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CIO Update | US Election 2020

06th November, 2020

Please note this article was written as at 5th November 2020.

After the fire and the fury, the astonishing stats and the alternative facts, it appears that the extraordinary Presidency of Donald Trump is coming to an end. In this article, we look at the typical aftermath of American elections, and frame it in the context of 2020-21. Of course, Trump may not go quietly, so we can expect plenty more noise. But as the markets churn with the headlines, we keep reminding ourselves of the mantra of James Carville, Bill Clinton’s 1992 campaign strategist; “it’s the economy, stupid”.

What does the new president mean for the economy?

The week before the election, we saw record GDP (gross domestic product) growth for Q3 in both the United States and the Eurozone. Coming after record declines in Q2, this leaves global GDP still well below 2019 levels.  We note that the macro data in the US has stayed relatively firm, while European figures have weakened as lockdowns are re-imposed.

It’s true that the world economy has suffered from a lack of political leadership, and that President Biden will be a welcome change.  But the most immediate problems are the Covid-19 virus and the giant hole that containing it has left in the economy.  The new US administration won’t bring a workable vaccine any faster than the old one, although it will surely bring a more organised approach to it.  As before, we are still several months away from a widespread vaccine solution.

As for the hole in the economy, this needs to be filled with more stimulus.  The US Senate and House couldn’t agree on the next phase before the election.  Once the dust settles, a more modest package, in the $1tn range, which is still about 5% of GDP, now seems likely.  As for his broader plans, a Republican Senate will not allow president Biden much of the spending he promised, but it also won’t allow him to raise taxes, so the net fiscal impact will still be positive.  In Europe too, governments are extending their support packages.  The Bank of England has just announced more QE (quantitative easing, i.e. bond-buying) and we expect the ECB (European Central Bank) to do the same.  Overall, the US economy should have recovered by late 2021 or early 2022, while Europe may take a year or more longer to get back to previous levels.

What will happen in the stock market?

Markets normally rise after US elections, as the result reduces the political uncertainty, and the winner usually comes with spending promises.  The table below summarises the outcomes of the past 50 years of elections.  Unfortunately, there are no reliable patterns in the data, no matter how hard we squint.  The last two times we had a new President with a split Congress, in 1980 and 2000, were just before recessions and markets were naturally weak.  Interestingly, of all the potential combinations, the strongest post-war returns have come with a Democrat in the White House and a divided Congress; President Obama from 2011 to 2014, according to CNBC.

*We measure total returns from the next calendar year(s) after each election.
2Sector rotation measures whether more of the top 3 and bottom 3 sectors flip or stay the same.
3Cyclical measures how many of the top 3 or bottom 3 sectors are cyclical.

 

Elections also bring tempting predictions of winning and losing sectors.  In 2016-17, many of the well-flagged “Trump trades”, such as healthcare and infrastructure, did not pay off, as the market followed the economic fundamentals.  The 2017 tax cuts boosted corporate earnings across the board, and bank stocks did particularly well because interest rates went up, while energy stocks lagged because oil prices stagnated.  This time many “Blue Wave” trades have already faded as Democrats failed to take the Senate. As an extreme example, “TAN”, a US-based ETF (exchange traded fund) invested in the solar industry, which had more than doubled in price this year, has now fallen by over 12% (According to Bloomberg 05/11/2020). We still believe that a reflating Biden economy will lift the broad market, including more macro-sensitive cyclical sectors and small caps, but hopes of a rotation into long-suffering value stocks have been dashed again.

Of course, plenty had already happened in the market this year before the election.  By the end of October, the global index was up over 40% from the trough in March, to be almost flat on the year (According to Bloomberg 05/11/2020), with the economy facing further lockdowns and uncertainty.  Valuations are unusually high for so early in a recovery. Then again, the markets have never had so much support from central banks and governments, and with the Republican Senate protecting corporate interests, the outlook for US earnings is positive. Even at these high prices, prospective returns from stocks are more attractive than usual compared to cash or bonds.

Will the new government make a difference to interest rates and bonds?

Interest rates are at all-time lows because central banks want to support households and businesses, and because inflation is very low.  The economy will need support for some time, and this weakness means that inflation should not be a problem for several years yet. The central banks, who have already made it clear that they will keep monetary policy very easy for longer than usual, will be in no hurry to raise interest rates under President Biden.

Given that interest rates are going nowhere, and inflation risk is still far away, there is little macro pressure on bond yields. Governments and corporates are issuing record amounts of new bonds, which should push yields up, but central banks are also buying more bonds again. Keeping interest costs down for borrowers means continuing low yields for investors.

Will the US dollar be stronger or weaker?

In theory if the US runs big deficits and inflation rises under the new Biden presidency, then the US dollar should weaken.  But we caution against dollar scare stories. All major governments are running huge budget deficits these days, not just the US.  A faster growing US economy may mean a larger trade deficit, as they import more goods, which would be USD-negative. As for inflation, policy makers everywhere are trying to reflate their economies.  The US may reflate sooner in growth terms, but consumer inflation is still several years away, so this is not an immediate risk.

However, if the world economy is improving, then its safe haven status is less relevant, and without higher rates to support it, we do see a slightly weaker dollar. Assuming that we don’t fall into another crisis, our base case is that USD weakens versus EUR by a few percent over the next 12 months, perhaps a few more versus GBP in a positive EU-UK trade outcome. Consensus forecasts (According to bloomberg 05/11/2020), for 2021 have EUR-USD in the low 1.20s, and GBP-USD in the mid-1.30s.

So, what does this all mean for my portfolio?

Despite all the drama, the election is not likely to make much difference to our investment strategy or to our portfolios, as the main pre-election themes are still intact.  The economy is recovering from a deep shock, and governments and central banks are committed to continue funding it. Austerity is not on the table – the policy debates will be about how much more spending and when.  There will be surprises and setbacks, but we’re not short-term traders, and we’ll continue to focus on the macro and earnings trajectories, as the most important drivers of returns over our investment horizon.

At the tactical level, we still favour stocks over bonds over the next 12 months.  Betting on elections is not our strategy, so we have avoided deep value plays or election-specific themes, but we have been gradually adding more cyclical exposure, including small cap US stocks, to our discretionary portfolios since the summer.  A blue wave might have really boosted these positions, although they have already risen in the post-election bounce, and we expect them to continue to benefit from the reflating economy in 2021. If markets do fall back, and the recovery is still intact, we may add further to some of these positions.

At the strategic level, investor choices are the same as before the election – between safe assets with negative real returns, i.e. after inflation, and expensive growth assets which will be volatile whenever macro doubts arise.  Either way future returns will be lower than in previous decades.  As always, we recommend that clients have a robust financial plan to determine the right amount of liquidity, cash and short-term bonds, to keep on hand.  Then with these short-term needs provisioned for, a longer-term investment portfolio will be able to grow through the interesting times ahead.

Should you have any questions in relation to your investments, please contact your Davy adviser.

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