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US Election Playbook: 3 outcomes for trading the market reaction
Election Night Volatility
Volatility, as viewed through the lens of the Vix, 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 (USDMXN, USDCNH among others) as a Biden win is seen as particularly positive for those currencies.
We’ve included three potentials 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 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 the removal of the 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 USDMXN, USDCNH 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.
Latest Presidential polls as of Oct 29th, from RealClearPolitics (who power our election tracker):
|North Carolina||48.4||47.7||Biden +0.7|
Sector & 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 4 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 benefitted 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 benefitted 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.
US Presidential debate farce, Compass points way to more lockdown worries
Staying up for the first Presidential debate would hardly have been worth it. Unedifying is the best word to describe. Biden held his own and the president missed his chance, mainly by talking over his rival at any opportunity; he did not allow Biden enough rope to hang himself.
Race featured prominently, but Trump only played to his base. This was the disruptive, abrasive Twitter Trump. We await to see whether the spectacle has had any impact on the up to one in ten voters yet to make up their minds. As grandpa Wilson would have said, I hae ma doots.
And as I keep saying, what matters in the US Presidential Election will be turnout in key battleground states and for this Trump needs it to be as rancorous as possible to energise his base. There is talk Biden won’t want to do more debates – that would be a mistake and make him look worse than he does after a relatively successful outing for the Democrat nominee, given the low expectations.
Equities down – will rebalancing give Wall Street a lift?
Stock markets fell yesterday, with European bourses down but off the lows. The FTSE 100 ended under 5,900. The S&P 500 butted its head against the 50-day moving average and came off to finish at 3,335.
US futures indicated further losses for Wall Street after the debate concluded. Asian markets were mixed. European stocks were mixed at the open but turned green after a weak start and the FTSE 100 rose above 5,900 with a weaker pound helping.
Month- and quarter-end rebalancing flows may make for volatility today. With US stock markets enduring a tough month there could be some reallocation back into equities that lifts Wall Street later.
Treasury yields ticked lower with bonds finding some bid, with the 10-year benchmark yield to 0.64%, its weakest since the start of September. I think last night gave the market a taste of the kind of election jitters to expect – the only thing the market wants is to get this election out of the way and draw a line under the whole charade.
Having kicked on from the 100-day line, gold firmed as TIPS moved more into negative territory but failed to clear $1,900.
Dollar slips lower, ADP in focus ahead of Friday’s NFP
The response in FX to the debate was a bit ‘meh’, but the dollar continued to ease back off the highs struck late last week and early this week, with DXY moving under 94, with bears eyeing the support at 93.70.
Later today is the ADP nonfarm report, which comes two days before the final NFP report ahead of the election. GBPUSD declined in early trade to test the 1.28 round number but the pair remains very much in its range of 1.27-30 that has bounded the price action for the last 3 weeks.
Britain’s economy contracted the most on record in the second quarter, albeit the 19.8% drop in GDP was less than the previously estimated 20.4%. Whilst this is backwards looking, just how optimistic can we be about the near future?
Compass Group uncertain about the future
Rising cases here threaten to mean further restrictions on our liberty that will act to further depress economic activity and consumer sentiment. Meanwhile unemployment will undoubtedly rise, harming the consumer sector even further.
Compass Group’s pre-close update contained some worrying signals for investors about this very problem, with management warning that the pace at which revenues and margins will recover remains unclear, especially given the possible increase in lockdown measures in the Northern Hemisphere through the winter months.
Group revenues fell about 19%, with Europe –25%, North America –19% and the Rest of World –9%. Sports and Leisure businesses in Europe and North America remain closed, but there has good recovery in Education and Healthcare. Shares fell 4%.
Lockdowns and expected disruption to arrangements mean airline shareholders need to keep a close eye on forward booking trends. Flight searchers are down anything from 60-80% from a year before, according to Kayak. The chart below shows demand for the UK over the course of the year. The figures for the rest of Europe are comparable.
Talk of negative interest rates has been doing the rounds a lot on Threadneedle Street of late. But the Bank of England would be well advised to consider a Federal Reserve study that says the European Central Bank (ECB) made a big error when it opted for negative rates.
