How the U.S. election may play out and what it means for markets

[AUDIO LOGO]

As we head towards the fall, the US presidential election will be top of mind for investors. But in a race that's already had plenty of twists and turns, how may things play out, and what could it mean for policy in the markets? Joining us now to discuss is Kevin Hebner, global market strategist with TD Epoch. Kevin, great to have you back on the program.

Hey, Greg. Great to be here.

All right. We're almost done with what we call the unofficial summer and head into the fall. Obviously, the US presidential election has become front and center. What are we seeing right now? What are the different polls telling us?

So we look at prediction markets a lot. And it's been interesting. Since July, the prediction markets have doubled the likelihood of a Democrat candidate winning, so candidate Harris, from around 27% in July to about 54% now. Overall, though, prediction markets are saying it's roughly 50/50 between the two candidates, Trump and Harris.

Some of the graphs you brought along are very interesting. The first one we're looking at here-- and you have different ones in polling, but this is the average betting site and how those odds have changed in what has been a very eventful several weeks.

Yes. And I think it's important when we're thinking about bold predictions for the next two months, is to look at what's happened over the last six weeks. There's been big changes. So I think we have to tone down the degree of confidence that we're making our proclamations about.

Tone down the degree of confidence. That was the betting sites. I want to show a few more to the audience, one about the pollings as well. And it sort of looks like the betting site to me.

Yeah, so polling has Harris about two percentage points ahead of Trump. And that might sound good, but ultimately, the US election is about the Electoral College. It's not about the popular vote. If you recall, in 2016, Hillary Clinton was ahead by 4 to 6 percentage points. And so because you've got great, big states like California and New York, they're going to vote for the Democratic candidate by 20 to 30 percentage points, so a lot.

So ultimately, there's a big gap between the popular vote and what matters for the Electoral College. So two percentage points, it's nice. It's a lot better than where Democrats were a month ago but probably isn't enough to win in November.

You bring up an important point here. We're talking about 50 states, but there's only so many that actually matter. You say 44 don't matter. It's up to six swing states. Walk us through those.

Yeah, so in 2016, there were 11 states that sort of mattered. In 2020, it was maybe eight. This time, max, it's going to be seven. It might be fewer. Of those seven, three are Great Lakes states, so Wisconsin, Michigan, Pennsylvania. Two are from the Southeast, so Georgia, North Carolina, and two from the Southwest, Arizona and Nevada.

And so ultimately, the rest of the country, which is over 80% of population, over 80% of GDP, in some sense, don't matter. In some sense, it's not a national election. It's about a few states. And so, for example, if you think of Wisconsin, Trump won Wisconsin in 2016 by 20,000 votes. Biden won it by 20,000 votes. So it's a really small number of votes when you're thinking of an election that has 150 million people going to the polls. And this time, it could well be everything comes down to Pennsylvania, which I think is a state that Canadians know quite well and has quite a diverse demographic.

I think we might have a picture or two in terms of some of those swing states and some of the changes we've seen since President Biden said I will not be your candidate and then Harris stepped in. What's this telling us?

So the red bars show how much Trump was ahead in each of the swing states, the seven swing states, in July. And so he was ahead in all seven. And that's why-- and our view at that point was there was 75% chance that Trump would win, though since that, we've had new candidate step up, Harris. You can see the green bars. Those are the most recent polls. And it says that all seven swing states are now in play.

So that's a really dramatic difference in a couple of weeks. And again, it comes down to bold predictions I'd be careful about. My guess is November 5, we're all watching the TV, watching the Electoral College votes come in. And it's going to be pretty tight.

Back in my days before business journalism, I'd have seasoned political reporters telling me the only poll that matters is the Election Day poll. But sometimes, it would play out that way. I think we have another picture or two about the states that Biden managed to flip.

Yeah, and so these are states that Trump won in 2016 and Biden managed to win in 2020, and that's five of the seven swing states, so a couple of southern states like Georgia and Arizona and then the three Great Lakes states, Wisconsin, Michigan, and Pennsylvania. So these are the states that move the rest of the states. New York and California are not going to move.

