaneously under pressure from the Trump administration for failing to share information and sound the alarm to prepare other nations. Bottom Line: If President Trump decides to prosecute China for its handling of the virus, and/or promote US-Taiwan relations in a way that aggravates China, then the trigger for a major geopolitical incident will have arrived. Investment Implications It is impossible to predict the precise catalyst or timing of such a crisis. We observe that the US and China are each experiencing historic economic dislocation, their strategic relationship has broken down over the past decade, and their populations are incensed at each other over grievances relating to the trade war, COVID-19, and various disinformation campaigns. Taiwan is at the epicenter of this conflict, due to its defense relationship with the United States and renewed political tensions with China under Xi Jinping. But the Chinese tech sector, North Korea, the South and East China Seas, Xinjiang, and Iran are also potential catalysts. Geopolitics is the other shoe to drop in the wake of COVID-19. Presidents Trump and Xi Jinping are the biggest sources of geopolitical risk, as we outlined in our 2020 forecast. They are cooperating in the immediate crisis, but in the aftermath there will be recriminations. A worsening domestic situation, a loss of prestige for either leader, or a foreign policy provocation could trigger punitive measures, saber rattling, or even military incidents. Risk assets are rallying on the light at the end of the tunnel. We are reaching and in some countries passing the peak intensity of the (first wave of the) pandemic. But the economic aftermath is extremely uncertain and the political fallout has hardly begun. In the US, the implication is clearly negative for Trump. But if that implication is realized, it points to much higher geopolitical risks within 2020 than are currently being considered as the world focuses on the virus. If President Trump chooses to wag the dog with Venezuela, that is obviously a much more positive outcome for global risk assets than if he attempts to achieve American strategic objectives of curbing China’s global assertiveness. Tactically, we remain defensive and recommend defensive US equity sectors and the Japanese yen. On a 12-month and beyond time frame we are more bullish on global growth and are long gold and oil. We remain strategically short CNY-USD and short Taiwanese equities relative to Korean.   Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com   Appendix Appendix TableThe Global Fiscal Stimulus Response To COVID-19 Footnotes 1 Given that one of Iran’s top health officials has criticized China for its questionable data and lack of transparency, one does not need to trust the US Intelligence Community’s assessment that China misled the world in the early days of the outbreak. See Matthew Petti, "Even Iran Doesn't Believe China's Coronavirus Stats," April 6, 2020. 2 Readers accustomed to the apocalyptic view of the US health system may wonder that the US comes out looking very well on health capacity. This is because we combine and standardize the scores for per capita spending and longevity. However our data also show that the US is inefficient on health: its life expectancy scores are slightly lower than those of the Europeans, yet it spends more per head. 3 See Josh Margolin and James Gordon Meek, "Intelligence report warned of coronavirus crisis as early as November: Sources," ABC News, April 8, 2020, and Maggie Haberman, "Trade Adviser Warned White House in January of Risks of a Pandemic," New York Times, April 6, 2020. 4 See "Taiwan says WHO failed to act on coronavirus transmission warning," Financial Times, March 19, 2020.

  Feature We are downgrading US President Donald Trump’s odds of winning election. We now consider him an underdog. Since November 2018 we had given Trump a 55% chance of victory – and when former Vice President Joe Biden clinched the nomination in the midst of the virus crisis we argued that the election was “too close to call.” Now, subjectively, we would say Trump has a 35% chance of winning. This is generous relative to history, but seems appropriate to us due to the unpredictable nature of the coronavirus pandemic (which could claim either presidential candidate), the massive US and global stimulus, and the weakness of his opponent. Trump’s approval rating has fallen, albeit slightly, amid the coronavirus pandemic (Chart 1). It is now deviating from the rising approval rating of President Barack Obama at this stage in the 2012 election cycle. Since Trump has been generally less popular than the average president (Chart 2), including Obama, this is a very worrying sign for Trump. Chart 1Virus Knocked Trump Off Track Chart 2Trump Has Zero Buffer For Loss Of Popularity It is also a worrying sign for global risk assets despite their recent collapse. Chart 3To Boost Economy, Trump Must Allow Outbreaks The risk that Trump becomes a “lame duck” president was one of our top two geopolitical risks for the year. The pandemic and recession have laid the groundwork for this risk to materialize (Chart 3).  Trump becomes a liability for the stock market if he concludes that he cannot win reelection. If he seems destined to lose, he has an incentive to use the powers of the presidency in his final months to “turn the tables” and change the narrative, or to cement his legacy by achieving long-term US national interests that have negative economic consequences. For now Trump apparently believes he can still salvage the economy in time to win reelection. He is softening his tone on the need for stringent social distancing policies that are designed to “flatten the curve” of the coronavirus burden on the health system. His administration will review the tough policies on Monday, March 30 before determining whether they should be extended. Individual states have leeway to maintain lockdowns, but a loosening of federal scrutiny would allow more workers to go back to work. While Trump’s desire to restart the economy is self-interested, it is true that too long of a shutdown could create negative feedback loops in the economy. A deeper slump might have worse consequences than the virus outbreak with targeted measures to mitigate the most vulnerable populations (e.g. those over 60, those with heart disease or type-2 diabetes). The problem for Trump is that if he runs on an economic ticket, he is already doomed. Unemployment is bound to rise and laid off workers tend to show up at polls to vote against the party in power. Otherwise Trump’s only