In recent months, the perceived gap between US stock market performance and underlying economic fundamentals has grown to extreme levels. While US market indices sit near all time highs, the economic backdrop remains shaky; more than 13 million workers are receiving pandemic-related unemployment benefits and a large number of small and mid-sized businesses remain closed or have gone bankrupt. With new Coronavirus cases surging again, the outlook for the economy depends very much on the evolution of the COVID-19 outbreak and the timeframe for an effective vaccine.

Interestingly, the results of the 2020 election now concluded may expand the rift between markets and the economy even further. As the final votes are being tallied, it appears that Joe Biden will be our 46th President and that Republicans will retain the slimmest of margins in the US Senate*. As a result, President-elect Biden may find it very difficult to pass much of his economic agenda. In particular, the Biden Tax Plan is all but dead on arrival, which included substantial tax hikes on corporations and high-income earners, as Republicans in the Senate will almost certainly reject this plan.

It is therefore not surprising that US stock prices rallied strongly in the days immediately following the election – corporations are now likely to enjoy relatively low rates of taxation for several more years and the lower Tax Cuts and Jobs Act marginal tax rates for individuals will probably survive at least until 2026. Perhaps most important to Wall Street, capital gains should retain their favorable tax treatment, even for very high-income individuals.

The outlook for ‘Main Street’ is perhaps not as rosy, however, as hopes for a second $2 trillion+ “Cares Act” stimulus bill are probably unrealistic at this point. Despite high levels of continuing unemployment, the next relief package is likely to be a much smaller, targeted bill that Senate Republicans can get behind. With Coronavirus cases surging again to all-time records in recent days, and many pandemic-related relief packages set to expire at the end of the year, economic growth is likely to remain muted until an effective vaccine can be distributed in large quantities. Ironically, this could serve as a catalyst for additional stock market gains, as slow GDP growth implies lower interest rates for longer. The Federal Reserve may feel compelled to do even more in this “slow growth” scenario, by easing financial conditions further through continued asset purchases, extraordinary lending programs, and by maintaining very low borrowing costs for corporations and small businesses.

*Control of the Senate will be determined by two run-off elections in Georgia on January 5, 2021. Democrats need to win both races to reach 50 seats in the Senate, with Vice President Harris casting tie-breaking votes.
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