While it appears that the election may not be finalized for a few days and there could be court challenges, investors seem to have drawn the conclusion that Joe Biden has won the presidency and Congress will remain split with Republicans controlling the Senate and Democrats the House. After starting to price a Blue Wave outcome for much of the past month, market performance today quickly reversed course. A Biden presidency with a Republican-led Senate likely means less fiscal spending, but also few tax increases and partisan constraints on legislative action. As discussed below, market pricing today across asset classes reflected this policy pivot, as well as policy clarity, which contributed to the VIX volatility index dropping 6 points, or nearly 17%.
The S&P 500 rallied 2.2% on the heels of the election results last night. The positive market reaction likely reflects 1) some relief that civil unrest has been avoided so far; 2) investors re-engaging now that the election uncertainty is beginning to resolve; 3) lower interest rates that are boosting equity valuations, especially for secular growth stocks.
As we explain in our sector discussion below, the most dominant trend within the market today was a rotation into secular growth areas and out of virtually everything else (both cyclicals and defensives), with the exception of healthcare. This shift was likely prompted by lower interest rates due to expectations for a smaller stimulus package. In the case of healthcare, substantial changes to healthcare policy or drug prices now look less likely.
Overall, we remain constructive on US equities and believe the recovery from the pandemic—aided by our expectations for widespread vaccine availability by the middle of next year—will continue to be the dominant market driver over the next several months. Still, markets could be volatile in the near term until the election is considered final. The near-term COVID-19 trends and timing of fiscal stimulus could also drive markets. Our preferred US large-cap equity sectors remain consumer discretionary, financials, healthcare, and industrials. We also continue to prefer US mid-caps.
The consumer will still benefit from fiscal stimulus, albeit a smaller package than in a Blue Wave scenario. Lower interest rates should help housing and home improvement stocks. Less threat of higher corporate taxes is also a positive for US-centric names. Affluent consumers should benefit from a much lower likelihood of tax increases. Overall, the outcome likely leans positive for the consumer.
Energy equities are enjoying a bit of a relief rally as the prospects for an aggressive green agenda fall. The sector is also benefiting from higher oil prices. The outlook for the sector remains uncertain, and we expect some volatility until uncertainties, mostly pertaining to the oil price outlook, diminish. That said, we expect some near-term price support from a more supportive election outcome.
These sectors are benefiting today primarily from lower interest rates as Blue Wave stimulus appears off the table. Investors also seem to be rotating back into growth “safe havens” as other more cyclical sectors lack some anticipated election-related catalysts. The groups may also be benefiting from less likelihood of higher corporate taxes. Lastly, a divided government lowers the probability of legislation that could crimp the market power of some of the mega-cap companies in these sectors, although we always viewed this risk to be low.
The expected election outcome is mixed to slightly negative for US financials. The next stimulus package is likely to be lower than would have been the case in a Blue Wave, weighing on interest rates. Bank stocks are highly correlated with interest rates. However, this is somewhat offset by a lower likelihood of higher taxes. In addition, regulatory risk should ease somewhat as the Senate stays in Republican hands. Nonetheless, we would still expect a Biden administration to name new regulatory leadership who could interpret laws and regulations in a less industry-friendly way.
A Biden presidency with a split Congress is the best near-term outcome for healthcare, in our view. More aggressive Democratic policies on drug pricing and a public option for health insurance are unlikely to pass a GOP Senate. Moderate drug pricing legislation remains possible and would enhance clarity, but the probability of a bipartisan compromise on any health policy legislation is below 50%, in our view.
Overall, a Biden win and a split Congress is a net positive for both sectors due to likely lower trade tensions, no risk of a tax hike, and less regulatory tightening. However, any fiscal stimulus will likely be smaller than we had expected, which is likely the cause of some underperformance today. Specifically, the railroads, defense, and waste industries would benefit from lower odds of a tax hike. Defense companies would also benefit from lower risk of a cut to defense spending. HVAC, construction, building materials, and alternate energy exposed names would be hurt from less spending on infrastructure and green tech.
The absence of a Blue Wave is modestly positive for energy infrastructure. However, we still believe administrative action and regulatory priorities, which can be achieved without legislative support, remain as risks. Similar to the broader energy sector, the performance of energy infrastructure will continue to be heavily influenced by oil prices.
Overall, with a Biden win and a split Congress, we do not envision the loss of 1031 exchanges, a major positive for the real estate market. The reversal of the SALT (state and local taxes) deduction limitations in high-tax states is very unlikely, which means that home values in these regions don’t get a boost. We now see less risk of substantial changes to the opportunity zone program. More broadly, lower interest rates should benefit both housing and commercial real estate activity and values. Several propositions in California could impact real estate values, but we are waiting for more precincts to report before drawing final conclusions.
Renewable stocks have been huge standout performers in the run up to the election and were clearly discounting a Blue Wave scenario and a more aggressive tilt to green policies. With this outcome now off the table, stock prices will continue to correct to more reasonable valuations. However, it’s important to keep in mind that improving economics are driving much of the transition to renewables, and this trend will support the stocks over the medium and long term.