option is to run as a “war president” and try to capitalize on the population’s general unwillingness to change leaders in the thick of a crisis. This strategy could work, but then Trump must tighten rather than loosen quarantines, at least over the next month. President George W. Bush benefited from the “war president” effect: his popularity surged after the September 11, 2001 terrorist attacks and the invasion of Iraq. It fell beneath 50% over the following three years, but it recovered as the election approached and the country decided not to “change horses in mid-stream.” Franklin Delano Roosevelt after Pearl Harbor is another analogy, albeit less applicable. Richard Nixon in 1972 is only roughly analogous because the recession began the year after his reelection. For President Trump to benefit from a similar dynamic we would need to see two things. First, his approval rating would need to hold steady through the worst of the crisis – from today throughout the spring – and then improve over the summer on the back of perceived progress in handling the outbreak. Second, we would need to see the economy improve from the deep contraction expected to occur in H1, so that by October voters feel the situation is improving and the future is brightening. Loosening vigilance against the virus and causing new outbreaks jeopardizes the first imperative, while maintaining or increasing vigilance jeopardizes the second part.   Few presidents have survived a recession – Trump is asking to do what no president has done since Teddy Roosevelt in 1904. Our quantitative US election model will shift decisively against Trump in April when new data becomes available for state economic indicators (Chart 4). Chart 4Quantitative Election Model Will Show Trump Defeat When Q1 Data Arrive This implies that Trump should double down on the painful isolation measures today to try to secure a victory in the battle against the virus. But then the recession is deeper – and the buck still stops with him for the initial mismanagement of the outbreak. Of course, the virus is not Trump’s fault, but it is a nationwide health crisis, and neither he nor his party can defend their record on health care. True, Biden is a weak opponent. Nevertheless a pandemic and recession would favor any opposition candidate. The burden is on Trump to surprise the world a second time. If the public becomes accustomed to the virus and the 8% of GDP US stimulus package kicks in, Trump might just pull it off, which is why we still give him a 35% chance. The silver lining for financial markets is that the 29% selloff in US equities from their peak earlier this year has already largely discounted any negative implications of a Democratic ascendancy, such as tougher regulation and higher corporate and individual tax rates. The fact that the Democratic candidate is Biden, not democratic socialist Bernie Sanders, is important because the Democrats are highly likely to take the Senate if they take the White House.  Biden would reduce some aspects of Trumpian populism and rehabilitate US alliances (e.g. with Europe). However, as with Trump, trade protectionism and great power competition with China and Russia will intensify.   A major underrated risk to markets this year is that Trump, running as a “war president” and facing a recessionary defeat, could adopt an aggressive foreign policy or trade policy, especially once the coronavirus outbreak subsides and a scapegoat is sought. A clash with China – including proxy battles over North Korea or Taiwan – is not out of the question. Bottom Line: We are downgrading Trump’s chances of winning reelection. However, a Biden presidency is no longer market-negative because the worst is discounted.    Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com    

Dear Clients, This week we are issuing two Special Alerts on the Russo-Saudi market share war, one of which you have already received. Our weekly publication will proceed as usual on Friday, March 13. In this Special Alert, we update our view of the US election and address the urgent question of US fiscal stimulus. Upcoming reports will address the question of stimulus outside the United States. All very best, Matt Gertken Vice President Geopolitical Strategy Feature Turmoil has engulfed financial markets as a Russo-Saudi market share war erupts at the same time as panic over the coronavirus spreads from China to Europe and the United States. The US and global stock markets are nearing bear market territory while the 10-year Treasury and global bond yields plumb new lows and deeper negatives (Chart 1). Our key risk-off indicators have all broken down (Chart 2). Chart 1The Bear Awakens Chart 2Global Risk-Off While the daily new cases of the virus are far from peaking in the US, the Democratic Party nomination process has eliminated the downside risk of a left-wing populist presidency. Political risk in the US will shift to Congress, fiscal stimulus, the general election, and the “lame duck” risk now threatening President Trump. Trump Not Yet Doomed, But No Longer Favored The US election is now “too close to call,” with the risks tilted toward a Trump loss. Bear markets tend to coincide with recessions (Chart 3). Woe betide a president seeking reelection amid a recession. Chart 3Bear Markets Tend To Coincide With Recessions We need to look to a previous era to identify precedents for Trump’s survival. William McKinley hung onto the office in 1900, Teddy Roosevelt in 1904, and Calvin Coolidge in 1924, all despite recessions.1 Rising unemployment will undo Trump’s re-election bid. In today’s terms, it is still possible that the virus panic will subside over the summer while a wave of global monetary and fiscal stimulus will kick in around September, creating a rebound that sends voters to the polls in an optimistic mood. But it is increasingly unlikely. Unemployment will rise as consumer confidence collapses in the face of the virus outbreak (Chart 4). This is deadly to a president with such narrow margins of victory in the key swing states. Chart 4Confidence Will Suffer, Layoffs To Ensue Chart 5Trump’s Approval Heading South Chart 6Republican Revival To Fall Back The coronavirus scare is already derailing President Trump’s approval rating. It had only tentatively recovered from a very low level throughout his first term and is highly unlikely ever to breach 50% (Chart 5). The surge in voters identifying as Republicans – which had recently, remarkably, surpassed Democrats – will reverse (Chart 6). Our quant election model is “too close to call” but will soon signal Trump loss. Our