Thanksgiving: Eye on the Market
The Armageddonists were not rescued from underperformance purgatory by COVID, and markets are at all time highs again with prospects for further gains in 2021. However, I can think of something that could rescue them, at least temporarily: the risk of electoral illegitimacy and Constitutional mayhem on January 6th. See pages 4-6 for a review of all the rules and procedures in play, including an update from Wayne County, MI.
A year ago, I wrote about the “Armageddonists”: the market-watchers, forecasters and money managers whose apocalyptic comments spread like wildfire in print and online financial news. As we wrote last year, anyone who was underinvested since they listened to the Armageddonists suffered large opportunity losses from 2009 to 2019 given how well equity markets performed.
So, did COVID rescue the Armageddonists by finally causing the market collapse they had been anticipating? Not really. Even if we give them credit for including pandemics in their panoply of disaster scenarios, the March selloff did not erase the underperformance linked to their views. Furthermore, the 2020 equity market selloff was so quickly reversed that it would have taken an almost immediate rebalancing into riskier assets to partially recover prior losses. So no, COVID did not rescue the Armageddonists from underperformance purgatory, and now markets are at all-time highs again.
Why did Armageddonist-driven portfolios underperform?
Fiscal and monetary stimulus explain a lot. The last decade has seen the longest period of negative real policy rates in recorded US history, other than during the Civil War, WWI and WWII. More recently, COVID stimulus was 2x the levels provided during the Financial Crisis, and was delivered 4x faster. Other factors that partially explain the speed with which bear markets are reversed: the technical shortage in US publicly traded equities, since M&A activity and buybacks outweighed primary and secondary issuance (third chart).
While stimulus helped, profits have been more resilient to COVID than Armageddonists may have expected. In Q3 2020, earnings beat expectations (-8% vs consensus -25%), with airlines, other travel-related businesses and energy accounting for almost all of the earnings contraction in the quarter. Free cash flow for the core of the market (excl. financials, REITs and energy) was actually up in Q1, Q2 and Q3 of 2020. At the current pace of improvement, S&P 500 EPS should exceed pre-pandemic levels by the end of 2021.
Despite the latest surge in infections and mortality in the Developed World, we anticipate a further recovery in consumption, inventory demand, capital spending and corporate profits in 2021, fueled by central banks purchasing another $3-$4 trillion in assets and by the eventual impact of vaccines3 on labor force participation and mobility. If so, portfolios would continue to benefit from normal allocations to risky assets.
However…I can think of one thing that could rescue the Armageddonists, at least temporarily: an unorthodox US transition of power that is seen as unlawful by the markets. That’s what we discuss next.
The remote risk of an American Horror Story: Constitutional mayhem on January 6th
Democracies can/should enforce the rule of law to ensure that only lawfully cast ballots are counted. However, the devil is in the details of how this is achieved; markets might react negatively if the US as the world’s reserve currency nation is seen as sliding down a path toward electoral illegitimacy due to post-election maneuvers by political parties. In the chart, we show equity market valuations vs constraints on government power. A modest decline in the rule of law, if it cost 3x-4x multiple points on earnings, could result in a de-rating of US equities.
The Constitution, the Courts, the Congress, electoral fraud allegations and a hyperlink for Thanksgiving
- Could one or more states submit competing slates of electors? Only North Carolina expressly grants the legislature a role in certifying electors. Other legislatures, despite constraints in their state constitutions and statutes, might assert authority to act under Article II of the Constitution and submit a competing slate of electors. While there’s no explicit authority granted to them, a Governor or Secretary of State could also submit a competing slate. Competing slates that are contrary to the popular vote could be invalid under the federal Election Day statute, and may also violate voting rights the Supreme Court recognized in Bush v. Gore. Competing slates are extremely rare: it only happened once in the 20th century (Hawaii, 1960).
- Competing slates would be dealt with via rules spelled out in the Electoral Count Act (ECA) of 1887: on January 6th, the newly seated Congress would resolve them. In case of a split Congress, the prevailing view is that ECA tiebreaker rules generally require Congress to adopt whichever slate was signed by the Governor of the state in question. Governor affiliations: Democrats in MI/PA/WI/NV, Republicans in GA/AZ.
- US-China historian Graham Allison wrote that the GOP could declare the ECA unconstitutional on the grounds that federal statutes cannot constrain the power the Constitution grants to chambers of Congress to count and determine validity of electoral votes. As the argument goes, counting must proceed under the 12th amendment, and if the House and Senate disagree on competing slates, VP Pence (as presiding officer of the joint session of Congress in which electoral votes are counted) could cast the deciding vote. In the nightmare scenario for markets, the ECA is jettisoned by the Senate, the GOP declares Trump as the victor by flipping 3 states, Democrats disagree and refuse to participate in the Jan 6th session, all of which sets up the prospect of dueling inaugurations, an outcome narrowly averted in 1876 and which led to the 1887 Act.
- Allison’s scenario assumes that Senate Republicans discard the ECA, despite the fact that it was created to address competing slate outcomes. In any case, let’s do the math: due to Senate seating rules, its composition on Jan 6th will be 51-R and 48-D, since one Georgia runoff election will not be seated yet and the other will still be GOP irrespective of the outcome (since it was a special election). So, if 2 or more GOP Senators respect the ECA when resolving competing slates, Gubernatorial tie-breakers would remain.
