Has the Blue Wave turned into a Blue Ripple? Gridlock = Goldilocks…..
• Biden is the projected winner of the US Election. Trump is unlikely to concede the elections, and the official announcement could take weeks before being finalised due to recounts and litigation.
• Key now is the control of the Senate, which remains up for grabs. Current standing of the Senate seats are at 48-48 (Vice-President decides majority for Senate if it ends 50-50). There are 2 seats which are likely to go to the Republicans and 2 other seats going for a run-off election on 5th January.
• With the elections likely to conclude, markets will shift their focus to vaccines development as well as additional fiscal stimulus (which may hinge around the Senate majority).
Joseph Biden Projected as President - Elect
After days of vote counting, multiple media agencies have declared Joseph Biden as projected President-elect and Kamala Harris as Vice-President-elect. Additionally, Kamala Harris’ election as Vice President-elect is historic in three “firsts”: Asian-American, Black and a woman. Nonetheless, President Trump has not conceded the elections, and therefore the automatic recounts and legal challenges could continue for weeks as part of the election process. Thus far, none of the legal challenges have had material consequences, and we will continue to monitor those developments. In that regard, Biden is presently ahead in states that could result in up to 300 plus electoral votes, above the 270 electoral votes required. Although this was a much closer than expected election, it is still not as close as the Bush and Gore election in 2000, when just 537 votes in Florida separated them.
Who will win the Senate race?
Biden could be the first new president elected in 32 years without control of Congress. Presently, the Republicans and Democrats each have 48 seats in the Senate. The Republicans will need 51 seats to be assured a majority (the Vice President casts the deciding vote if the two parties are at 50 seats). Two Republican seats in Alaska and North Carolina, which have not been called, will likely remain under the Republicans. Another two Senate seats in Georgia will likely go for a run-off election on January 5th. In this scenario, the Democrats would need to win both seats, while the Republicans are required to take one of the two seats, to claim majority.
During the presidential elections in 1992 and 2008, where a Democrat president won in both years, Georgia had subsequent run-off Senate elections, which saw voter turn-out fell by circa 40%. However, the turnout may drop by far less this time round. The latest elections recorded the highest voter turnout in more than 100 years, and importantly, the run-off elections in Georgia will potentially decide the Senate. Of course, the Blue Wave of 52 to 55 Senate seats as predicted by the polls did not occur.
How likely can the Blue Ripple turn into a Blue Current?
Currently, PreidictIt has just under a 30% probability of the Senate turning to the Democrats. Therefore, the markets are presently pricing in a gridlock. In addition, albeit the Democrats held control of the House of Representatives as expected, they had unexpectedly lost seats. Hence, this meant that voters voted for more of a Presidential change, rather than a change of power distribution at the party level / policy level in Congress. Biden ran on a unifying platform, and he will need his deep skills of bipartisanship if a divided congress is the final outcome. However, we will need to wait till January to know if the Republicans can maintain Senate control with certainty.
What about the timing and size of fiscal stimulus?
Speaking of bipartisanship, Mitch McConnell, the Senate majority leader, has stated after the election that getting an economic stimulus package is “Job One”. However, this is easier said than done. The Congress could do an interim “Skinny” fiscal package before year-end, including areas amenable for both sides, expanding unemployment insurance eligibility, and PPP loans (small business loans) if the two sides can compromise on state and local aid. In addition, some of these key areas of consensus could be extended till January as well as an interim measure. Interesting, a larger and more comprehensive deal before year-end is still possible. If the Senate is less likely to change in control (more chance of compromise?) and/or the Senate is still in play, then the Georgia run-off elections could spur the Republicans, who are more fiscally conservative, to pass a broader fiscal stimulus deal. Nevertheless, the level of fiscal stimulus overall will be lower than under a Blue Wave. If any fiscal stimulus is passed, it is unlikely to affect fourth quarter growth, but impact next year’s. However, the market would look through the timing issue.
The Federal Reserve is reconfirmed as “President” of the financial markets…
If fiscal policy disappoints or is delayed to next year, this would add additional pressure on the Federal Reserve to act to ease policy in December. While the Federal Reserve held rates as expected in early November, they discussed the asset purchase program and its role in supporting economic recovery. Given the worsening Covid-19 situation, and depending on the outcome of the fiscal policy side, the Federal Reserve could increase the size, extend the duration and/or the commitment of the present asset purchase program. The spotlight on the Federal Reserve, and other central banks ECB, Bank of England could grow by December. In fact, the ECB have already mentioned a recalibration of policy in December due to the second wave. This is the never-ending story since the great financial crisis of the “central bank put” which remains alive and well.
What do we think?
We advised in our pre-election note “Do Elections Matter?: Focus on Policy NOT Politics” that the elections are a bigger political than economic event, and what matters is how it impacts the economic cycle. We advised to buy the dips ahead and fade any dollar strength, as historically, equity markets have a moderate correction into elections and rebound afterwards, no matter which party is elected as uncertainty dissipates. We had two separate corrections which happened in September and the week before the elections due to the European second wave of the coronavirus. In addition, we highlighted that volatility was running 50% above normal levels due to the short-term election uncertainty and the spikes in Covid-19 cases, and that the volatility could fall in equity and FX markets after the elections.
AVERAGE S&P 500 PERFORMANCE BEFORE / AFTER PAST ELECTIONS SINCE POST WORLD WAR II (EX 2008)
Source: Bloomberg, BNP Paribas (WM), as of 14 October 2020
The market reaction played out in this exact fashion last week. The S&P 500 volatility index (VIX) fell 40% from 41 to 25 (still high historically), and markets rallied over the week with the S&P 500 +7%, Euro Stoxx 50 +8% (+10% in USD), MSCI China Index +6% and Gold +4%. FX volatilities also dropped and the Dollar index weakened to a two year lows, near the September critical levels. Interestingly, 10-year Treasury yields fell 5 bps on dimming fiscal stimulus expectations, but not as much as expected after Friday’s recovery. In the medium term, we expect higher yields as the US and global economies recover next year.