The absence of a Blue Wave outcome is roughly neutral for utilities. Though legislation-driven federal green and renewable infrastructure priorities appear unlikely, we believe economics and state mandates will continue to drive utility investments in renewables. As investors focus on the continued recovery from the pandemic and prospects for a successful vaccine, we believe utilities could lag the broader market.
The government bond market gyrated throughout the day and into the evening on 3 November as the probability of a divided government fluctuated with the election returns. The preservation of a Republican majority in the Senate, which is now the most likely outcome, reduces the risk that taxes will increase markedly. Federal expenditures will be lower and new legislation will require bipartisan compromises. In the absence of a clear winner in the presidential race, yields drifted lower on expectations of a slower economic recovery and a more restrained fiscal policy outlook.
The recent move in the Treasury market is not a flight into safe-haven assets, but instead a correction to an overconfident market that was heavily swayed by momentum and polling data. The 10-year yield reached the June high of 95 basis points, as the 5-year/30-year curve steepened to 133.5bps, a level not witnessed since November 2016. As the likelihood of a large fiscal stimulus package faded, the government bond market quickly retreated. We are now at levels last seen on 28 October: a 78bps 10-year yield and a 122bps 5y/3y spread. Risk assets are tighter, volatility has started to decline, and the reliance on the discovery and dissemination of a vaccine will be the economic driver. With the Fed on hold and large stimulus already in the marketplace, strengthening fundamentals will lead both the US 10-year yield and inflation expectations higher by year-end. However, if the election outcome remains uncertain for an extended period of time, then demand for safe-haven assets will rise, pushing the 10-year yield toward the post-COVID low of 50bps.
We expect credit spreads to remain supported by an improving economy, a more benign rate backdrop, and reduced likelihood of higher corporate tax rates. A recovering economy is a good scenario for credit as company fundamentals rebound but corporate behavior remains conservative when it comes to leverage, with an emphasis on balance sheet repair. Investor demand for credit should stay strong in a lower-for-longer rate environment, especially given the preponderance of low and negative yielding debt across the globe. Finally, the prospects for higher corporate tax rates have diminished in the absence of a Blue Wave. The elimination of this potential strain to corporate cash flows is a credit positive with average debt leverage at historically high levels.
In early morning trading, munis rallied, taking their cues from the sharp decline seen in US Treasury benchmark yields overnight. Near-term, we expect munis to continue to follow the direction of the government market, but move at a slower pace. As a consequence, muni-to-Treasury yield ratios will remain elevated. Fiscal stimulus to state and local governments is now expected to be less generous than under a Blue Wave scenario. This represents a headwind for municipal credit quality. The likelihood of higher federal taxes, which would have increased demand for munis, has diminished. At the same time, we expect taxable muni issuance to remain heavy. We maintain our preference for high grade munis rather lower rated credits in the face of an uncertain economic and political environment.
While much of the attention has focused on the impact to US investments, the election also affects markets in other areas of the world.
We believe a Biden presidency with a divided government is the most optimal outcome for Asian equities, as Biden’s foreign policy approach will reduce uncertainty while a divided Congress reduces the risk of higher taxes. While he will face more hurdles under a divided government, Biden’s green agenda could help Chinese solar companies and Japanese automakers. Finally, US-listed China shares could benefit from less delisting threats. A Biden win is also positive for the Chinese yuan, since he is less likely to use tariffs as a policy tool.
For European stocks, the negative effect of a smaller fiscal package may be offset by reduced trade tensions, particularly for industrials, autos, and materials. European utilities and autos should be relative beneficiaries of supportive green initiatives. Limited healthcare policy changes under a divided Congress may bring some relief to the healthcare sector.
Reduced trade tensions and limited healthcare policy changes are positive for Swiss equities. The Swiss Market Index has a heavy exposure to healthcare (around 40%), and Switzerland is a small and export-oriented economy dependent on international trade and services.
Given the expected roll-out of vaccines and ongoing global policy support, the backdrop for emerging markets remains benign. And reduced US external policy uncertainty could also improve the visibility for emerging markets. That said, a smaller than expected fiscal package could weigh on those countries dependent on US growth, and ESG considerations will come into focus more, meaning countries with subpar human rights and environmental records will likely face criticism, though strategic ties are unlikely to be severed over infringements.
A Biden presidency with a Republican Senate presents limited positive impact on sustainable investing strategies. We expect a near-term pullback in stocks aligned with green themes as expectations associated with a Blue Wave subside. However, we believe that themes such as renewable energy, smart mobility, and energy efficiency remain attractive, supported by improving economics and supportive global and state-level policy. Biden has proposed social policies implementable through executive orders, which would support ESG leader strategies. Examples include implementation of the rule prohibiting the importation of goods made with forced and child labor, and the ban on federal use of private prisons.
With President Joe Biden inaugurated and the 2020 election cycle complete, our focus now turns to the new administration’s policy agenda and what it means for investors’ portfolios. For our current views throughout this presidency, visit ubs.com/cio-potus46.
Should you wish to view our 2020 US elections content archive, you may close this window to proceed.