The Tell: The Elizabeth Warren stock-market correction will happen sooner than you think: RBC

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Investors won’t wait until Election Day to voice their displeasure at higher taxes and stricter regulations being proposed by Democratic nominees for President.

That’s because the contours of the 2020 presidential election will come into sharp focus by the end of the first quarter of next year, Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets wrote in a research note Monday, arguing that markets will likely react to potential policy implementation long before general-election ballots are cast.

Calvasina wrote that Mass. Senator Elizabeth Warren “appears to have a good shot at winning the Democratic nomination for president” given that she now has moved into second place in the polling average, behind former Vice President Joe Biden, while polling data show that she is the second-favorite choice of voters who prefer Biden, Calif. Senator Kamala Harris and South Bend, Ind. Mayor Pete Buttigieg, putting her in a good position to “emerge as the consensus candidate” when all is said and done.

Though institutional investors still believe that President Trump will win reelection next year, based on RBC client polling, Calvasina warns that investors should not become overconfident of this scenario.

“We think it’s far too early to call the outcome of the 2020 election, and expect a close race,” Calvasina wrote. “But our analysis of the electoral math tells us that investors need to at least consider the possibility that the Democrats will emerge victorious.”

She points out that the next Democratic nominee would need to win only the states Hillary Clinton won in 2016, plus Pennsylvania, Michigan and Wisconsin, which Clinton lost by very narrow margins, in order to win the presidency. Democratic Congressional candidates won more votes than their Republican counterparts in each of these states during the 2018 election, while the president has negative approval ratings in those states, she pointed out.

And while the Democratic nomination process will formally continue through the summer of next year, 40% of delegates to the nominating convention will be assigned through caucuses and state primaries held in early March of 2020, and two-thirds by the end of March. “If Warren wins the nomination, we expect most of the pain associated with a White House victory to occur well ahead of Election Day,” she wrote.

The reaction could be severe. “The combination of a Warren White House and a Democratic Congress would be extremely challenging for stocks from a bottom-up perspective,” Calvasina argued, given the ambition and scope of the senator’s policy prescriptions on everything from banking regulation, to wealth taxes, to Medicare for All. Investors surveyed by RBC see health care, financial and technology stocks as those that would take the biggest hit if Warren is elected and Democrats take back the Senate.

RBC Capital Markets

If fears of a Warren presidency do, in fact, lead to volatility in equity markets during the first quarter of next year, Calvasina argued that it will be short lived. She argued that even if Democrats take back the White House, regaining the Senate will be more difficult, and a Republican Senate could block many of the more extreme proposals put forward by Senator Warren, like a wealth tax or the institution of Medicare for All.

“Most of the sectors at high risk under a Warren Presidency from a policy perspective (Financials, Energy, Health Care, Industrials) are already deeply undervalued versus the broader market,” Calvasina pointed out.

Furthermore, the stock market has historically performed well when Democrats have had one-part control of Washington, and actually have performed best when a Democrat is in the White House, but control of Congress is split.

RBC Capital Markets

“In the short-term, stocks don’t respond well to heightened economic policy uncertainty,” she warned. “Ultimately we think Corporate America and U.S. equity investors would learn to adapt to new political leadership, as they always do.”