US elections: where are we and what's next?

WHAT YOU NEED TO KNOW

Polls and betting markets point to a potential ‘blue wave’, with Biden winning the presidency by a good margin and the Democrats taking back the Senate. Regardless of the result, analysis shows that financial market performance in the months following an election tends to be driven by the overall macro backdrop.
Further out, rather than whether the next US president is going to be Trump or Biden, we think the implications for financial markets and the real economy will depend on whether the election delivers a divided or unified government. We expect extended legislative gridlocks if it’s divided and significant policy change if it’s unified.
A unified Biden government would probably result in the largest net fiscal stimulus. Infrastructure, managed healthcare and sustainability themes should benefit, as well as relations with the EU (but not with China). However, tax hikes would hit corporate earnings. The yield curve should steepen, but moderately, as the Fed is likely to mitigate any pick-up in yields. Reform and regulation may negatively affect the pharmaceuticals, tech, energy and financials sectors. The US dollar is likely to weaken.
A unified Trump government, which would surprise markets, would seek to boost US growth via tax cuts, along with further financial and energy sector deregulation. The net fiscal boost is likely to be a middle-ground one, and less than in a blue wave scenario. The yield curve should steepen, but marginally, also given the monetary policy set-up. Tensions with China, and perhaps with the EU too, would likely remain or even increase. The US dollar is likely to strengthen.
One risk is that a contested outcome, the probability of which may rise if the result is very close or subject to recounts, may initially trigger a bout of risk-off sentiment. This could negatively affect many sectors and risk assets in general. It would likely result in a flatter yield curve and stronger US dollar on safe-haven demand. The medium-term impact would depend on the outcome of the dispute.

THE VOTERS: WHAT DO THEY PLAN AND EXPECT?

Biden leads Trump in the polls by a wide margin: about 10 percentage points nationally, though by a narrower margin in likely swing states. Popular polls-based statistical models, ranging from the Good Judgment Project’s Superforecasters to the US election prediction model built by The Economist, currently place Biden’s chances of winning the election at more than three out of four. However, these surveys of voter intentions could be affected by all sorts of biases – including a misrepresentation of the preferences which, anecdotally, appears to happen with non-mainstream candidates such as Trump. Notably, as we saw with the US election four years ago (and Brexit), they may not be very accurate.

Furthermore, even if polls are accurate, they just represent how people say they’ll vote and not necessarily what they’ll actually do. There’s no way to reliably predict how people’s intentions turn into action, but one guesstimate could come from what people think will happen, based on their assessment of what others will do. Betting markets are just that. Interestingly, they showed high uncertainty until mid-August, with an even probability that either candidate could win (at that point). Thereafter, Biden gained a moderate lead until mid-September, which has increased in October, giving him close to a two-thirds probability of winning.

Regardless of its reliability, information on the race for Congress suggests that things are a lot less clear cut: the Democrats seem ahead nationally, but by a small margin. Time series are shorter and datasets more sparse. However, based on what’s available, the probability of a Democratic sweep – the blue wave scenario, whereby they retain control of the House and take back the Senate – fell from slightly above 55% to slightly below 45% over the summer, before stabilising at around 50% from late August to late September, and then jumping again to just above 55% recently, but in a volatile fashion.

THE MARKETS: HOW DO THEY REACT?

Higher political uncertainty and slower economic momentum are two of the reasons that led us to close our overweight on US equities and return to neutral ahead of this important risk event. Looking at the election cycles over the past 20 years, markets have tended to behave very differently right after the vote. Our findings are based on three-month changes across key asset classes, ranging from equities and government bonds – in both nominal and real terms – to the US dollar and the price of gold. They suggest the economic backdrop has been a far bigger driver of post-election market performance than the presidential winner or winning party.

For example, the pullback in the S&P 500 and Treasury yields following the 2000 and 2008 elections, when different parties won in clean sweeps, was more likely because of the economic crises prevailing at the time (the bursting of the tech bubble and the global financial crisis, respectively) – not necessarily a reaction to the election outcome. Different parties won the White House in 2004 and 2012 too – the improving economy and the easing of the euro crisis would seem the more likely catalysts of the subsequent gains in stocks and bond yields. The rally following the Trump and Republican clean sweep in 2016 owed much to the reflation trade and ongoing growth optimism.

As this history lesson suggests, US market performance in the months following this year’s election is more likely to hinge on the degree of success in containing the virus outbreak and the US macro outlook than on whether a Republican or Democrat wins. This means that once a medical improvement does materialise – in the form of a vaccine for Covid-19 and/or as better therapeutics, hospital capacity and a broad adaptation of the health system – we believe some of the key markets will behave more in line with the recovery/reflation trade phases of the US elections back in 2012 and 2016, although one was won by a Democrat with a split congress and the other by a Republican with a clean sweep.

THE POLICY PLATFORMS: WHO STANDS FOR WHAT?