quant model was already flashing that the election is “too close to call,” due to the negative impact of Trump’s trade war on key swing states like Michigan and Pennsylvania. The weight of a feather can shift Wisconsin into the Democratic camp and turn the election against Trump (Chart 7). The model will inevitably show Trump losing the election once state-level data starts to reflect the virus shock. Chart 7Our Quant Election Model Says “Too Close To Call” … But Virus Panic Will Cause Wisconsin To Switch Bottom Line: The US election is too close to call at this point. With eight months to go, many things could still change, but a spike in unemployment will ruin Trump’s reelection bid. Biden, Not Sanders, Waiting In The Wings Chart 8Biden Has All But Clinched The Democratic Nomination The bad news for Trump – but the good news for markets – is that former Vice President Joe Biden has solidified his status as presumptive nominee for the Democratic Party presidential candidate. Biden romped to victory in Michigan and Missouri on March 10 – and is virtually tied with Vermont Senator Bernie Sanders in Washington, a liberal state that should favor the self-professed democratic socialist Sanders. Biden now clearly leads the count of pledged delegates to the Democratic National Convention on July 13 – and voting patterns in the remaining primary elections would have to reverse entirely in order to give Sanders a 1,991-vote majority of delegates in the first round of voting in July (Chart 8). It is unlikely that Sanders can deprive Biden of a majority of delegates even though he will trounce Biden in the final debate on March 15. The important state elections on March 17 are all favorable to Biden: Arizona, Florida, Illinois, and Ohio. Our delegate projections show Biden winning an outright majority by May 12 (Chart 9). Chart 9Biden Set To Win Majority Of Democratic Delegates By Spring Over the past year many clients have argued to us that neither Biden nor Sanders is electable. We have rejected this view on the basis that the economic cycle would most likely determine the election, since Trump had the misfortune of being a late-cycle president. The financial markets have dodged a bullet with Biden’s nomination since Sanders was capable of winning the nomination and now, with an impending recession, would be even odds (or favored) to take the White House. Chart 10Head-To-Head Polls Show Trump Vulnerability Average head-to-head polls show both Biden and Sanders beating Trump in the battleground states. This always suggested that Trump was highly vulnerable. But on the margin Biden is more electable than Sanders: he polls better against Trump than any Democrat, while Trump polls worse against him than any Democrat. Biden has an Electoral College pathway to victory via Florida and Arizona, as well as via the Midwestern states where Sanders is also competitive (Chart 10). Democrats ultimately chose Biden because he seemed the most likely to beat Trump. He also has the best position on the issue most important after the economy, which is health care (Chart 11). This reputation comes from his association with both President Barack Obama and the Affordable Care Act (Obamacare). A contested convention, in which the Democratic Party splits and progressive voters sit out the election, was always unlikely and is now virtually foreclosed. As he clinches the nomination Biden will seek to win over the support of progressives by choosing a progressive running mate and adopting more left-leaning policies on issues like inequality and the environment. Chart 11Democrats Chose Biden To Win And Restore Obamacare Chart 12Democratic Primary Turnout Strong In Vital Midwest Voter turnout in the primary elections suggests that voters are fired up in the Midwest (Michigan, Minnesota) but more complacent in the South (Texas, North Carolina) (Chart 12). Primary elections are different from general elections, but a worsening economy will provoke higher turnout. At minimum these data reinforce the point above that Trump is highly vulnerable in the Midwestern “Blue Wall” that narrowly brought him to power. Bottom Line: Biden is not only electable but at this stage equally likely as Trump to sit in the Oval Office in 2021. This is a market-positive policy outcome compared with the alternative – a Sanders presidency – which was almost equally probable in the event of a recession. Financial markets will see Biden as less negative than Sanders on regulation and taxes, and less negative than Trump on trade and foreign policy. Fiscal Stimulus A major source of uncertainty surrounding the election is fiscal policy, as a Democratic victory implies an increase in taxes on households and businesses. Not only is there a spike in tax provisions set to expire (top panel, Chart 13), but President Trump’s signature Tax Cut and Jobs Act could be repealed if he loses or made permanent if he wins. Chart 13Fiscal Uncertainty Looms Over US The short-term outlook is also in flux because the Trump administration is frantically trying to piece together an economic stimulus package to respond to the coronavirus shock. Democrats control the House of Representatives and have an incentive to delay and water down Trump’s stimulus proposals. However, they cannot be seen as playing politics with the nation’s health and livelihood and will ultimately agree to fiscal stimulus. This contradiction implies that financial markets will experience ongoing volatility as talks take place. Ultimately, Trump and the Democrats will cooperate, particularly as the financial constraint intensifies through market selling. Trump’s bid will be to stimulate the overall economy while House Speaker Nancy Pelosi and Senate Minority Leader Chuck Schumer will target the virus so as to keep the nation’s attention on health care without granting Trump a re-election fiscal bonus. The most significant short-term stimulus on offer would be a cut to payroll taxes. Trump’s preference may be to eliminate the entire 6% tax levied on worker income permanently, but he is more likely to get something on the magnitude of the 2011-12 temporary payroll tax cut (second panel, Chart 13). This was a two percentage point reduction in the tax (to 4%) for one year that ended up being extended for a second year. The size of the impact is roughly $75 billion for each percentage point for each year ($300 billion for two percentage points over two years). The risk is that the House Democrats may require modifications to Trump’s Tax Cut and Jobs Act that cause an impasse and financial markets to sell off before an agreement