Breaking news: the risk of canvassing board rejections of the popular vote
- After being deadlocked, Wayne County’s Board of Canvassers finally certified its results last night, asking the Secretary of State to conduct an audit of unexplained “out of balance precincts” (whose differences were all minor, well within the bounds of expectations and lower than in 2016).
- That should resolve Michigan once and for all, but the State Canvassing Board still needs to certify its results too. If the State Canvassing Board for some reason does NOT certify or is deadlocked, an old Michigan state law appears to allow the state legislature to make the decision instead. The State Canvassing Board could be required by State Courts to certify if their reluctance to do so is based on factors outside the scope of its review powers, but that would require a judgment call by the courts.
- However, even if the State Board certifies willingly or from a court order, this same state law still appears to allow the legislature to assume responsibility for resolving the election if “results are contested”. The law is written in the passive voice and does not specify who is doing the contesting, but case law dating back 100 years indicates that all a losing candidate or dissenting member of the State Board of Canvassers would have to do is contest the outcome and the decision could be thrown to the legislature.
- If it went this far, and I don’t think it will, it would probably come down to the Michigan Supreme Court. Federal courts could get involved, but outcomes would be murky given Constitutional constraints on federal courts from getting involved in election decisions by state legislatures.
- Another remote risk: Attorney General Barr could in theory direct investigators to seize or impound election records to investigate voter fraud, which would slow down canvassing and recounts. Usual DoJ policy would hold off until after the election is settled before investigating fraud for prosecution or civil enforcement proceedings. But if this happened, it could prevent a state from meeting the Dec 14th Electoral College deadline. However, states have already begun to certify results and once results are certified, even if DoJ seizures interfere with recounts, initial certifications would likely stand as the basis for appointing electors.
- On recounts, Georgia plans to complete it in time for its Secretary of State to certify election results by Nov 20 (a deadline a court may be able to extend); early results show few vote changes so far. Recounts might also be requested and conducted in Pennsylvania (Biden +0.8%), Wisconsin (Biden +0.7%) and Nevada (Biden +2.7%). Historically, recounts have not changed outcomes with margins this large.
- Bottom line: a LOT of very unorthodox things have to happen for Trump to be re-elected. Based on the uncertified vote results, Trump would have to reverse or impede results in three states to prevent Biden from reaching 270 electoral votes (EV). Biden unofficially has 306 EV, so Trump would need to flip three states via one of the avenues described above (see table on following page for EVs by state and other data).
- How remote are these risks? Ed Foley of Ohio State (the constitutional election law expert cited by Allison) wrote his own article last week entitled “Relax. Biden will be sworn in on Jan. 20”, and another expert that I have been working with agrees with him. Among their arguments: the high hurdle needed to prove sufficient levels of unlawful ballots for courts to set aside the outcome in that state.
- Even so, I’m not ruling anything out. Trump fired the top US election security official last night, and his campaign lawsuits are petitioning judges to prevent state certification of results due to fraud and other improper conduct. The RNC hasn’t signed on to many of these lawsuits, and some Trump law firms are reportedly abandoning him. But anything is possible, particularly since a senior DoJ official who oversees voting investigations stepped down from his role after Attorney General Barr authorized US attorneys to probe alleged fraud. The departing DoJ official stated to colleagues that the new DoJ policy abrogates the forty-year old Non-Interference Policy for ballot fraud investigations. I have not mentioned Contingent Elections, since most scenarios I can think of entail one candidate or the other reaching 270 EVs; and/or since if any state’s EVs are not submitted by the December 14th deadline, such EVs would most likely be removed from the numerator and denominator of the Electoral College equation. As a result, a candidate would need to obtain a simple majority of all remaining EVs to win.
What about the Supreme Court?
- First, the Court could hear appeals on state challenges, such as late-arriving absentee ballots in PA (too few to change the outcome); complaints on transparency of vote counting (judicial relief could entail recounting certain counties); illegal acceptance of certain votes (votes in question too small to change the results); and complaints that the voting process suffered from pervasive irregularity and fraud (most of these claims have been rejected by lower courts over the last 2 weeks).
- Second, what if the Court heard a challenge to constitutionality of the ECA? Such a lawsuit would probably fail: the ECA does not violate the rights of any person in particular, therefore no one has standing under Article III of the Constitution to contest it. Furthermore, since the Constitution grants sole authority to chambers of Congress to count and determine the validity of electoral votes, a federal court (including the Supreme Court) lacks jurisdiction under the Political Question Doctrine to constrain Congressional authority.
Sources and articles cited
I’ve been working with Michael Morley (FSU), who teaches and writes in areas of election law, constitutional law, federal courts, election emergencies, post-election litigation and defendant-oriented injunctions “Donald Trump’s Stealthy Road to Victory”, Graham Allison (Harvard) in The National Interest, 11/6/2020 “Relax. Biden will be sworn in on Jan. 20”, Edward B Foley (Ohio State), Washington Post, 11/11/2020.