VOLATILITY DROPS AND MARKET RALLIES AS WINNER BECOMES CLEARER
Source: Bloomberg, BNP Paribas (WM), as of 14 October 2020
GREENBACK AND TREASURY YIELD WEAKENS ON PROSPECT OF A DIVIDED CONGRESS
Source: Bloomberg, BNP Paribas (WM), as of 14 October 2020
The Market Narrative is now Shifting to the Positives
(1) Election event risk is dissipating but we are still awaiting “official” confirmation.
(2) A presently divided Congress means: (a) less fiscal stimulus, (b) no major increase in taxes, and (c) no major changes in regulation as witnessed by the rally in technology and health-care sectors post-election.
(3) Gridlock = Goldilocks. The pressure on global central banks for more monetary stimulus could grow in December, given new waves of coronavirus in Europe and North America. Remember the virus appears to thrive in cold temperatures as evident earlier in the year, and from the breakouts in meat packing plants.
(4) Progress on vaccines will be critical to the pace of reopening / recovery of the global economy in 2021. It will be particularly key for the cyclical sectors of the market, and the medium term path of bond yields.
We remain overweight on equities, investment grade corporate bonds and gold, while remaining cautious on the dollar in general.
Reading the Tea Leaves
US post-election issues to watch include discussions on key cabinet posts. This will be closely scrutinised by Wall Street, who will be judging the trade-off between moderate vs more progressive Democrat candidates, which may face potential struggles against a possible Republican controlled Senate.
Finally, markets will be sensitive to any comments on trade, if the change leads to a moderately more positive outlook on global trade. This may result in a lower risk premium, which will be positive for EM Asia.
CIO INSIGHTS – GDP & CPI FORECASTS
KEY ECONOMIC VIEWS
The second Covid-19 wave and renewed lockdowns will impact economic growth in 4Q20. Asia, in the contrary, shows overall decline in new Covid-19 cases and the region is showing signs of recovery, as high frequency indicators such as traffic congestion and pollution levels suggest strong pickup in industrial activity.
In 2021, the effects of the massive stimulus programs, central bank bond purchases and pent-up demand should drive growth higher globally.
Inflation is expected to remain low for some time. The Fed and ECB will maintain and even expand their monetary policy support next year if necessary. In Eurozone, deflation remains the key risk.
EM central banks, with the exception of India, can further ease their monetary policies as their inflation remains low.
CIO INSIGHTS – EQUITIES
• 3Q20 earnings results so far have been good. 82% of the S&P 500's market cap have reported with earnings surpassing estimates by +19% in aggregate and 85% of companies beating their projections. 45% of the MSCI Asia ex-Japan market cap have reported with overall earnings beating 9.6%.
• We believe significant downside risks for global equity markets should be limited amid expectation of more Covid-19 treatment and vaccine news, the world on a recovery path and diminishing political uncertainties. We expect earnings to expand by 20% if not more in 2021 after a 19% decline in 2020. Investors should take advantage of volatility to play the reflation theme.
• We expect dollar weakness and earnings growth to be the key drivers for Asian equity markets. The economic recovery is most visible in China. A strengthening RMB is also supportive for China equities.
CIO INSIGHTS – FIXED INCOME
• We stay positive on US investment grade corporate bonds. They are not cheap but are credible alternatives to government bonds given the central banks’ support.
• US high yield indices’ average credit rating have improved, thanks to the large amount of fallen angels and the removal of the weakest names because of defaults. Yields are attractive in a yield-starved world but spreads have reached low levels. We stay neutral on US high yield.
• We keep our positive stance on Hong Kong and Singapore credit. We are generally very comfortable with Hong Kong blue chips companies given their long operating history and prudent risk management. For China credit, valuations are not cheap, but liquidity is abundant and supply is manageable. We stay neutral on China credit.
CIO INSIGHTS – FOREX
• We expect both the nominal and real yield differential with other major currencies will remain very low. The wider twin deficits and the overvalued USD compared the purchasing power parity also point to further weakening of the greenback. Our 12-month target for USD Index is 90.2.
• After hitting a 6-month low in September, the British pound was surprisingly steady in October and got stronger in November despite worsening Covid-19 situation in the UK. While the stalemate of Brexit negotiations remains, especially on two key obstacles - fisheries rights and level playing field, markets have been optimistic and did not seem to price an exit without agreement. Our 12-month target for GBPUSD is 1.39.
CIO INSIGHTS – ALTERNATIVES & COMMODITIES
GOLD: We remain bullish on gold as real interest rates should remain extremely low for longer, and gold is seen as a hedge against the depreciation of fiat currencies due to excessive money creation. Our 12-month expected trading range remains at $1900-2100/oz.
OIL: As the Covid resurgence is threatening the demand recovery, the OPEC+ hinted that they will continue to balance the market. Reduced investment in the shale oil industry but also in classical oil fields will weigh progressively on the supply and help Brent prices to move back to $45-55 at the beginning of 2021 and possibly higher after.
LONG-SHORT EQUITIES: We are positive on long-short equity strategy. The health crisis creates winners and losers, offering attractive long/short opportunities for stock pickers. We are becoming more comfortable with quantitative market neutral strategies
GLOBAL MACRO: We are positive on global macro strategy. After the largest liquidity injections ever, managers expect pressure on the dollar and possible inflation and rising rates. Increasing de-globalisation and differentiated country fiscal policy should offer more relative opportunities.
Source: BNP Paribas Wealth Management as of 31 October 2020
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