is reached.2 The Democrats, for their part, have a wish list of spending programs that they will insist on in exchange for a payroll tax cut. In particular they will seek to expand unemployment insurance for workers who lose their jobs in the impending slowdown, food stamps for unemployed and for children at home amid school closures, and mandatory paid leave (for parents with kids at home as well as sick people). The bill for such items can easily add up to $50-$100 billion in new spending. In addition, Congress and the White House have already approved an $8 billion virus mitigation package and additional packages of this size can happen quickly as the crisis requires. Trump is interested in another round of farm aid, given that China will fall short of its commodity purchases under the “phase one” trade deal, which could amount to $12-$15 billion. And Trump could always unilaterally rollback some of his tariffs on China or other trade partners. The combination of new spending and payroll tax cuts could bring the package to the $300-$400 billion range that Trump’s top economic adviser, Larry Kudlow, disapprovingly said was out of the question. It could easily amount to half of that. If the market continues to tank and the outlook for the US economy grows blacker, it will convince the Democrats that Trump is ruined unless they hurt their own image by appearing blatantly obstructionist amid a crisis. Bear in mind that the market wants a substantial stimulus not only because of the desire for a clear rebound in activity once the virus panic subsides, but also because the increasing odds of a Democratic victory in November mean that US tax rates will go up and corporate earnings will be revised downward. The country now faces a 50% chance of a 1%-2% fiscal tightening for each year in 2021-25 (Chart 14). Chart 14Biden Tax Hike Will Hit Corporate Earnings Chart 15US Fiscal Thrust To Surprise To Upside Thus a 1% of GDP fiscal stimulus for 2020 is the minimum necessary to improve sentiment. The US fiscal thrust – the change in the cyclically adjusted budget deficit – has already turned slightly positive this year, from what was expected to be a slight negative, due to a fiscally profligate budget deal between Trump and the Democrats last year (Chart 15). The one thing these blood enemies have in common is the need for more spending. Infrastructure spending is popular and has room to rise. Eventually the US will get stimulus, and it will surprise to the upside, even if the Democrats drag their feet to ensure that maximum political damage is inflicted on Trump this year. Not only is the fiscal setting inherently more dovish than it was in 2008, but Congress is bailing out plague-stricken households, not just Wall Street, this time around. The real game changer would be an infrastructure package. Americans spend about $140 billion or 0.7% of GDP each year on transport infrastructure, but popular opinion in both major political parties supports increases (Chart 16). The proposed sums are very large – Trump is proposing $1 trillion over a decade while Biden is proposing $1.3 trillion. The House Democrats have a bill worth $760 billion in new spending over five years ready to be passed. Also Trump is willing to capitulate on the Democrats’ preferred type of spending (direct deficit spending) due to his election constraint. These plans are all projecting considerable infrastructure spending on top of the Congressional Budget Office’s base line projection (Chart 17). Chart 16US Spends 0.7% Of GDP On Infra Each Year Chart 17Median Voter Wants More Infra Spending The fiscal multiplier of government spending is generally higher than tax cuts. Furthermore, the coronavirus hurts the economy by frightening households into their homes, which means that even the Democrats’ proposed cash transfers for low-income earners (those with a high marginal propensity to consume) may be impeded. Government-mandated infrastructure spending, by contrast, ensures that economic activity will pick up once the measures take effect (that is, with a 6-12 month lag … something the Democrats will become increasingly willing to agree to this spring given the election calendar). The impending US fiscal stimulus provides justification for going long infrastructure, construction, engineering, materials, mining, and environmental services sub-sectors included in the BCA Infrastructure Equity Basket (Chart 18). China’s large-scale stimulus measures reinforce this recommendation, since these firms are levered to China/EM growth. On a tactical basis, this trade is akin to catching a falling knife. Given our expectation that the world still faces challenges in overcoming the current turmoil, and the Democrats will hem and haw so as not to grant Trump his re-election wish list immediately, we await an opportune time to initiate this trade. A final reason to remain defensive on risk assets: the “lame duck” risk. If and when Trump’s re-election appears out of reach, he has an incentive to turn the tables. This could involve a radical or disruptive move in foreign or trade policy (e.g. on Iran, North Korea, Venezuela, China, or even Russia). At that point Trump could attempt to cement his legacy of cold war with China, or he could even lash out against Russian President Vladimir Putin, who has ostensibly stabbed him in the back by initiating a market share war with Saudi Arabia that may not be pieced back together in time to prevent job losses in shale oil swing states (Chart 19). Chart 18Look For Chance To Go Long Infrastructure Stocks Chart 19A Russo-Saudi Oil Market War Hurts Trump In Shale Swing States Presidential powers are least constrained in the international sphere. At the moment Trump is trying to save the economy and his presidency. But if it becomes a foregone conclusion that they cannot be saved, then he becomes a pure liability for risk assets. Housekeeping We are throwing in the towel on our US tech sector shorts for a loss of 36% and 11%, respectively, and also closing our long Thailand relative trade for a loss of 17%. We are also closing our tactical long Italian government bonds relative to Spanish for a loss of 2%. Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com   Footnotes 1 Coincidentally all were Republicans, like Trump – not that it matters. 2 The Democrats may seek to have Trump increase the tax rate on the highest income earners to the pre-TCJA level, or they may seek to increase the cap on the state and local tax deduction, which allows households (mostly high-income earners) in high-tax states to reduce their federal tax bill.

