Foreign-policy shifts, global trade, the fate of stimulus and the path of the coronavirus are just a few of the variables that investors should consider as President-elect Joe Biden prepares to take office.
It's been a year of dramatic swings and unpredictability, and the 2020 U.S. election was no exception. But at least some clarity is now in view, as President-elect Joseph R. Biden was declared the winner over the weekend by most media outlets.
For markets, the irony is that this rollercoaster election has meant relative tranquility. Implied volatility dropped sharply and equities and credit have rallied back to near local highs. Part of the reason may be that markets were already braced for uncertainty. The VIX, or so-called volatility index, ended October near 40, more than double its five-year average, making it easier for markets to follow the usual pattern of struggling just before an election and improving afterward. We saw the same pattern in 2016.
In addition, projected outcomes from the election didn’t materialize. Before Tuesday, Nov. 3rd, a Democratic election sweep seemed plausible. So did a surprise upset, given what happened in 2016. Either outcome could have catalyzed a large (and probably painful) adjustment to consensus positioning; neither came to pass. Markets were left with a scenario that suggests fewer legislative changes, and thus, fewer portfolio changes—with one very important caveat that I’ll address in a moment.
With Democrats now set to control the White House, but congressional power remaining divided, with a likely Republican-led Senate and Democrat-led House of Representatives, the chances of a larger and more proactive fiscal stimulus have diminished. “Proactive” is the operative word here. Our U.S. public-policy team believes that divided power could increase the risk that additional fiscal help may not arrive until economic problems worsen.
That means foreign policy may see more action than fiscal policy. A Biden administration could be less open to a U.S.-UK trade deal and more committed to the Good Friday Agreement—a peace accord between Northern Ireland and the Republic of Ireland—than the current administration. Both factors could tilt the balance toward closer UK alignment with Europe and increase the chances of a deal on Brexit. This would be bullish for the pound.
Reactive fiscal stimulus (or none at all) would also mean that developments relating to the pandemic would become more critical for markets. We’ll be closely watching COVID-19 case numbers, which are rising again in the U.S. and Europe, and following developing news on a vaccine.
While we’re hopeful about the latter, mounting case numbers and no new fiscal relief still mean some downside risk to the economic data in the near term.
For U.S. equities, the impact of the pandemic and uncertainty on fiscal relief is one reason why Mike Wilson, our Chief Investment Officer and Chief U.S. Equities Strategist, believes that the S&P 500, the broad market benchmark index, will hover around the 3100-3550 range through year-end, as markets digest these overlapping narratives.
U.S. equities sat at the low end of that range in late October, and closer to the higher end recently, but more time may be needed before a sustainable “breakout.” This election doesn’t change our story of a steady economic recovery and an ongoing bull market for global equities and credit. We think that both remain intact in a divided-government scenario.
What about other markets? At the moment, our bullish cross-asset exposures are concentrated in owning global credit and selling equity volatility. We think that both remain attractive, even if major fiscal support isn’t forthcoming. In emerging markets, our strategists are more constructive on currencies and credit there, than equities. We remain cautious on oil, given weak fundamentals, but have turned more constructive on several large EU energy majors.
One final twist: Senate control is currently split 48-48 between Democrats and Republicans. As of this writing, two races, in North Carolina and Alaska, respectively, remained uncalled. But those appear to be Republican wins, for a 48-50 tally. That leaves two Senate seats in Georgia, a state with a razor-thin margin in the Presidential contest, set for a run-off election on Jan. 5, 2021.
These run-offs will determine whether we have a united or divided government, since a 50-50 Senate split would give Democrats formal control of the chamber because the Vice President becomes the tie-breaker.
This would have enormous implications for policy outcomes. What we've just said about the election and the markets may need to be revised based on these results. We will let political experts opine on the probabilities, but expect these races to get an outsized amount of market attention.
The 2020 election isn’t quite done, but as the vote count has worn on, one result looks clear. The United States of America is set to have a new President, with important implications for foreign and fiscal policy.
But it’s also important to step back and pause. Markets, like politics, are fickle. The winds change, and much conventional wisdom regarding a change of government in 2000, 2008 and 2016 turned out to be decidedly wrong. This election isn’t a “game changer” but simply one more step in America's journey.
Adapted from a recent edition of Morgan Stanley Research’s “Sunday Start” series (Nov 8, 2020). Ask your Morgan Stanley representative or Financial Advisor for the latest market strategy coverage and reports. Plus, more Ideas from Morgan Stanley’s thought leaders.