By Andrew Sheets, chief global strategist at Morgan Stanley
It's been a year of dramatic swings, and the 2020 US election was no exception. Prediction markets put former Vice President Joe Biden’s chances at about 70% on Tuesday afternoon, 25% at 10pm Eastern Time, 50% by midnight, 35% by 3am Wednesday and 80% by 10am. It was a roller-coaster night (and week) to cap a roller-coaster year, and the election may yet provide a final twist.
For markets, the irony is that this roller-coaster of an election has meant relative tranquillity. Implied volatility has dropped sharply, and equities and credit have rallied back near local highs. Part of the reason may be that markets were already braced for uncertainty (the VIX ended October near 40), making it easier for them to follow the ‘usual’ pattern of struggling ahead of an election and improving afterwards. We saw the same in 2016.
A second key development is that 'tail' outcomes did not materialize. Before Tuesday, scenarios of a large sweep by Democrats seemed plausible. So did a surprise upset, given what happened in 2016. Either tail could have catalysed a large (and probably painful) adjustment to consensus positioning, but 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 I’ll address at the end.
With it looking likely that Democrats will control the White House, but congressional power will remain divided, the chances of a larger and more proactive fiscal stimulus have fallen. 'Proactive' is the operative word here, as our US public policy team sees divided power leading to increased risk that more fiscal help wouldn't arrive until economic problems worsen.
It could mean that foreign policy sees more action than fiscal policy. We think that a Biden administration would be less open to a US-UK trade deal and more committed to the Good Friday Agreement than the current administration. Both factors would tilt the balance towards closer UK alignment with Europe and increase the chances of a 'deal' on Brexit. This is bullish GBP.
Reactive fiscal stimulus (or none at all) also means that developments relating to the pandemic become more critical for markets. We’ll be closely watching COVID-19 case numbers, which are rising again in the US and Europe, and announcements on a vaccine, which our biotechnology team expects later this month. While we’re hopeful on the latter, mounting case numbers and no new fiscal relief have created some downside risk to the economic data in the near term.
For US equities, this is one reason why my colleague Mike Wilson believes that the S&P 500 will stay in a 3100-3550 range as markets digest these overlapping narratives. We were at the low end a week ago and closer to the high end recently, but think that more time is needed before a ‘breakout’. This election doesn’t change our story of a sustainable 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 EMFX and credit than equities. We remain cautious on oil, given weak fundamentals, but have turned more constructive on several large EU energy majors.
And we may see one final twist. Senate control is currently split 48-50 between Democrats and Republicans, but two Senate seats in Georgia, a state with a razor-thin margin in the presidential contest, are set for a run-off on January 5. These run-offs will determine whether we have a united or divided government, with 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. Stay tuned.
The 2020 election isn’t quite done, but as the vote count has worn on slowly, one result looks clear. The United States of America looks set to get 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 on America's journey. Keep an open mind, and wish it the best.