Special Report

Highlights Joe Biden is the Democratic Party’s presumptive nominee following Super Tuesday. The onus is on Bernie Sanders to upset the race yet again. This is unlikely. Biden’s nomination is less market-negative than that of Sanders, but increases the risk of a Democratic Senate and hence tax hikes. The coronavirus threat to Trump’s reelection is two-pronged – and rising. Go long global equities ex-US on the basis that the virus fears will give way to public resilience and global stimulus. Feature A non-populist, non-protectionist candidate is emerging as the Democratic Party nominee for the US presidency – a positive development for global risk assets in 2020. Judging by preliminary results from the Democratic Party’s “Super Tuesday” primary elections, former Vice President Joe Biden has become the presumptive nominee, one of our key 2020 views. Our simple, back-of-the-envelope projection of delegates to the Democratic National Convention in Milwaukee, Wisconsin, July 13-16 shows that as long as Biden maintains his average vote share thus far, he is narrowly on track to win a majority of pledged delegates and thus clinch the nomination by June (Chart 1).  Chart 1Projection Of Democratic Delegates To National Convention, Milwaukee, July 2020 The chief risk to our view – that Vermont Senator Bernie Sanders, a left-wing populist, would run away with his momentum in February – has peaked. While Sanders won an average of 38% of the delegates on offer, he only won 28% of the popular vote, compared to Biden’s 44% of the delegates and 33% of the popular vote. The centrists as a bloc are outvoting the progressives and only two candidates are left. Ultimately Biden’s two-pronged path to victory in the Electoral College in November reinforces the Super Tuesday results, giving him greater electability and making him the likeliest victor of the Democratic Party primary. Super Tuesday Makes Biden Presumptive Nominee Biden racked up victories in key states including Texas, Massachusetts, Minnesota, and Virginia. He is now the leader in delegates to the party’s national convention (Chart 2), the popular vote, the number of states won, and the biggest states. The exception is California, one of the country’s most left-leaning states, where Sanders won, albeit with the combined progressive vote less than 50%. The voting pattern shows that Democrats still prefer centrist candidates to left-wing or “progressive” candidates by 50% to 40% on average (Chart 3). With two candidates left, this dynamic should favor Biden. Chart 2The Delegate Count Thus Far Chart 3Popular Vote: Biden/Centrists Versus Sanders/Progressives Chart 4Super Tuesday And Beyond By winning Texas and sweeping the South, Biden is heavily favored to win Florida on March 17 – always one of his strong suits vis-à-vis Sanders and a sign of electability in November. But his surprise victories over Sanders in Minnesota and Massachusetts show that he is competitive in the Midwest and Northeast, meaning that he is also likely favored to come out on top in Michigan and Ohio on March 10. The same goes for Illinois, the home state of his 2008-12 running mate Obama, on March 17 (Chart 4). True, in Minnesota and Massachusetts Biden benefited from Senator Elizabeth Warren’s clearing the 15% threshold, thus subtracting from Sanders’s vote share and delegate share. Warren may or may not drop out of the race. Sanders needs to arrest Biden’s Super Tuesday bounce and convince Democratic voters that he is more electable against Trump than Biden. This is a tall order for March 10-17, but Sanders has performed as well or better than Biden in the Northeast and Midwest as a whole, and these are the two regions that yield the most delegates in the rest of the primary (Chart 5).  Biden’s centrist rivals dropped out of the competition after his big win in South Carolina on February 29. His remaining centrist rival, Mayor Michael Bloomberg, suffered a humiliating defeat – pulling in Aspen, Colorado and Napa Valley California along with American Samoa despite spending over $400 million in advertisements (Chart 6). As we have argued, it takes votes, not just money, to win elections. Chart 5The Battle For The Northeast And Midwest Chart 6Bloomberg’s Folly It is a two-man race. If Biden can beat Sanders surrounded by competitors, then the onus is on Sanders to change the game from here. Otherwise Biden wins. Bottom Line: Biden is the likeliest winner. We will have to see another drastic change in momentum for this outcome to be overturned. Sanders’s underperformance on Super Tuesday suggests that his challenge to our base case (a centrist nomination) has peaked.    A Contested Convention? Still Unlikely Chart 7Biden’s Super Tuesday Bounce The coalescing of the centrist and progressive blocs, combined with a likely Super Tuesday bounce, will put Biden back in the lead in national polling (Chart 7). A contested Democratic convention remains unlikely, though it cannot be ruled out. Biden and Sanders are racing neck-and-neck for delegates and another twist in the race could deprive Biden of the simple majority of pledged delegates needed to clinch the nomination. The problem for Sanders is that in a close delegate matchup, a centrist candidate is favored to come out with the nomination. VIX futures suggest that this outlook is priced in, as they are falling for July (the month of the convention) relative to June (the conclusion of the primary election). Volatility induced by the primary election should gradually subside from now through July. Volatility will spike with the conventions in July mostly because of the uncertainty over the general election, and it should also pick up in September and October ahead of the November 3 vote. The spike in volatility that is always to be expected in the October ahead of a presidential election should continue increasing relative to July (Chart 8).   