Volatility as viewed through the lens of the VIX index has already risen sharply in the lead up to the election but has been largely because of the surge in virus cases, and lockdown measures in Europe in particular, weighing on risk sentiment.
As far as the election itself goes, I think Trump is closer to victory than the pollsters, bookies and financial markets believe, which in itself favours election night volatility as states are called one-by-one, and a big response early Wednesday when European cash equities open to we would assume some clear result.
What also favours a large swing in futures pricing and in some FX crosses will be the way in which calls on individual states are made. With some states processing the in-person ballots before the postal ones are counted, and with some states allowing postal votes to arrive after Nov 3rd (as long as they are postmarked by this date), we could get an inaccurate and uneven sample when the West Coast polls close.
If the polls are correct and show a comprehensive Biden victory, volatility would likely ensue as investors call their accountants to assess their holdings in expectation of much higher taxes. FX crosses to watch will be focussed in the EM space (USD/MXN, USD/CNH among others) as a Biden win is seen as particularly positive for those currencies.
We’ve included three potential outcomes (the fourth variant: Trump wins and Senate turns blue has been omitted since if there is a Trump surge it’s hard to see the Senate going Blue).
A little stock market history
The stock market has risen under both Democrat and Republican presidents – stocks don’t really care who’s in charge. Moreover, ongoing monetary policy support underpins the equity market valuations – the Fed is not about to remove the punch bowl. Whilst longer dated Treasury yields have started to rise after a period of stagnation this appears to be on the expected increase in the money supply and fiscal expansion which would accompany just about any of the results.
We should note that yields are very much within tight ranges and any significant break free to the upside would require a serious bout of inflation (as previously argued this may be the consequence of a vast increase in the money supply). Fiscal stimulus is coming over the hill whatever the result – the only exception would be a contested result which would of course tend to create heightened volatility and a slower path to stimulus.
Fiscal largesse will make a significant difference and we would tend to think that a Blue Wave result would support the largest fiscal expansion of the possible outcomes. A Biden White House and GOP Senate increases the risk of delay, particularly if some of the new senators don’t feel like voting for huge increase budget increases.
A disputed election would need to be resolved in the Supreme Court and Trump has just scored a big win with his new justice. Whilst a disputed result is possible and would cause the most volatility, it is a) being over-egged since postal votes should not make a big difference in the key states and b) it certainly won’t come to the point where Trump refuses to leave office. Leaving the unedifying and frankly undesirable prospect of a disputed result aside, we can look at the three main possible outcomes and what these mean for the markets.
Red Rum: Trump win, Senate stays red
Less stimulus – not the $3tn Heroes Act but something that is a little short of what the market had been hoping for. Removal of tax and regulatory uncertainty supportive of equity valuations however.
Nominal yields down and real yields more negative, favours gold + growth stocks + multiple expansion: more upside for the S&P 500 with removal of expected increase in corporate and capital gains taxes and reduction in policy and regulatory uncertainty.
Growth beats Value status quo
Dollar could outperform in the near term with a strong post-election euphoric bounce until stronger economic, monetary and fiscal trends are reasserted and drag on USD – however trade tensions could be a headwind for USD bears.
Policies supportive of US shale and further drilling, increasing domestic supply. Less stimulus could be –ve for demand, therefore WTI prices could tend to fall, especially as it looks like the winter is set up for inventory builds. Global demand will matter more for commodities in general and even for oil there are greater forces at work than who’s in charge.
Reinvigorated Trump with Senate support would likely see the president up the ante on trade, which would tend to be negative for emerging markets and boost the USD. It could also be a negative for European equities and the euro.
So Mauve: Biden win, Senate stays red
Less uncertainty over policy likely to support equities, whilst a Biden presidency ought to see some degree of a reset with trade partners that would boost sentiment and corporate earnings.
Stimulus delays could create near-term volatility but it would be in no one’s interests to drag their feet for long given any ballot box risk would be two years away.
Tax uncertainty removed = +ve for equity valuations.
Improvement in trade relations with partners and China could see EM supported as well as European equities/currency – would also tend to boost US corporate earnings
Not as bad for the dollar as a Blue Steal result with trade reset likely to support flows, also less fiscal expansion a factor, but USD seen weaker in this outcome as part of broader downtrend.
