Five big election questions

We’re just 15 days
away from the US election, an event which dominates conversations in the
markets, as it does in everyday life. There is so much that can happen between
now and the 3 November and we watch for this week’s third (and final)
Presidential for signs that Trump can claw back some ground in the national and
state polls. Fiscal remains the buzzword, but forget the Republicans move to
pass a $500b bill, it will not see the light of day and expectations of a new
stimulus bill have been pushed into 2021. 

If the market
continues to believe a ‘Blue Wave’ (I.e. Biden in the White House, and the
DEM’s in the House and Senate) is the likely outcome then volatility and market
positioning shouldn’t shift too greatly. 

That said, while
everyone has questions, here are a few that I continue to consider.

1) Contested vs
accepted. While expectations of a
contested election have receded a touch of late, it is still the dominant
question. Looking across the options landscape, I still see so much hedging of
potential drawdown in risk assets that it makes me question whether any
outcome, be it Trump or Biden, Blue wave or split Congress doesn’t actually
matter – the fact we have certainty and we know what the business landscape
looks like, could be enough to cause an unwind of contested hedges and sheer
relief that a decision will not involve the Supreme Court. Even if this relief
is short-lived remember that markets love certainty. 

2) What are stimulus
expectations? The belief, at least from the optimists, is that fiscal will
continue to support, and when married with incredibly accommodative central
bank policy should drive consumption, an earnings recovery and even inflation
in 2021. This is also conditional on a vaccine being rolled out next year and
COVID-19 hospitalization rates remaining low. At this stage, there are high
expectations that if Biden can get the White House (WH) and have full control
of Congress that he’ll push through a $3.5t fiscal program in early 2021, a
fate that could have sizeable implications for inflation expectations and
markets more broadly. If Biden gets the WH but the REP’s hold the Senate, the
next most probable scenario (according to the odds), then there is little
chance the GOP will pass this size stimulus and we’ll be looking at something
closer to $1t. 

Should Trump get the WH and we see a split
Congress (the DEMs seem assured of the House) then we can expect a stimulus of
$500b to $1t.

3) To what degree is
the ‘blue wave’ scenario already priced? If we look at betting
site Predicit they have a ‘blue wave’ scenario priced at 58%, with
Superforecaster at 61%. So, there is still a large degree of doubt, and this mostly
lies with the DEM’s ability to take the Senate, which seems a close call. In
terms of markets, the idea that a ‘Blue Wave’ would set off a reflationary
trend in assets can loosely be seen in the US bond market with the 30-year
Treasury pulling higher from my simple COVID basket and US 10-year yields
widening to 136bp over German bunds, although Europe also has a pressing
inflation problem.

In the rates market, we
see the first rate hike from the Fed has been brought forward over the past
month from June to March 2024, reflecting a view that the Fed may have to
tackle higher inflation if the DEM’s can push through a $3t+ stimulus in 2021.
If markets were fully reflecting a ‘Blue Wave’, I’d expect good sellers of
various 2024 Eurodollar interest rates contracts, and a repricing of the first
hike to late 2023. 

In equity markets, we’ve
seen a strong outperformance from the MSCI Global Alternative Energy Index over
the MSCI Energy Sector, a reflection that Biden will try to push through a $2t
green energy bill. Elsewhere, if the market was truly fully positioned for a
‘Blue Wave’, I’d have expected small caps to outperform large caps and a more
bullish trend in cyclical sectors vs defensives and value over growth stocks. 

(Blue – MSCI energy
index, white – alternative energy index), orange – Predicit chance of ‘Blue
Wave’)