There are five possible outcomes, which we think will have different implications for the economy and financial markets:

Divided Red (R President, R Senate, D House): This is the status-quo scenario. Policy changes would likely be moderate in the near term. Expiring tax cuts could probably be extended, especially if the economy were to underperform following tighter measures to contain the spread of Covid-19. Fiscal policy would likely stay expansionary, but reactively. US interest rates would remain range-bound and the US dollar shouldn’t be impacted that much.
Divided Blue (D President, R Senate, D House): In this scenario, the Democrats take the White House, but fail to take back the Senate. Regulation and oversight would probably increase, but not very much. At the margin, this may pressure financial, energy, internet and pharmaceutical companies. US rates are unlikely to move significantly and the dollar could depreciate modestly.
Unified Red (R President, Senate and House): In this scenario, Trump wins a second term and the Republicans take back the House. Trade tensions with China would likely rise further. Tax cuts should remain very much on the agenda. US GDP growth would probably accelerate and the US dollar strengthen. Given the growing deficit, bond yields would rise – but only marginally, as the Fed would likely manage to keep them at low levels. Financials and energy should benefit from continued deregulation.
Unified Blue (D President, Senate and House): This is the scenario we think markets deem to be the most likely, based on polls and betting odds – Biden wins and the Democrats take back the Senate. The budget deficit should rise more visibly, especially to finance infrastructure projects. Corporate taxes would probably rise too, impacting earnings. Fiscal spending should boost economic growth and lead to a rise in bond yields – but only to a moderate extent, as the Fed should anchor them. Healthcare reform would likely be a positive for managed care organisations, but a negative for pharmaceuticals. Increased regulation could impact the tech sector and financials.
Delayed result: It’s also possible that no formal result is announced within the typical timeframe. This could be because of delays in counting postal votes, recounts in close states or a contested outcome. The impact may vary in intensity depending on the reason for delay. A late result on account of tallying postal votes would likely be less impactful than an announced outcome that is contested. Keeping this caveat in mind, this would likely be negative across sectors, at least initially, due to uncertainty and overall risk-off – and, unless it gets very prolonged, support the US dollar on safe-haven flows.

To what extent the policy platforms can actually be implemented depends on the extent of the majority. Simply winning the Senate, for example, would not be enough for Biden to be able to implement broad changes. This is because 60 votes out of 100 are needed to overcome filibustering, and this applies to almost all policy areas other than taxes. Conversely, only a ‘reconciliation bill’, which just requires a simple majority, would be needed if he wanted to restore the top marginal income tax rate to 39.6% for those earning over USD400,000 a year and to partially reverse Trump’s corporate tax cuts, raising the rate from 21% to 28%.

COVID-19 WATCH

Globally confirmed cases of Covid-19 have now increased to almost 40 million, up from over 37 million seven days previously.

In the US, new cases and fatalities appear to be following a diverging pattern. The uptrend in new cases has continued over the past few weeks. However, this follows a significant slowdown over the summer, possibly related to the containment measures put in place to mitigate the spread of the virus. While the numbers aren’t yet at the July peak, it looks as if they’re approaching it rapidly. Conversely, new fatalities remain rather low this time around, and much lower than at the April peak.

A possible reason for the increased number of new cases and the contained number of new fatalities could be the extra testing, which has detected many more cases relative to the first wave. If this were the only explanation, then new fatalities would be expected to pick up at some point. However, the lag seems particularly long. This spring, these two indicators moved in synchrony. This summer, new fatalities did pick up, but after some time and to a lesser degree. Now, despite the rise in new cases, new fatalities keep trending down – not up.

So, apart from extra testing, complementary explanations are that intensive care unit and overall hospital capacity are now less stretched; the therapeutic toolkit to mitigate the symptoms has improved; the health system as a whole has adapted and can cope better; the level of alertness among the more vulnerable subjects is higher; the containment measures are having some effect; and the second wave appears to be concentrated in the younger, more resilient segments of the population.

This means that, unless the health and social systems are overwhelmed, the preferred approach is likely to continue to be to tighten or relax targeted social-distancing measures as required, until therapeutics and overall capacity in the health system have improved further, and while a vaccine is developed. This approach can put some downward pressure on parts of the services sector. But it’s likely to leave the economy as a whole relatively functioning and open. This is why the macro data have weakened less than expected and, on the whole, continue to show that recovery is progressing – albeit somewhat more slowly.

OPINION POLLS POINTING TO CONSISTENT AND WIDE BIDEN LEAD

BETTING ODDS POINT TO RISING PROBABILITY OF BIDEN WIN

A TIGHTER RACE FOR CONGRESS

OVERALL MACRO CONTEXT MORE IMPORTANT THAN ELECTION OUTCOME FOR MARKETS

EXPECTED POLICIES: SCENARIO ANALYSIS

NEW COVID-19 CASES ON THE RISE IN THE US, BUT FATALITIES REMAIN LOW

Authors:

Daniele Antonucci - Chief Economist & Macro Strategist
Bill Street - Group Chief Investment Officer

This document has been prepared by Quintet Private Bank (Europe) S.A. The statements and views expressed in this document – based upon information from sources believed to be reliable – are those of Quintet Private Bank (Europe) S.A. as of October 19, 2020, and are subject to change. This document is of a general nature and does not constitute legal, accounting, tax or investment advice. This document does not provide any individual investment advice and an investment decision must not be based merely on the information and data contained in the document. All investors should keep in mind that past performance is no indication of future performance, and that the value of investments may go up or down. Changes in exchange rates may also cause the value of underlying investments to go up or down. Copyright © Quintet Private Bank (Europe) S.A. 2020. All rights reserved.