As repeatedly stressed in these columns, negative rates represent a monetary policy black hole from which it is very hard to escape and it harms banks, eroding their profits and capital ratios over time.
The study from the San Francisco Fed notes that “banks expand lending only temporarily under negative rates” and “as negative rates persist, they drag on bank profitability even more”.
It concludes: “While lending initially increases under negative rates, our analysis implies that gains are more than reversed as negative rates persist. Overall, our results suggest that caution is warranted when considering negative monetary policy rates to encourage additional bank lending. Under extended negative rate episodes, evidence shows that both bank profitability and bank lending activity decline. This calls into question one of the primary motivations for negative policy rates.”
Chart: Negative rates are meant to increase loan growth, not depress it
Elsewhere in commodities, oil was softer as the API weekly inventory data showed a small draw on crude stocks while there was a build in gasoline inventories. As noted yesterday, traders should be wary of global onshore inventories flipping from draws to builds
The American Petroleum Institute recorded a draw of 831k on oil inventories whilst gasoline inventories rose 1.6m vs expectations for a draw of 1.3m. Oil stocks at Cushing, Oklahoma rose by 1.61m. As data points to a slowdown in the velocity of people, demand for oil is already rolling over and stocks may well start to build without China hoovering up the excess.
EIA data on tap later today will provide further guidance for markets. WTI (Nov) retreated to a two-week low at $38.42 but recovered $39, which is forming the near-term support. September lows at $36 are in focus.
US Presidential Election: Not Red, Not Blue, but Green to win?
With a recent poll showing that 14% of registered voters see climate change as the most important challenge facing the country, victory in November may well hinge on the success or failure of the respective parties to own this issue. For context, such a figure implies that around 30 million voters could cast their ballots this Autumn with the environment at the forefront of their thinking – that’s two to three times as many as in 2016.
Of those who care about climate change, one-third describe themselves as ‘very progressive’, suggesting that it is the Democrats who have the most to gain from grasping the initiative on the environment.
Voters focus on green policies, but does Biden?
Despite this potential vote-grabber for Biden, the issue features only 25th on a list of policy proposals on the Biden 2020 website. His plan has three main avenues of execution:
- Reinstating Obama-era regulation through executive order
- Investing $1.7 trillion in green energy and jobs through an act of Congress
- Leading international treatymaking efforts on the world stage.
That’s a long way from the $16 trillion investment into the “Green New Deal” that Bernie Sanders was promising. Herein lies the dilemma which will ultimately decide Democratic fortunes this year – how can they appeal to the middle whilst also ensuring that their base turns up to vote? It looks like climate change isn’t a hill for them to die on.
Rebranding climate issues for rust belt voters
The electoral system also explains why the climate features so far down Biden’s list. The rust belt is a crucial cluster of states for both parties when it comes to grabbing electoral college votes, and many of these rely heavily on so-called ‘dirty industries’ for employment and prosperity. Pennsylvania is the main example of this, where Trump secured victory by less than 45,000 votes in 2016. As the third largest coal-exporting state in America, voters in this area may not react well to Biden’s green vision, allowing Trump to take home 20 crucial electoral college votes.
There is however an opportunity to re-brand green credentials as a wider vote winner. The climate issue is ripe for conversion into an anti-China policy, thanks to their role as global polluters in chief. With approval of China down to -40% in the wake of coronavirus, and Trump likely to leverage this sentiment in his own favour, the environment offers the Democrats a line of attack which can be employed without turning off their core base of support.
How will America’s Climate Policy shift after the US Presidential Election?
There are three main scenarios that could play out in the US Presidential Election.
Scenario One: Trump Wins a Second Term
With or without a Republican Congress, Pres Trump would likely continue to use executive orders to cut back the environmental regulations that were instituted by the Obama administration. So far, Trump’s repeals have included the moratorium on federal coal leasing and the extent to which federal agencies must take account of the environmental impact of their actions.
- This would benefit fossil fuel companies
Scenario Two: Biden beats Trump, and the Democrats gain Congress
In this instance, the Democrats would have carte blanche to deliver on all of Biden’s campaign pledges, including the $1.7 trillion of government spending. In the wake of coronavirus, huge government investment will be expected, providing the perfect cover for such a policy. However, with a majority only guaranteed for two years, and other objectives clearly taking priority, it is unclear whether a Pres Biden would deliver the entirety of his environmental agenda, even in the greenest of scenarios.
