Do Elections Matter? Focus on Policy NOT Politics

The much anticipated US election is quickly approaching on November 3rd. Much ink has been spilled on this topic analysing the politics. While it is no doubt a big political event, it is debatable how big of an economic event it may be. The key is to separate politics from policy. Clearly, policy is what matters for financial markets.

Update On Current Election Polls

Biden is leading national polls by roughly by circa 7-8%. What is interesting is his overall polling numbers have been relatively steady, unlike Hillary Clinton in 2016.  Furthermore, 26% of voters were undecided in 2016, while the number of undecided voters this time around is only estimated to be around 10-15%. Important to know in 2016, polls narrowed to within the margin of error in the final weeks of the election and that was enough for the key swing states to move in Trump’s favor. 

Currently, Biden leads relative to Hilary Clinton in 2016 in the key swing states. For the elections to be close, a narrowing of the polls ahead of the election is required, particularly in these swing states. Otherwise, there is possibility of not only a Biden win, but also a recapturing of the Senate and a sweeping of the congress or a “Blue Wave”. This will be a key area to monitor in the final weeks of the campaign. Of course, there has also been questions raised regarding the accuracy of the polls, especially given the last elections in 2016 where the margin of error was a defining factor.

What Happens If It Is A Contested Election?

Mail-in votes have been rising in prior elections from 7.8% in 1996 to 20.9% in 2016, and will increase further for this coming election. Each state sets its own rules with regards to when the mail-in votes are counted. Some swing states such as Florida start counting mail-in votes before the election, and do not allow mail-in votes after election day. Other states may allow mail-in votes to arrive for up to several weeks after election day. Hence, if the election is close, recounts, legal cases, and delays could occur and this is not unprecedented. The Bush/Gore election in 2000 delays/legal cases lasted 34 days after election day, with Al Gore conceding only after losing a Supreme Court decision. The S&P 500 dropped a moderate 4% over the course of five weeks.

Nonetheless, the expectation this time round is already for some chance of a contested election. Some or all of this may already be priced in, evident from the heightened implied volatility shown till January. Volatility will likely drop after a clear indication of a result, and hence this provides an opportunity to use volatility instruments before the election. Should the result be definitive, instead of contested, markets could rally given the cautiousness already factored in.

How Do Equities React In An Election Year? What Is Difference In Performance Over Time Between Parties? 

On average, the equity market is up during an election year, and also crucially after the election, regardless of which party wins. However, there are instances where the market is down during election year. An example is 2008, where the performance was negative due to the great financial crisis. Clearly, the business/economic cycle has a much bigger impact on the financial markets compared to elections in general. 

Looking back at history, ironically, the performance of the stock market under a Republican or Democratic administration controlling both chambers of Congress is similar at 14.5%.  Furthermore, with a divided Congress, Democratic presidents seem to have outperformed. However, as highlighted above, the ruling party can affect the economic cycle but is definitely not in control of it. Inevitably, the incumbent gets lauded  or blamed for the economy, although this often can be correlation without causation.

2020 has been an unusual year so far with the black swan event, the Covid-19 pandemic. This has led to a global recession, which was the key driver of a sharp but quick market downturn earlier in the year. Stock markets have since recovered given the massive amount of monetary and fiscal stimulus, along with an increase in vaccine news flow. Nonetheless, the economy recovery remains tepid and not entirely out of the woods yet. With this in mind, it is interesting to note that a recession usually negatively impacts the incumbent, as only 2 out of 7 incumbents returned to office with recession prior to re-election thus far. In short, it is Biden’s election to lose. 

What Are The Potential Winning/Losing Sectors In This Election? 

Mr. Biden will push to make the US carbon neutral by 2050. This is a $2 trillion infrastructure program , including zero-emissions public transport, upgrading 4 million buildings for energy efficiency, and weatherizing 2 million homes. Hence, sectors such as utilities, industrials, renewable energy, selected autos, cyclicals and materials in general will stand to benefit. Traditional / dirty energies would of course suffer. These projects will be funded through an increase in the corporate tax rate from 21% back up to 28%.

Biden's policies would also relatively favour workers and individuals, with the example of raising the minimum wage to $15/hour. These policies of providing better salaries to low skilled workers would support consumption and could be modestly reflationary. Policies on technology and banks will be closely watched, but they are expected to be evolutionary not revolutionary.

On the other hand, if President Trump wins the upcoming election, he has no ability to recapture the House. Hence, from a policy perspective, further tax cuts look unlikely. Items not requiring congressional approval such as deregulation and trade tariffs are expected to continue. The overall low tax and business friendly environment would remain as well. Republicans also traditionally favour sectors such as defence and (traditional) energy. Like Biden, President Trump also favours infrastructure spending. 

What Is The Impact On The Dollar And Bond Yields?

If Biden wins the election and the Democrats secure a majority in the Senate, a larger fiscal stimulus could be passed assuming one is not passed before the election. Especially in the case of a Democratic sweep, the yield curve could steepen somewhat on expectations of larger public spending. Our 12-month forecast for the US 10-year treasury yield is 1.25%.

Furthermore, given the end of the uncertainty of the election, the dollar could weaken moderately. In the case of a Democratic sweep, there is the potential for the greenback to weaken even more given higher deficits and fiscal stimulus. Should President Trump get re-elected, dollar weakness will likely be less pronounced although we should still see moderate weakening.  

