Key highlights: What does Joe Biden’s win mean for fiscal support and markets?
- Recent comments from legislators suggest this outcome likely leads to at least some additional fiscal support, reducing the tail risks associated with divided government.
- The stage is set for sustained US dollar weakness and the continued outperformance of emerging market assets.
- The odds of legal challenges reversing the outcome of the presidential vote are negligible.
US election results Market reaction and implications
We believe that the early cycle environment remains positive for global equities and the tactical outperformance of cyclical segments of the market.
In our view, the clearest market implication of the election is that the stage is set for sustained softness in the US dollar and the outperformance of emerging market assets.
Most of the protectionism discount embedded in foreign assets is slated to fade, and a moderation in the outlook for fiscal stimulus likely reduces the odds of a disorderly spike in real yields that could buoy the greenback.
Emerging market (EM) currencies trade at attractive valuations and have among the most catch-up potential of the procyclical trade set. We believe that EM equities are poised to benefit from this currency appreciation, while positive trends in global trade as well as Chinese manufacturing imports and credit growth support continued outperformance. The growth outlook could receive another tailwind before year-end, by which time we expect the emergency approval of at least one COVID-19 vaccine by the US Food and Drug Administration.
Financial assets have reacted positively to the conclusion of the elections. Implied volatility across asset classes had been rising ahead of the event, and proceeded to tumble after Election Day. In our view, investors have correctly extrapolated that the result is clear, and any attempts to contest the election will not be worthy of serious consideration or alter the current outcome across several states.
Volatility craters after the US vote
Z-score of where implied volatility for different assets stands relative to its one-year average
US election results Transition turmoil?
Based on the election results, there is still more than 5% of the Trump presidency left before the Jan. 20 inauguration. This transition period includes both the prospect of a contested election and geopolitical risks that may contribute to market volatility.
We ascribe negligible, near-zero odds to a potential reversal of the declared outcome of the presidential election. Biden has secured a plurality of votes in more than enough states to command an electoral college majority. And in swing states, particularly Pennsylvania, his margin of victory is sufficient based on votes cast by the day of the election.
Legal challenges to the voting protocols as well as the election results in many states are already underway, and the possibility of recounts looms. The president pledged that there would be lots of litigation, which we expect will be manifold, broad in scope, and have varying degrees of credibility and materiality. An important factor to monitor will be the final reported margin of victory in a collection of states that give Biden at least 270 electoral college votes. The bigger this is, the lower the likelihood that legal challenge(s) would result in a different outcome. In any event, the experience of 2000 suggests that all legal challenges should be resolved by Dec. 8, the safe harbor deadline by which states must certify their election results.
A primary focus on domestic considerations pertaining to the presidential election result over the transition period may diminish the risk of international disputes. But we do see a meaningful threat of an escalation in US-China tensions initiated by an outgoing president who may blame China as the cause of negative socioeconomic conditions that prevailed in 2020. Measures could include an end to phase one trade deal, bans on the use of Chinese e-commerce payment platforms by US corporates, and sanctions against Chinese/Hong Kong banks.
We expect China would continue to hold off on strong retribution to any fresh measures imposed by the Trump administration, judging that they would be undone early in Biden’s tenure. We suspect markets too would be able to “look through” some of these developments. That said, we also see a non-negligible risk of an escalation of tensions in the South China Sea or elsewhere in the region during this transition phase in US leadership.
Actions taken in the transition period are not likely to cause irreversible damage, but the US-China relationship already appears to be on an irreversibly negative trajectory. We do not believe that this will change under a Biden administration.
US election results US-China under Biden
In our view, Biden’s approach towards China is poised to be more predictable, but still confrontational. There will be less emphasis on the balance of trade and a gradual move away from tariffs, but technology will serve as a focal point in the continuing deterioration of US-China relations. Unlike the outgoing president, Biden may choose to build multilateral coalitions with American allies to address China on matters pertaining to trade, technology, human rights, and the environment.
The incoming president’s methods for leveling perceived inequities in the US-China relationship will likely focus on building up the US, to the extent Congress is amenable, rather than measures in which the primary aim is to curtail Chinese production.
US election results Conclusion:
The passing of the US elections allows investors to begin to focus less on policy risks and more on the global economic recovery from the COVID-19 downturn. Now that the relief rally has seen investors price out some of the negatives that may have accompanied a Blue Wave or highly disputed, inconclusive election, underlying trends that were in place before the election are poised to resume. We are cognizant of near-term downside risks pertaining to COVID-19, chiefly a more severe than anticipated seasonal wave of infections and ensuing mobility restrictions as well as the potential for delays and disappointment on vaccine development. Such a backdrop could elicit a return to the outperformance of tech stocks, particularly ones that benefit from a stay-at-home environment. Our procyclical bias would be challenged in this situation. Ultimately, we expect the market to be forward-looking and focus primarily on re-opening in 2021, even if the growth outlook faces intermittent headwinds.
We have the highest conviction in sustained dollar weakness and the outperformance of emerging market assets. A diminished threat of tariffs under the incoming administration should reduce much of the protectionism discount in foreign currencies and reverse prior US dollar strength. The lack of an aggressive fiscal impulse stateside will keep real yields subdued, in our view, also contributing to a broad downdraft in the dollar. We deem a broad swath of emerging market assets – from foreign exchange, to equities, to dollar-denominated debt – to be particularly attractive in this backdrop.
Nasdaq 100 earnings, price outperformance fading in early-cycle environment as policy risks mount
The forward earnings outlook points to stronger profit growth for the broader US market relative to tech-heavy Nasdaq 100 Index in the coming year, which informs our bias towards value, procyclical stocks.
US small caps, which have the most leverage to the improving domestic economy, should also outperform their larger cap peers.
The ongoing normalization of the global economy and expected development of a trusted, effective vaccine are shaping up to be the dominant features of the macroeconomic and market backdrop in the months to come. While the lack of a clear Blue Wave failed to spark a swift procyclical rotation, we believe that the presence and proximity of these catalysts bodes well for the sustained success of this trade set over time as the expansion progresses.
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