Election home stretch
Summary: Markets remain choppy and generally directionless as we reach the home stretch of the US presidential race. Overarching political uncertainty continues to cloud the near term outlook.
We are a seeing a general risk aversion grip risk assets as the US election draws closer and overnight US equities sold off by the most in more than a month. A confluence of factors have combined to stoke nervous sentiment - COVID-19 case counts and mitigation efforts are stepping up, daily new cases in the US are at record levels and increased restrictions in Europe will weigh on an already plateauing recovery, stimulus hopes are dimming and the risk that the election result is disputed remains.
Although there are external factors (like a vaccine) that could significantly change recovery dynamics and the outlook for risk assets and pro-cyclical sectors very quickly, there remains a number of hurdles to cross in the coming months. It seems that even once the event risk of the election passes, Northern Hemisphere recoveries hampered by the resurgent virus and the US economy devoid of further a COVID relief package, against a fast approaching benefit cliff are the next hurdles. All pandemic related UI programs (PUA, PEUC, etc) expire on December 31st.
The next big trade will be the rotation trade as markets look ahead the continued normalisation, or some semblance of post-pandemic normal, but a prior requirement is a clean election outcome and continued success in containing COVID-19. On the first, we gain some clarity in less than a week, on the latter an upside risk is positive news on a vaccine and better treatments/patient care but the downside is we are nowhere near containing the spread of COVID-19. There is a huge amount of uncertainty between the timing on a vaccine and the current rising case count, which sees heightened volatility remaining part of the picture.
Cases are rising once again in the US and Europe. In Europe, mitigation efforts to control the spread of the virus are also mounting and against the current case load trajectory look set to be tightened further. Even if full-scale lockdowns are not enacted consumers spending behaviours will be altered, presenting a drag on faltering economic recoveries. These uncertainties continue to support our long held notion of range bound markets, with risk assets in limbo under macro uncertainties. However, as we have outlined prior, opportunity is weighted toward cyclical stocks where the risks of overly crowded positioning and excess speculation are not prevalent and valuation/expectation starting points provide a better outlook for gains. Although, clearly these allocations require the participation of the real economy for true outperformance.
The Stimulus Wait
On the US stimulus front, any remaining hopes of a deal prior to the election have been shuttered. Senate majority leader McConnell has adjourned the Senate until November 9 without a deal on the additional COVID relief package. This opens the floor for a potential wait on the next round of fiscal stimulus until February 2021 in the event Biden wins and the Democrats take the senate. With likely passage of the $3.4trn Heroes act at that point.
However, if Republicans retain control of the senate, this wait could be even longer and any package eventually agreed upon would undoubtedly be a lot smaller, think less than $1trn. A concerning dynamic which will be negative for consumption/investment in 4Q20/1Q21 and undermine the 3Q rebound. Recovery momentum is too fragile to go without the additional fiscal aid, with consumer and business sentiment weighed by both the virus and absent stimulus. The capacity for markets to “look through” this stimulus gap is likely dependent upon the blue sweep scenario.
The only clear passage for more aid prior to inauguration is in the event of an outright Trump win, which is highly unlikely. Post the election, if Trump loses, it is unlikely that a deal will be reached on additional aid, with no incentive for the Trump administration to corral senate Republicans toward a deal, but also because there is a chance the election result is disputed in which case passage of further aid will be incredibly difficult.
Unless there is a clear landslide for the Democrats that emerges on election night even before all mail in votes are counted, there exists a very real possibility that we will not know who has won the White House on election night. In that scenario we could see Trump clinging to any initial lead and moving to dispute the as more ballots are processed throughout the week. The Trump campaign has already detailed their intent to challenge ballots that lack signatures or postmarks or have other technical faults, according to the Washington Post.
Trump has many times declined to commit to respecting the integrity of the election results, which raises the stakes on a contested outcome. The President has repeatedly stated and taken to twitter his strategies to undermine confidence in the electoral process and the legitimacy of mail in votes.
Polling by YouGov shows that 51% of likely Democratic voters plan to vote absentee, compared with 32% of Republicans, who are far more likely vote in person on election day. As we have explained before, certain battleground states (Pennsylvania, Michigan, Wisconsin) exclude election officials from beginning to count votes until election day, therefore Republicans votes are likely to be counted first, leading to a potential election night “red mirage” in which Trump appears victorious before all mail-in ballots are processed. In Pennsylvania (a battleground state) for example, mail in ballots can still be counted 3 days later on November 6. Meaning there is a real possibility election night initially looks like a Trump victory that is reversed as more mail-in ballots are processed in the days following the election.
Other nuances come down to states like Florida, which holds 29 Electoral College votes. Florida is the largest swing state given the two most populous states, California and New York, are perennial Democratic wins. Polls this week show Biden with a four-point advantage over Trump in Florida, if that polling is correct and Biden wins Florida the pathways for Trump victory become incredibly limited in the Electoral College. In Florida, counties can begin processing votes prior to the election and on the night will count close to 99% of ballots (mail-in and in-person ballots). If it’s a clear Biden win in Florida, once mail-in and in-person ballots are processed, we can be fairly sure of calling the victor on the night. However, if it is close, focus will quickly shift to the Midwest and the Senate race, as well as the prospects of recount calls and a contested election.