- This would benefit companies that can boost their green credentials
- It would harm “dirty energy” businesses
Scenario Three: Biden beats Trump, but the Democrats fail to capture the Congress
Here, Biden would have to rely on the power of executive orders and the office of the Presidency to implement parts of his climate proposal. As easily as Trump repealed them, Biden could reinstate Obama’s regulations. Also, he could use America’s status on the world stage to influence treatymaking and catalyse future climate accords. However, the $1.7 trillion investment in green energy and jobs is not possible without congressional approval, leaving the former VP with a half-delivered promise.
- This would be like half a heart transplant: the economic damage of regulation would be incurred, but without investment elsewhere to compensate
Despite any green rhetoric, the truth is that the environment simply isn’t a priority for the Biden campaign, and this is unlikely to change once in office. A New Deal might be in the offing to respond to the huge economic downturn, but it’s unlikely to be a very Green one.
How will the US-China relationship define the Presidential election?
Trump knows that antagonising China is a dangerous game. But in the run up to the election, it’s also a political necessity.
Before the coronacrisis, there was already a perfect storm of economic and security disputes brewing between the US and China. Covid-19 compounded all the existing issues as well as adding a whole new dimension to the rift. Tension is escalating on all fronts.
Phase one of the trade deal is dead. The promises made by China – purchasing at least $200 billion in US exports over two years – looked unrealistic from the get-go. But the virus means meeting phase one’s targets will be downright impossible. Throw in that China is already buying more from competitors (its imports from Brazil are up 35% on May 2019) even in an economic downturn, and any revival of the Trade Deal before the Election look dead and buried.
The tech war has entered a period of unprecedented turbulence. Trump continues to affirm that Huawei threatens national security, upping the ante in May when a new rule was issued barring Huawei and its suppliers from using American technology.
The Trump administration is reportedly exploring several measures that could punish China for its handling of the virus, including suing the Chinese government for reparations and cancelling US debt obligations to the country. Meanwhile, China has ordered its state-owned enterprises to stop purchases of US farm products after the US threatened to withdraw its special status treatment for Hong Kong – itself a response to China’s new security law for the territory.
The President was aiming to run his campaign based around strong economic performance, and failing that, a successful response to the pandemic. As both these options become increasingly difficult to achieve, China must serve as the scapegoat on which Trump can pin his administration’s failings.
Usefully for Trump, the American people aren’t too fond of the Chinese right now either. A Pew Research Center poll from April suggests that Americans have increasingly negative views of the country with two-thirds now holding an unfavourable opinion towards China.
This sentiment is widespread across a range of groups in America, which is unusual in an ever more polarised electorate.
A Republican ad campaign has been launched proclaiming, “One nation deserves the blame: China”, while the America First Action SuperPAC says it’s spending around $10 million on ads in swing states condemning Biden over China.
It’s rare for two thirds of Americans to reach such a strong consensus so inevitably both the incumbent and his challenger are attempting to burnish their anti-China stripes.
Each also believes they can use China to score personal points against the other candidate.
- Trump is quick to criticise “Beijing Biden” and his son’s alleged profiteering from Chinese business.
- A recent Biden campaign ad reads, “Trump rolled over for the Chinese. He took their word for it.”, and goes on to cite some of Trump’s early remarks praising China’s pandemic response.
This fight isn’t without its risks however.
- In May, Biden’s aforementioned ad sparked outcry from representatives of Asian American Organizations who accused the Democratic candidate of feeding the rise of anti-Asian racism in the US.
- For Trump, a new economic cold war would imperil any incipient return to growth not to mention leave it isolated when big global discussions take place. Hence the recent decision by the US Commerce Department to allow American companies to collaborate with Huawei on 5G technology standards.
As we know though, Trump is no stranger to risky political moves. With winning the election his top priority and alternatives running out, the President will hold onto the anti-China card for dear life to avoid being trumped by Biden.
The battle of ‘who’s tougher on China’ shows no signs of relenting. Both candidates will be forced to push harder and harder to have the last word on an issue which has galvanised such a strong reaction among the American public.