How can we be confident? The combination of the party establishment and the alternate or “reformist” centrist faction should be sufficient to overwhelm the combined “progressive” or anti-establishment bloc. Biden could fail to win the nomination on the first ballot, but the pro-establishment “super delegates” (party stalwarts who are not pledged to any particular candidate) would have the ability to swing subsequent ballots either in his favor or in favor of an alternate centrist (Chart 9). From a game-theoretical point of view, a sequential voting procedure is deadly to Sanders. His only hope was to rack up such a strong plurality in the primaries that he could take the convention by force. That is now unlikely. Chart 8VIX, Rightly, Not Pricing Contested Convention Chart 9Which Way Will The Super Delegates Swing? Even without a contested convention – and certainly with one – the Democratic Party could suffer from internal divisions that affect its challenge to the Republicans in November. The closer Sanders comes to Biden in delegate count, and especially if he should lead Biden yet still lose the nomination, the more his supporters will cry foul. In that case the party would send anywhere from 30%-40% of its voters away feeling disenfranchised. The worst-case scenario for the Democrats would be a convention troubled by open partisan rancor and social unrest, as occurred in the infamous 1968 convention in Chicago. Peace protesters against the Vietnam War and supporters of anti-war Senator Eugene McCarthy besieged the convention and were hounded and repressed by police forces under Chicago Mayor Richard Daley. Moderate Vice President Hubert Humphrey won the nomination despite the strong showing of anti-war sentiment in the primary election. The convention exposed the party’s rifts for all the nation to see. Humphrey went on to lose the election to Republican Richard Nixon. Chart 10Democrats Need To Avoid 1968 Replay Something akin to 1968 could occur this summer if Sanders’s supporters believe he has, for the second time, been deprived of the nomination unfairly in preference for a lackluster establishment candidate who will lose to Trump. But circumstances today are not (yet) so dire. The backdrop in 1968 was one of general upheaval, with opposition to the Vietnam War and the assassinations of Martin Luther King Jr and Robert F. Kennedy, the latter directly contributing to the dispute over delegates at the convention. The labor market was extremely tight (as today), but inflation was spiking (unlike today), fueling domestic unrest (Chart 10). The Democratic Party establishment is neither as disconnected from its base nor as draconian as in 1968. Biden or any other centrist nominee will seek to placate the left wing, likely through a leftward shift on some policies and a progressive vice-presidential pick. Opposition to Trump will act as a unifying force among Democrats. Bottom Line: A contested convention remains unlikely, but it cannot be ruled out. Biden is more likely to win the nomination due to his Super Tuesday bounce and the tailwind for centrists over progressives within the primary voting patterns thus far. If the convention is contested, it will likely result in a centrist candidate and the alienation of the progressive wing, and thus favor Trump’s reelection odds. Implications For The General Election Since November 2018 we have emphasized that US presidential elections are referendums on the incumbent party. Only rarely can the opposition defeat a sitting president amid an expanding economy, even if the ruling party lost the midterm election (as did the GOP in 2018). Major scandals reduce the historic reelection rate, but Trump has been acquitted so his biggest scandal is largely neutralized (Chart 11). The uptick in his approval rating after signing trade deals with China, Canada, and Mexico and getting acquitted by his fellow Republicans in the Senate confirms that he should be seen as favored for reelection. His approval is historically low but not prohibitive, as it tracks with Obama’s ahead of the 2012 election – low approval being in part a structural indicator of highly partisan times (Chart 12).  Chart 11Unseating An Incumbent Is Difficult Chart 12Trump’s Low Approval Not Prohibitive Yet Trump is only slightly favored. The coronavirus outbreak – and more importantly, the fear of it – threatens to damage Trump’s economy and highlight his fatal policy flaw: health care. Most of his first year in office consisted of a failed attempt to repeal and replace the Affordable Care Act (Obamacare), leaving 28 million Americans without health insurance (uninsured individuals increased by 2 million in 2018, the first increase since Obamacare was passed). The Democrats weaponized this gaping policy vulnerability in the vital Rust Belt swing states during the midterm election. Anything that shifts the focus of the election to health, as opposed to the growing economy, is positive for the Democrats on the margin (Chart 13). Granted, the narrative over Trump’s handling of the coronavirus crisis will become a non-diagnostic partisan battle. Neither Xi Jinping nor Donald Trump are responsible for the virus outbreak, but Trump is accountable for the popular perception of his handling of it whereas Xi is not. Ultimately the underlying material conditions of the economy will prove decisive. If the fear factor at home and abroad results in a sharper slowdown and higher unemployment by November, Trump is doomed. The swing states are already vulnerable because they took a heavy blow as a result of Trump’s trade war with China (Chart 14). Chart 13Is Health Care Trump’s Fatal Flaw? Chart 14Virus Fears Threaten Trump's Economy On the other hand, if the fear factor subsides due to the virus’s non-apocalyptic death rate, globally coordinated stimulus – starting with China but reinforced by the Federal Reserve’s surprise 50 basis point rate cut on March 3 – could generate a rebound by Q4 