These factors mean the risk that the election result is disputed remains, unless the turnout for the Democrats can drive an obvious, irrefutable landslide on election night.
As this column has long attested, turnout is likely to be the swing vote in the US presidential race, given just over half the population actually vote. With less than a week until Election Day political engagement is surging. The number of early votes alone in many states is on track to surpass the total ballots cast four years ago. These numbers suggest we could be on track to see the highest turnout ever in this year’s presidential race. Turnout is unprecedented, and few turnout to keep the status quo. It’s a “now or never” election for the younger demographic.
The Younger Demographic to Become a Swing Factor
A national poll of Americans ages 18 to 29 from the Institute of Politics at Harvard Kennedy School found that enthusiasm for voting in 2020 is on par with 2008, a historic election for youth turnout. A statistic that supports the swing toward the generational shift of political power ongoing in the US, which is only going to grow over the next decade.
The 2016 mechanism that played to the Trump win in reverse drives voter turnout in support of the Democratic Party. Not necessarily because Biden’s platform provides a cohesive vision for the future. But because those who have “lost their voice” with respect to climate action, principles of democracy, international cooperation, and women’s reproductive rights, galvanised by the anti-Trump vote, turnout in force, particularly the progressive youth.
Here we see the younger generation playing a key role in driving a Democratic sweep. Young people have voted overwhelmingly Democratic in the last four presidential elections.
The 2018 mid-term elections had highest turnout of any mid-term election held since the 1914 elections. Participation was especially high among young people who voted overwhelmingly in support of Democratic House candidates. If the polls are right and the trend from the mid-terms has been continued, this should work in favour of the blue sweep.
The youth vote provides a crucial swing factor for a Biden victory, amid a concentrated effort by social media networks to re-energise younger voters, where green policy, education and social issues like racial equity and gun control are huge drivers for this cohort. This as Facebook, Instagram, Snapchat, and Spotify have all initiated their own voter registration efforts in a bid to drive turnout, particularly among younger voters.
As my colleague John Hardy notes, huge early voting numbers (surpassing the entire 2016 vote) in Texas suggest higher odds of a Democratic landslide if the activity there is representative of tendencies nationwide in voter turnout as the demographics of the traditional non-voting population (the young in particular, but also ethnic minorities) skew heavily Democratic. A Biden win in Texas would really “rock the boat” in American politics. A new era of political competition in Texas would mark a powerful warning sign for the GOP in embracing the youth vote to have a future path to the White House.
This overarching political uncertainty continues to cloud the near term outlook for risk assets. In 2000, the S&P 500 dropped 9% before George W Bush emerged as the victor in early December. And this year’s election could come with an even greater legal challenge should the results be a close call.
A contested outcome in the worst-case scenario, setting the stage for civil unrest across a nation already divided as factions of the population on either side believe the victory has been stolen.
This scenario has the capacity to change market dynamics and sentiment very quickly if a period of protracted uncertainty emerges. Particularly as the combination of rising COVID cases and the stimulus impasse will also add to the angst. Large hedges in the form of put options are in play through to December 2020 and if dealers looking to hedge, short futures on any post-election jitters, this could be a catalyst for more broad based weakness. As we have seen before, most recently in August 2020, dealer hedging has the capacity to exacerbate directional market moves.
However, come November 3 if a clear winner emerges and the probabilities surrounding a messy, drawn out contested result are priced out, those corresponding hedges will be unwound quickly. This dynamic alone could easily see the market trade higher in the event of a blue sweep. This alongside the sector/industry specific beneficiaries which include - infrastructure spending/fiscal expansion supporting industrial metals, mining/materials stocks, renewables, education, and gun stocks (sales increase front running regulatory concerns). Commodities, materials/mining stocks represent not only a hedge against rising inflation expectations that will be pulled forward under a unified Democratic administration, but also leverage the coming focus on infrastructure spending and tail wind of a weaker dollar provided by aggressive fiscal expansion.
Alongside the benefits for Asian assets that comes with a Biden administration taking a less tough stance on China.
+Sector/industry beneficiaries on blue wave - infrastructure, materials/base metals, renewables, education, gun stocks (sales increase front running regulatory concerns) and marijuana stocks.
+Asian assets with a Biden administration taking a less tough stance on China/possible tariff reductions – positive for Asia FX + Equities
+Inflation – fiscal primacy against supply constraints - inflation upside, higher UST yields, TIPs and commodities (precious metals, base metals and agricultural commodities)
+EMFX – Asia, MXN, RUB
Lastly, taking a big picture view, the trajectory of both fiscal and monetary policy, which remains supportive, will outweigh the election result. Alongside the economic recovery and path to normalisation where the prospects of virus containment is the single most important factor. A contested election would undoubtedly bring a bout of risk-off volatility, but this would likely be an opportunity to add to long-term opportunities.