Little impact on commodities – arguably less stimulus creates headwind to recovery but broadly speaking the global post-Covid expansion will matter more, as well as the relative weakness of the dollar.
Blue Steal: Biden win, Senate goes blue
It’s a reflation and redistribution thing – more stimulus = more spending + higher prices (tax reform nails the rich who have less marginal spending power than poorer folks)
Timing is everything: do tax hikes get applied instantly and retroactively – which could spark selling into the year-end before stimulus floods through in the spring of 2021.
Lots of stimulus is a +ve for stocks and favours Value stocks – less overall potential for the broad market but tilted in favour of Value again over Growth.
Remember the fiscal expansion is two-fold: Covid relief and massive infrastructure boost.
Rising nominal yields, steepening of the curve = bad for gold (unless and until inflation appears) + good for banks.
Expected hike to corporate taxes and capital gains tax creates policy uncertainty and could generate additional volatility into the year end as investors liquidate positions to realise returns prior to the tax rises.
Higher corporate taxes and regulatory uncertainty increases risk premium for equities, whilst could see nominal yields rise and reduce the TINA appeal for equities.
Seen as more negative for USD with fiscal expansion and tax/regulatory regime weighing on demand for US equities
Over the medium to long term, a Democrat clean energy push would restrict US output and reduce demand for oil products. Larger stimulus would boost demand near-term – also watch as to whether a Blue Steal result leads to a deal with Iran that brings more production onto global markets.
Result likely +ve for emerging markets with dollar weaker, better trade relations – look to USD/MXN, USD/CNH upside in this scenario.
Better trade relations with partners a +ve for Euro (see weaker dollar narrative) and for European equities, particularly cyclical names.
Key question that will remain unanswered on Nov 4th: Does the gigantic stimulus that Biden and company would unleash flood the US economy with too much liquidity at a time of strong economic recovery, creating inflation and leading to monetary policy uncertainty? In other words do we get so much fiscal stimulus that the Fed becomes cornered and is forced into hiking rates much sooner than planned.
Polling continues to show Joe Biden commanding a roughly 7.5pt lead nationally, whilst in the key battlegrounds the lead is less than half at 3.4pts. There are ranges and differences between states, but the broad picture remains that a Blue Wave is to be expected if we take the polling data as accurate. However, on a personal basis, my belief is that Trump has many ‘quiet’ supporters who do not show up in the polls, and many of whom will have been affected by the unrest over the summer. The Senate race is extremely tight right now but still indicate the Democrats just taking back control.
Sector and single stock volatility picks
Within our Biden20 basket of stocks which could do well from a Democrat clean sweep, green energy stocks look most exposed to downside if there were a Trump victory, since it would materially affect the expected regulatory backdrop for clean energy investment.
Biden plans to set the US on an “irreversible path” to net-zero carbon emissions by 2050, with an ambitious goal to build a carbon pollution-free power sector by 2035. The proposals clearly imply a far more aggressive shift away from fossil fuels than a Trump administration would pursue.
The proposals would also involve upgrading millions of commercial and residential properties over four years to increase energy efficiency, with among other things the installation of solar panels, which is a potentially huge growth area (Sunrun, Solaredge, FirstSolar in our Biden20). We also note a positive policy position on EV (Tesla, Nikola) with plans to invest in 500,000 electric vehicle charging stations. European clean energy stocks would also benefit from a Biden win, whilst automakers like VW and Daimler could benefit too.
As far as the corporate tax agenda goes, there could be several companies who benefited most from the 2017 tax cuts who see earnings cut in 2021 in the event of a ‘Blue Steal’ result. Among European stocks, those with a large exposure to US sales like Ferguson, CRH, Ashtead could see a reduction in EPS due to tax hikes – however it is likely that massive infrastructure spending and stimulus would offer significant support to those names in particular. Our Trump20 Blend includes some of the largest US stocks which benefited from the 2017 tax cuts (and therefore could see the worst EPS haircut in the event of a Biden win and Democrat Senate). These include Nvidia, Netflix, Salesforce.com, CSX, Boeing, Union Pacific and ServiceNow.