that redounds to Trump’s favor. Doesn’t America’s extreme political polarization create a kind of tribalism that overwhelms traditional “pocketbook” variables in forecasting an election (Chart 15)? Aren’t Democrats sufficiently fired up against President Trump to generate massive voter turnout that wipes out his thin margins of victory in the key swing states? After all, turnout in some of the primary elections is on par with the year the Great Recession began (Chart 16). Chart 15Does Reality Matter Amid Polarization? YES Chart 16Democrats Not Turning Out At 2008 Levels Most likely the economy will be decisive. Democratic fury against Trump will not translate as easily to the broader public if the economy is decent or rebounding in the second half of the year. Voter turnout tends to correlate with unemployment, including in the swing states (Chart 17). The coronavirus shock to the economy, not the blame game surrounding the virus or health care system, will be the determining factor. Chart 17Voter Turnout Responds To Economy … Including In Key Swing States This offers little consolation for Trump, since the brunt of the coronavirus impact on the economy is yet to be felt. While we still give Trump the benefit of the doubt for reelection, our quantitative election model says that the election is “too close to call,” primarily because of weak state-by-state leading economic indicators for Pennsylvania, Michigan, and Wisconsin (Chart 18). These indicators will tick down further due to the virus impact before they tick back up. Our base case is that the uptick will occur, but clearly the fear factor is the biggest risk to Trump’s reelection. Chart 18Quant Model Says US Election “Too Close To Call” The fact that Biden is a slightly more competitive candidate against Trump than Sanders will not help. Biden has a broader Electoral College pathway than Sanders. Both are competitive in the key Rust Belt swing states on which the 2016 election hinged – Michigan, Pennsylvania, Wisconsin. But Biden is also competitive in Florida, Arizona, and North Carolina, states largely closed to Sanders. Still, the difference between the Democratic challengers is marginal as neither is extremely charismatic and the election is a referendum on the ruling party and national direction as a whole. The Senate race is critical to the general election outcome (Chart 19). A Democratic president will be constrained if the Republicans maintain control – Sanders’s revolutionary agenda would be put on ice from the beginning, whereas Biden would have to focus on compromise (and would be prevented from repealing Trump’s tax cuts). Because Republicans saw a banner year in the Senate election in 2014 they must defend a larger number of competitive seats this year (10) than Democrats do (3) (Chart 20). If Democrats win the White House then they also need to win all three “toss up” races (Arizona, Colorado, Maine) – which is very doable – as well as keeping hold of their weakest seat (Alabama) or winning one additional seat (Kansas? North Carolina? Iowa?) in order to get an even balance in the Senate. This would give them the minimum necessary for majority voting since the vice president casts the decisive vote in a tie. Chart 19Democrats Lead Generic Ballot Chart 20Balance Of Power In The US Senate, 2020   Winning this many seats seems extremely difficult, based on the voting patterns in 2016 and 2018 (Table 1, Appendix), unless one considers the type of national environment that would see the incumbent Trump removed from office: it is an environment in which either voter turnout or support rates have shifted, in which case voters who view the Republicans as discredited are less likely to retain Republican senators who carried Trump’s water in the impeachment trial. Note that Biden is an asset in every key Senate race mentioned above except Colorado, whereas Sanders is probably a liability. Chart 21Balance Of Power In the US House Of Representatives, 2020 By contrast the Democrats are defending many more seats than Republicans in the House of Representatives (Chart 21). Yet Republicans would have to retain their five toss-up seats, three vacant seats, while poaching 18 of the Democrats 19 toss-up seats, to reclaim a majority (Table 2, Appendix). This is possible if there is a strong economic rebound in the second half of the year and Trump is “winning” on other policies, but it is unlikely. Thus a second-term President Trump is much more likely to be constrained by the House than a first-term President Biden is likely to be constrained by the Senate. It follows that Trump would focus on foreign policy, where he faces the fewest constitutional constraints – and in a second term he would be unshackled from reelection concerns. He would only be constrained by the desire for a magnificent legacy that keeps Ivanka Trump electable someday. This is not a constraint worth betting money on, especially not in the first two years when he is fresh off reelection (2021-22). The implication is more trade war with China, Europe, or both. Meanwhile Biden with the Senate would focus on the Democrats’ domestic legislative agenda – and would be likely to rack up successes. Without the Senate he too would be driven toward foreign policy, and given his age he would face a limited reelection constraint, like Trump. Bottom Line: Biden’s likely nomination solidifies our view that if Democrats win, they are likely to eke out a bare one-vote majority in the Senate, though not guaranteed. Biden is a Democratic asset for key Senate races while Sanders would be more likely to be constrained by a Republican Senate. If Democrats lose, they would have to lose in the context of a big economic rebound (or some other policy windfall for Trump) in order to yield the House of Representatives. In the context of the coronavirus shock, this seems unlikely. But it is likeliest if the economy is rebounding and the Democrats run a “socialist” for the presidency. Economic Policy Implications The most important investment takeaway from Super Tuesday is that the “Bernie Sanders Panic Index” risk will now tend to subside and the key sectors of the US stock market – tech and health – plus financials and energy will no longer have as big of a threat of punitive regulation hanging over their heads (Chart 22). Chart 22Bernie Panic Index Will Subside Biden’s approach to health would be to restore and expand Obamacare, which is already the law of the land and thus not nearly as disruptive as the attempt by Sanders to create a universal single-payer program that would eliminate private insurance (a large source of uncertainty since it would have been extremely difficult to achieve yet central to his agenda). Incidentally, Big Pharma faces headwinds under Democrats or Republicans, as the populist demand for lower prices will carry the day. President Biden would certainly re-regulate, reversing the deregulatory tailwind for corporate profits and animal spirits under President Trump (Chart 23). But there is much less negative of an impact on business optimism and the job market under Biden than Sanders. Business concern over tax hikes, as outlined, will largely depend on the Senate outcome (Chart 24). The consolation for the financial markets is that, with Biden the presumptive nominee, the tax cut rollback would not be complete: Biden aims for a 28% corporate rate, which is still a net seven percentage point cut from 2016. Chart 23Trump’s De-Regulatory Shock Chart 24The Oval Office Has A Pen And A Phone   The financial industry has faced a long and rocky recovery since the 2008 crash, reminiscent of the tech sector in the wake of the dotcom bubble (Chart 25). A Democratic victory will be negative on the margin, as even Biden will need to sharpen his knives when it comes to the banks. Even the Wall Street candidate Bloomberg had proposed a financial transactions tax. By contrast, Trump would clearly benefit this sector – as long as the business cycle recovers and the yield curve steepens. Chart 25Regulation Returns To Financial Industry? The loser, in either outcome, is the tech sector – which is the most richly valued. Both Republicans and Democrats are investigating Big Tech for anti-competitive practices. Wealth inequality, and the eventual end of the bull market and business cycle, will generate public unrest and encourage the government to identify and punish scapegoats, as in the past with leading companies that had excessive market concentration (Chart 26). Yet neither Trump nor Biden will be as aggressive on this front as Sanders would be. Chart 26Anti-Trust Suits Distract From Inequality, Late-Cycle Woes Chart 27Infrastructure Stocks Will Reboot There is little difference between Trump and Biden (or Sanders for that matter) on the question of infrastructure. Americans want better infrastructure but an economic slowdown is required to provide the impetus. Democrats are unlikely to grant new spending to Trump prior to the election unless he is reelected or a full-blown economic collapse is occurring (in which it is his final act). The performance of BCA’s Infrastructure Basket will improve after the election given that both parties are embracing expansive fiscal spending while China is launching another stimulus mini-cycle (Chart 27). The fiscal trajectory of the United States is unlikely to correct anytime soon. Trumpism has routed the fiscal hawks within the Republican Party and Biden is attempting to lead a Democratic Party that is making increasingly extravagant spending demands. The median American voter is demanding greater government provision of services and social spending. If Democrats win the White House and Senate, they will be able to claw back some revenue by repealing Trump’s tax cuts, but the pressure to spend will outweigh their ability to increase taxes (Chart 28). They will need to expand non-defense discretionary spending even as mandatory outlays rise inexorably due to the aging of the population (Chart 29). Chart 28More Fiscal Profligacy In The US Outlook Chart 29Zero Chance Of Entitlement Cuts Investment Conclusions The US election is eight months away and much can change between now and then. What we know is that Biden now has the clearest path to the Democratic nomination, while Sanders would require another rapid reversal in momentum in order to take the lead. Even if he does, the Democratic convention will favor a centrist as long as Sanders falls short of a commanding lead, which is likely given the 50%-versus-40% split in favor of centrists over progressives thus far. A two-man race will favor Biden as long as this dynamic persists. Biden is slightly more competitive against Trump than Sanders, and slightly more likely to take the Senate for the Democrats. Yet ultimately Trump’s presidency will live or die based on the economy. Otherwise a significant policy humiliation (or surprise right-wing third party candidate) would be required to undo his reelection bid. Chart 30Valuations Favor Non-US Stocks Unfortunately for Trump, the coronavirus outbreak presents precisely this two-pronged risk of worsening economy and policy failure. If this risk fully materializes then he is finished, but markets will most likely have the consolation that it is Biden, not Sanders, waiting in the wings. Our base case remains constructive over the next twelve months, particularly for global stocks ex-US, which are much more heavily discounted and will benefit from Chinese stimulus (Chart 30). The virus shock is clearly a massive risk, but as long as the death rate does not surprise to the upside the ultimate impact will be public resilience and global stimulus.   Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com   Appendix Table 1Democrats Likely To Win The Senate If They Win White House Table 2Republicans Unlikely To Reclaim House Even If They Keep White House Footnotes