And there's at least 10 states in the middle of the country that Trump won by over 30 percentage points. So when the campaigns are trying to decide where to spend their time, where to spend their money, 95% of it will go in the seven swing states. So they'll ignore California and New York, and they'll be spending a lot of time here. 95% of the money, 95% of their time will be in a small number of states.

And just emphasizing, to some extent, it's very different than a parliamentary system like we have in Canada, the Electoral College system. It's a small number of states and might come down to a few counties in some of these states making all the difference.

That's an incredible landscape and a great breakdown of the backdrop we have right now. Given all that, we think about the presidential race fairly tight, so you don't make any bold predictions. What about Congress itself? This is very important for anyone who takes the White House in terms of getting an agenda through.

Yeah, so for the White House, we were thinking 75% for Trump. Now it's down pared down to about 55%. But again, this is a number that's going to change. In particular, the September 10 debate is really important for that. For the Senate, we had 75% that the GOP takes the Senate, and we stick with that 75%. The House continues to look very 50/50, so it's a coin toss.

And then what's important overall is, does a party get a sweep? So do you have both the White House and Congress? Because Congress controls the purse strings, and Congress also initiates legislation. So that's really important. And we have a 30% probability of a GOP sweep and a very small probability, 10%, of a Democratic sweep.

Ultimately, what the market would like, I think, to see is a divided government, because then you don't get measures that need to be ratcheted back later, I think, a more determined approach to policy. And that seems to us to be 60% likely.

What do we think about policy going forward then? Because, of course, in the end, that informs what's going to happen in the markets.

So a lot of the discussion is on fiscal policy, and nobody is talking about fiscal austerity. Candidate Harris, Vice President Harris, she's talked a lot about child tax credits, earned income tax credits, these sorts of things paid for by higher taxes on wealthier people, also higher corporate tax rates. The market would be very unhappy about higher corporate tax rates, but that would only actually happen if you had a Democratic sweep, which we think is unlikely.

Fiscal policy for Trump-- he wants to cut taxes on everything-- corporate tax rates, individual tax rates, taxes on tipping. And he's been arguing that if you cut taxes, that's going to create so much growth that it'll more than pay for itself. I don't think anyone aside from ex-president Trump believes that's true. And so it could end up-- if he actually had a GOP sweep and managed to enact his tax proposals, it could add about $5 trillion to the US deficit-- or debt, rather. It's a very big number.

In either case, we're going to have deficits continuing to be over $1 trillion a year. These are enormous numbers in an economy that's pretty strong.

Let's talk about another part of the economy that's catching your attention south of the border. All we talk about in Canada is housing. It's been that way forever. But in the States, it's actually starting to become a more of a potent issue.

Yeah, and it's interesting. So since the housing crash in 2007, there's been a lot of discussion about housing, but nobody's really done anything. And then last week during the DNC in Chicago, ex-president Obama gave a speech, and it was a very good speech. But the first policy measure he mentioned was housing. And that took a lot of people by surprise because it's not something that Democrats had really talked about on the national stage.

One reason for that-- and the chart that you have up shows affordability. So this is affordability for first-time homebuyers. And I think this is something which Canadians have a lot of empathy for. Housing is the least affordable it's ever been in the United States. That partly reflects higher mortgage rates, partly reflects higher home prices. But the big driver has been less supply of housing since 2007.

We have that mantra here in Canada, right? Build more homes. But then you look at the starts and what the start is telling us.

Yeah, and so this looks at housing starts. And I've adjusted this for increases in the population, but the rate of housing starts currently is 50% of the pre-2007 level. So this means the US is probably 2 million to 8 million homes short of what it needs for its population. That's a big deal, 2 million to 8 million people. I think ultimately, this is what is driving the affordability issues. And in the focus groups that both the Democrats and Republicans are having, in all cases, housing is one of the number one issues that people are concerned about. [AUDIO LOGO]

[MUSIC PLAYING]