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The Big Shift

Why Congress is likely to gain importance with respect to financial market price impacts, relative to monetary policy.



Government intervention is a classic creator of “market inefficiencies,” and superior analysis of inefficiencies provides opportunities for investment outperformance.
There are two primary governmental drivers of financial market price changes: monetary policy and fiscal policy. Monetary policy has dominated since the 2007-08 financial crisis. However, there are a few reasons why the balance of market-moving power may shift toward fiscal.
  1. Economic theory that claims that the primary constraint on government spending is inflation, rather than deficits, has rapidly moved into the Overton window in 2020. This theoretically frees up fiscal policy to have nearly unlimited firepower to target issues like underemployment, inequality, climate change, and healthcare.
  2. A potential Blue Wave is on the horizon, eager to address social, economic, and environmental issues through sweeping legislation and rule-making.
  3. There's less room left to advance monetary policy, given actions taken already. There are practically infinite levers to pull through new legislation and regulation – this is not the case with the blunt instrument of monetary policy.
Monetary policy was likely a major contributor to dampened asset price volatility over the past eight years. Alternative options for gaining exposure to risky assets, such as simple index-tracking funds, increased in popularity. With the shift toward more active fiscal policy–which is implemented by bills in the U.S. Congress and resulting rules in the Federal Agencies–public securities price action is likely to be increasingly driven by the discounting of expected effects of legislative and regulatory proposals.
Proposed policies have specific sets of winners and losers, which leads to more dispersion in prices across companies and industries, relative to the blunter monetary policy tools. We’ve found that this is even more pronounced with Democratic proposals.
Our natural language processing connects Skopos policy analytics to companies, determining the risk that a particular proposed policy might pose. By systematically applying this to all public companies, we’re able to assess the potential impact score for all policies for all companies at any given point in time. For this note, we conducted an analysis on more than 129 million policy impact scores, across thousands of companies, from January 2015 through today.

 

Figure 1 illustrates two high-level differences between the policies proposed by Democrats and Republicans.

  1. Democratic policies are predicted to be worse for incumbent public companies (the blue line is consistently below the red line). Figure 2 visualizes the distribution of policy impact scores: there are more frequent occurrences of negative bill-company impacts in legislation proposed by Democrats, and more frequent occurrences of positive bill-company impacts in Republican proposals.
  2. The directional impact of the average Democratic policy varies more through time (the blue line is more variable than the red in Figure 1).
To determine the spread across individual companies on any given day, we group by sector each day then take the standard deviation of the impact scores, separately for Democratic policies and Republican policies. We group by sector before computing deviation so we can determine how much company-specific variation among peers there is, rather than sector-wide impacts. We then average the standard deviations of each sector to summarize the difference in this measure across political parties.

We find that the within-day-within-sector spread between winner and loser companies is much larger with Democratic policies (0.74) than Republican policies (0.31). We’ll release a note soon where we explore a trend of convergence we’ve recently observed between Republican and Democratic company policy impacts.
In the meantime, it seems safe to say that more fiscal policy (and especially more of it coming from Democrats) could lead to more winners and losers. This, in turn, leads to possibilities for effective investment management if the investment decisions are driven, at least in part, by the anticipation of the impacts of the bills and regulations on specific securities.
If you would like to learn more about how Skopos Labs and our clients are preparing for a potential big shift from monetary to fiscal primacy, feel free to reach out to team@skoposlabs.com.


Best,

John Nay 
Founder & CEO
Skopos Labs

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