How Does The US Election Impact The US – China Trade War?

Clearly, China relations will remain an issue no matter the administration. However, in the case of a Biden victory, it can become more predictable and less unilateral. The US may re-engage China on market opening by returning to lower tariffs or removing it entirely. Nonetheless, human rights, market access, intellectual properties and key technologies will remain crucial issues. Regardless, the feel good factor and the positive sentiment could boost Asian currencies and selected equity sectors. We remain overweight Asian equities including: China, Taiwan, South Korea, as well as Singapore, India, Indonesia.

If Trump is re-elected, (with a divided Congress), trade is one of the few areas he is free to invoke executive actions and tariff measures. Hence, expect tensions to remain with a focus on the agreements to fulfil the phase one trade deal. This is also likely be the new normal and the market would remain sensitive to trade tensions in the second term. 

Conclusion

In summary, the election provides some selected policy risk and creates opportunity overall as volatility increases. Volatility, which is already at high levels even before the US election, will likely drop with a confirmed result. The most important question to ask post-election is “where are we in the economic cycle?”. We see continued economic recovery next year with better earnings. The focus then will shift to the quantum of fiscal stimulus, vaccine developments, and ongoing robust liquidity. We had previously forecasted a market pullback from overbought levels in August, and advocated a “barbell” strategy. We continue to recommend the “barbell” approach going forward – to get invested with exposure to risk assets and buy on dips on one hand, and to hedge with defensive strategies such as gold, dividend stocks and quality corporate bonds on the other hand. Don’t let the election paralyze your portfolio strategy. Embrace the opportunities that uncertainties create.

KEY ECONOMIC VIEWS

GROWTH

• Economic indicators have picked up significantly in many economies, suggesting a strong rebound in Q3 2020, especially in Eurozone and in the US. In 2021, the effects of the massive stimulus program and central bank bond purchases should drive growth higher in developed countries.
• Unemployment remains a source of concern for growth, as it will weigh on consumer confidence. The virus coming back in waves implies more local targeted lock-downs. However, major progress on a vaccine and lower mortality rates could bring a positive surprise to growth forecasts.

INFLATION

• In the US, the Fed's has a new target based on an average inflation rate of 2%. This suggests that they will tolerate inflation to overshoot the target for some time.
• The ECB considers that inflationary risks are low and should maintain its monetary policy for a long time with a possible further easing if necessary.
• EM central banks, with the exception of India, can further ease their monetary policies as their inflation is still low.

CIO INSIGHTS - EQUITIES

We would not be surprised if down the road investors look back to October 2020 and conclude it would have been an excellent month to go bottom fishing in equity markets. The wall of worry is already quite high. Authorities are anxious to limit downside risks and have a better understanding of how to handle the virus. Vaccine news should improve in coming months. The underlying economic and earnings trends should remain positive, even if progress remains disappointingly slow. Investors should take advantage of rising volatility to buy on dips, ideally around the 200-day moving average.

Sectorwise, we upgrade Industrials to positive from neutral, mainly due to improving manufacturing sentiment indicators. We also tactically downgrade energy to neutral from positive as Covid-19 cases are increasing again in the West, likely delaying the oil prices recovery. Nevertheless, European oil majors remain attractive in the long term.

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 bonds are expensive relative to expected default risks. Higher volatility ahead of the US election may reduce the liquidity of the asset class and exacerbate their moves in the near term. We prefer to stay neutral on US  high yield bonds.

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 for the time being. 

CIO INSIGHTS - FOREX

USD

The US dollar registered a temporary rebound as expected. The second wave of virus in Europe, US elections and Brexit tough negotiations were the key drivers. We keep our bearish USD scenario as fundamental drivers, such as yield differential, the current account balance and the fair-value (PPP), hint at a weaker dollar. Our 12-month USD Index target is 90.

CNY

USD/CNY broke below 6.80, supported by continued improving China economic data and a wider rate differential with the US. We do not see further CNY appreciation in the short term amid upcoming US election. However, the supportive economic environment next year should support the CNY. We thus revise down the USDCNY (stronger CNY) to 6.70 from 6.80 over the next 12 months.

CIO INSIGHTS - ALTERNATIVES & COMMODITIES

COMMODITIES

GOLD: Recent corrections offer nice entry points to benefit from further upside. Fundamentals of gold remain positive: (1) negative real rates for longer, (2) inflation fears linked to presumed excessive money printing and to a weakening USD. Our 12-month expected trading range remains at $1900-2100/oz.

OIL:Fears  over the global demand in the wake of the covid-19 resurgence seems exaggerated in our view. Crude demand is currently exceeding the supply leading to a decline in stockpiles. We expect Brent prices to trade in the range $45-55/b in Q4 and above in 2021, underpinned by a lack of capex investments.

ALTERNATIVES

LONG-SHORT EQUITIES: We are positive on long-short equities. With the exception of some NASDAQ stocks, the March sell-off has left discounts in quality stocks with strong recovery potential. The crisis will also no doubt create losers, offering attractive long/short opportunities for fundamental stock pickers

GLOBAL MACRO: We are positive on macro managers. Increasing deglobalization and differentiated country fiscal policy should offer more opportunities. Upcoming US elections could usher a big change in US politics, with equally massive potential impact on markets. 

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