Patience Required: How the Close Vote Count May (or May Not) Impact Markets and Investors
Nov 3, 2020
Tonight has been a tense night in America. Let’s try to park those emotions at the top of this page, as we believe investing is best done dispassionately. In this post, we’ll try to take an objective look at:
- What we know about the election results so far
- How the U.S. election fits into the bigger picture of our global market outlook
- How the early results and potential outcomes might inform our thinking going forward
What we know from election night
At 8 p.m. Pacific time, none of the key outcomes have been officially called by the major news agencies. But the probabilities have clearly shifted. This is a very, very close race, and that is saying something. Democratic presidential nominee Joe Biden had a large polling lead coming into election night, which suggested at least the possibility of a blowout victory. The so-called blue wave has not materialized. President Donald Trump appears to have an advantage in Florida, Georgia and North Carolina. If he carries these states, the outcome will hinge (like 2016) on the Rust Belt—i.e., Michigan, Wisconsin and Pennsylvania.
Some early data seems to support the notion that Trump could carry these key states as well. However, caution is warranted for the time being. Mail-in voting, which tends to favor the Democrats, is being tallied more slowly in these states and could close the gap. Unfortunately, we are unlikely to know the victor tonight. The secretary of states in both Pennsylvania and Michigan have indicated that their races may not be known until Friday, Nov. 6.
A close presidential race also lowers the probability of Democrats taking control of the Senate. But there, too, we simply don’t have enough races called at this stage to say anything decisively. Democrats would need to win three Senate seats for the slimmest margin of legislative control in 2021. Of the seven most competitive races (all held by the Republican party), none have been called at this time.
Bottom line: The probabilities have shifted toward a gridlocked Congress and a tight presidential decision, but all outcomes remain uncertain.
The big picture
It can be tempting to jump into the weeds about what a certain election outcome might mean for the economic outlook, interest rates or equity markets. And we’ve certainly war-gamed those scenarios internally as an investment firm. But I think tonight—even more than ever—we need to first ground ourselves with a broader view of the investment landscape.
First and foremost is where we are in the global business cycle. The enormity of the shock from the COVID-19 pandemic drove the sharpest economic recession in modern history. But because of an equally historic fiscal and monetary policy response to this crisis, households and businesses have largely been cushioned from the blow.
In the United States, for example, transfers from the government were so large that aggregate household income actually grew during the recession. Global economic activity quickly transitioned back to positive growth in May as economies began reopening. And through October, these positive growth rates have largely continued across the developed and emerging world. It’s not unusual to see above-trend economic and earnings growth as countries emerge from an economic recession. Spare capacity provides room to grow without inflationary consequences or central bank rate hikes. In some ways, our outlook is that simple: We’re early in a new cyclical expansion, and that is a time in the cycle that has typically favored being invested in riskier areas of the market, like stocks and credit.
The virus remains a source of uncertainty, of course, with major European economies transitioning back to partial lockdowns this month. But there are some glimmers of hope, too. Pfizer and Moderna have guided investors to expect efficacy results from their final stage vaccine trials sometime in November. Scientists are cautiously optimistic that a vaccine could be delivered at scale in mid-2021. If that view is correct, life should be looking more normal 12 months from now than it does today—again, supporting a positive cyclical outlook over the medium-term. Vaccines should also broaden the recovery, eventually lifting dislocated sectors (e.g., restaurants and other service sectors).
Key political issues for financial markets
While we think the macro perspective of an early cycle recovery is the critical insight here, politics can shape our outlook around the margins. Here we need to disentangle the White House and Congress.
The president controls U.S. trade policy and can also guide the regulatory agenda. In this regard, a Biden victory is thought to support non-U.S. equity markets (particularly in Asia), as he is expected to take a more predictable and multilateral approach to Sino-American policy. In terms of regulation, Biden has emphasized the importance of the environment, which could be a moderate headwind to the domestic energy sector. Meanwhile, both candidates have talked about stronger antitrust enforcement of mega cap technology companies. Democrats seem a bit more enthusiastic about this issue, however, and so a Biden win would likely be viewed as a negative for technology stocks and the growth style.
The control of Congress, meanwhile, is arguably more important than the presidency for the macro-market outlook. That’s because Congress controls the power of the purse—both taxes and spending. With gridlock around a new fiscal stimulus package in the U.S., a unified Congress (where the Democrats win the Senate) should deliver the most fiscal stimulus in 2021. Enhanced unemployment benefits, household checks and additional funds for small businesses and dislocated industries would likely total $2 to $3 trillion. That would provide even more support for an economic recovery that has surprised most economists to the upside thus far.
In this scenario, long-term U.S. Treasury yields would be expected to rise, and small cap and value stocks—which are more cyclically exposed—should outperform. There could be offsets from tax policy, however, with Biden’s proposal to unwind half of Trump’s corporate tax cut, likely subtracting 5 or 6 percentage points from U.S. earnings growth. Put differently, the implications for interest rates and relative equity styles in this scenario are more apparent than the tug of war for broad equity benchmarks.
Finally, a divided government—where Republicans retain control of the Senate and shift back toward fiscal conservatism—would likely stifle both tax and fiscal stimulus efforts. Again, this would be a mixed bag for equity benchmarks, but would likely lead to lower interest rates and act as a moderate headwind to the opportunity we see in the value style today.
Markets have traded in-line with these scenarios overnight. 10-year Treasury yields have dipped moderately to 82 basis points. NASDAQ futures are trading roughly 3% higher overnight, leading U.S. shares. As a longer-duration style, these securities seem to be benefitting from lower discount rates and perhaps a less bad scenario from tax and regulatory policy.
It looks like we will all need a healthy dose of patience this week, as results continue to roll in. A protracted period with no known result could inject volatility into financial markets. What we do know is that the U.S. and global economy are both still in the early innings of a new cyclical expansion. Our strongest advice tonight is for our clients to stay invested and maintain their discipline. Politics offer plenty of surprises, but there are some very powerful economic forces already at work that don’t care at all about who is in the White House.
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