U.S. Further from new beginning than expected
Election thriller in the USA. It could take days, if not weeks, to reach the final result. After the share price fireworks at the beginning of the week, investors initially remained on the sidelines. A short time later, the stock markets were already picking up momentum again. What do investment strategists think of the market? How should investors behave??
Author: Hanspeter Frey
For the chief investment strategist of the German fund house DWS, Stefan Kreuzkamp – and probably not only for him – one thing is clear: For the second time in a row, the U.S. presidential election has surprised many augurs. As things stand, Donald Trump and the Republicans have done better than expected. "A Democratic landslide appears to be off the table", a new beginning will therefore not be possible, he says. This should please large parts of the US economy and investors in the short term.
In fact, the tax club that Democrats generally wield could become less of a threat if the current voting patterns are confirmed. But for many companies in the rest of the world, and for about half of Americans, Kreuzkamp argues, it's more of a disappointment. In the medium term, this could also become a burden for the stock markets, and the imagination for change could dwindle. "Low interest rate environment alone seems to remain safe", he adds.
Clear picture only next year
Without Democrats controlling both the White House and Congress at the same time, it runs toward a continuation of the status quo, meaning in particular no rollback of Trump's tax reforms. But it would also mean that the timely passage of a large stimulus package has become less likely. If Trump remains in office, simmering conflicts are also likely to become more acute, for example with China.
However, it is clearly too early to make a final assessment. The DWS chief strategist would not overestimate market reactions to date. Investors would probably not get a clear picture of what the new administration intends to implement and with what priority until the first half of 2021. "However, major drivers of the capital markets are in any case largely independent of the election result. This includes the further course of the pandemic in the short term and central bank policy in the medium term.". The latter is likely to continue to provide a low interest rate environment and do everything else it can to support the markets. "This is also true outside the Americas", Kreuzkamp notes.
Risk assets under pressure
Paul Brain, Head of Fixed Income at Newton Investment Management, a subsidiary of BNY Mellon IM, also thinks it is unlikely that the Democrats will win a majority in both houses of Congress. The debate over a substantial fiscal package could thus continue to boost U.S. government bonds and put pressure on risk assets.
"As long as the outcome remains in limbo, volatility will increase. The dollar will continue to suffer from uncertainty and yields on 10-year U.S. Treasury bonds will fall." Patience is required in view of the lack of clarity. "In a portfolio context, we are maintaining a neutral equity allocation for now", Brain points out.
No "Blue Wave"
Michael Strobaek, Credit Suisse's Global Chief Investment Officer, is also eyeing the Congress. Democrats appear to have defended the House of Representatives. The Senate, however, is still highly competitive. As of now, there is a strong case for two runoff elections in January, so the final result for the Senate will be some time coming. In a 50-50 outcome, the vice president will ultimately decide on all bills. Even if the "blue wave" has not occurred as predicted by CS strategists, it is still possible, he said. Joe Biden is likely to account for a large share of the absentee ballots.
After rising before the election, the VIX volatility indicator remains in the mid-30s and is likely to remain elevated due to the uncertain election outcome. "For the time being, we will maintain our neutral equity allocation in the portfolio context", explains, and advises clients not to commit to a particular election outcome.
Growth hopes fading
Keith Wade, chief economist at Schroders, voices what a large number of people around the world are probably thinking: "Once again, Donald Trump has confounded pollsters by winning key swing states and rejecting the predicted 'blue wave'." Joe Biden could still become president, but Democrats' hopes of winning the Senate would dwindle. Another divided Congress would represent a continuation of the gridlock that has prevented passage of a new financial package in recent months to support the economy battered by Covid-19.
The markets, which had begun to consider a significant stimulus package, were now curbing their growth expectations. The contemplated aid package would have added one percentage point to U.S. growth. There is now the prospect of a continuation of the status quo. Legal disputes over the presidency cannot be ruled out. That would be a bad breeding ground for the economy and markets. The longer the stalemate lasted, the more uncertainty would spread and stifle hopes of a growth spurt.
What does the Fed?
"Market reaction so far has been decidedly orderly", notes James Athey, investment director at Aberdeen Standard Investments "it's too close and too early to tell which way it's going to go, so sitting and waiting is the order of the day." Part of the calm, he said, is due to the expectation that the Federal Reserve will already step in if there is greater volatility. "But the Fed won't act if things stay completely quiet." So in a way, the cat is biting its own tail. A close result, however, would put more pressure on the money guardians.
Athey, like the rest of the experts, sees a divided Congress, let alone a contested outcome, as a bad omen for the prospects of a new stimulus package. The lack of fiscal stimulus will require a Fed response sooner or later, and that is worrisome. Markets are increasingly programmed to know that the central bank will intervene at the sight of trouble. "This kind of dependence is not healthy", stresses the Aberdeen strategist.
Cyclicals under pressure
Lower likelihood of massive fiscal stimulus puts pressure on cyclical sector stocks. Thomas Heller, CIO of Schwyzer Kantonalbank, points this out. Renewable energy stocks also quoted lower. Without a Democratic majority in Congress, increased support for the sector isn't likely. "By contrast, a Republican Senate majority is less likely to see action on high drug prices", comments Heller. Pharmaceutical stocks were in demand.
For investors, no need for action can be derived from this mixed situation. Schwyzer KB went into the U.S. elections with an equity underweight and will not react immediately to the hang-up. She will reassess the situation when there is more clarity. Until then, it's a case of "wait and see", he says.
Strong nerves needed
Patience remains in demand, and strong nerves as well. Also, Caroline Hilb-Paraskevopoulos, head of investment strategy and analysis at St.Galler Kantonalbank, does not expect clarity soon, especially since Donald Trump has announced that he would not accept Joe Biden's election victory. "It remains a neck-and-neck race, and the closer the race, the longer the result is likely to be in store", says Hilb.
For Sebastien Galy, senior macro strategist at Nordea Asset Management, a Biden administration would be one where you have a pretty good idea what it would do. But Galy could also live well with Donald Trump remaining in the White House. "A Trump administration would be one we understand quite well." The market is hesitating between these two. "That means short-term volatility, he said, and suggests we be patient and wait for the data until we have clarity on who the next U.S. president will be."
Don't overstate politics
One thing must not be forgotten amid all the opinions and reactions: Political stock markets have short legs. This is an old stock market rule. Recall the assessment of Oliver Blackbourn, portfolio manager multi-asset of Janus Henderson Investors. More important for the direction of equities and fixed-income securities are the path of fiscal and monetary policy, the further development of Covid-19 and economic growth, he stresses in his brief analysis. Short-term market reactions should not be taken as indicators of long-term trends.
Basically, the other strategists also agree with his credo, and experienced investors know it just as well: In the end, it is the fundamentals such as earnings growth and interest rates that give the markets direction.