Washington

Spreads expected to narrow in the wake of US election

Joe Biden has won the US presidential election. The incumbent Donald Trump is contesting the result, but his chances of success are minimal. For investors, the key concern is whether the Senate will remain in Republican hands after the run-off election on 5 January. Overall, there are many indications that risk assets will benefit and the US dollar will weaken.

Elected but not yet home and dry would be a fair summary of the result of the US presidential election on 3 November that brought the Democrat challenger Joe Biden a lead of around 5.7 million votes, equivalent to 51 per cent of all ballots. The incumbent Donald Trump has so far refused to concede. He has even gone as far as initiating legal proceedings aimed at overturning the result of the election. A smooth transition of power to the next administration led by President-elect Joe Biden and Vice President-elect Kamala Harris is not possible for now. The threat of institutional paralysis in Washington is looming large in the midst of the coronavirus pandemic.

Nevertheless, the equity markets reacted positively to the election outcome. That makes sense looking at it rationally. The fact that Trump has not accepted the result is ultimately irrelevant in the view of Union Investment’s analysts. His lawsuits have very little chance of succeeding. The coronavirus pandemic means that the number of votes cast by mail-in ballots was exceptionally high. Most of these votes went to Biden and not Trump, a fact that Trump – who is still talking about irregularities – has not accepted. However, even the Republican secretaries of state, i.e. the people responsible for verifying the election results in the individual states, have rejected his accusations. Georgia is a prominent example. In Pennsylvania, the Republican state legislature declared that it will respect the outcome and will not send an opposing electoral delegation to Washington.

Still much to play for in Georgia

The key question is therefore whether there will still be a ‘Biden sweep’, which would mean both the House of Representatives and the Senate in Democrat hands. The narrow result of the election in the state of Georgia is the reason why this remains unknown. A run-off election on 5 January will finally decide who gets the two Senate seats. Should these switch from the Republicans to the Democrats, the casting vote by Senate President Kamala Harris would give the Democrats control of the Senate. This is the ‘Biden sweep’ scenario, and it still might come to pass despite having already been priced out by the capital markets.

'Georgia on my mind': Democrats have a second chance to secure a Senate majority

Georgia
Sources: RealClearPolitics, Union Investment, as at 8 November 2020. *Assuming the Republicans take Alaska and North Carolina, as expected.

Dollar and US government bonds weaker

A ‘Biden split’ is the current baseline expectation of Union Investment’s analysts. The regulatory risks for certain sectors would be more limited under this scenario than in a ‘Biden sweep’. The Democrat President-elect would also have limited room for manoeuvre in terms of finances. Individual asset classes would be affected in different ways by this, but both scenarios have one thing in common: they would likely lead to a weakening of US government bonds and the US dollar. Spreads will probably narrow under the 46th US President, Joe Biden, as it can be assumed that the foreign policy arena would shift towards greater cooperation with allied nations and less confrontational rhetoric.

The direction of US trade and technology policy, for example towards China, is unlikely to change fundamentally, as Biden has already made clear. The potential for further tension in relations with China therefore remains. For Europe, the political trend is at least somewhat positive. In contrast to the Trump administration, Biden’s presidency looks set to restore calm to transatlantic ties, particularly in the case of Germany and France, which should help export-driven German companies in the automotive and industrial sectors, among others.

With regard to the impact on individual asset classes, however, it makes sense to continue differentiating between the two potential scenarios of a ‘Biden split’ and ‘Biden sweep’ for now.

  • A ‘Biden split’ would likely put moderate pressure on the prices of US government bonds due to the absence of uncertainty, particularly concerning trade. The US dollar, which enjoys ‘safe haven’ status, would also likely weaken as risks are priced out. However, the greenback would probably also suffer from the comparatively weaker growth prospects of the US economy and a lack of budgetary consolidation. Similar to Donald Trump, Biden’s main tool in this scenario would be executive orders, because the Republican majority in the Senate would be highly likely to block all of his legislative initiatives. As taxation and spending decisions have to be approved by Congress, most of Biden’s investment programmes would probably be untenable and his economic policy agenda would be less likely to generate the desired stimulus for growth. The strategic competition with China offers a glimmer of hope for investment in modern infrastructure and future-focused technologies, as there is cross-party consensus in the US that the two superpowers are locked in a battle for supremacy. This could provide a jumping-off point for bipartisan efforts by Democrats and Republicans that include initiatives to promote smart infrastructure and cutting-edge technology. In the medium term, however, it could prove more difficult to bring down the national debt because the rate of economic growth is likely to be lower than in the ‘Biden sweep’.

 

Government bonds and US dollar price out the 'blue wave', coronavirus vaccine breakthrough drives yields

Government bonds
Source: Union Investment, as at 16 November 2020.
  • In the ‘Biden sweep’ scenario, the forces that would drive the aforementioned weakening are configured slightly differently. The US dollar would in this case come under greater pressure, as Trump’s corporate tax reform could be rolled back, making it more difficult for companies to repatriate profits to the United States. This would have a negative impact on the US dollar. Meanwhile, rising inflation expectations would weigh on the prices of US government bonds. With a majority in the Senate and the House of Representatives, the incoming president would have a greater chance of passing a comprehensive fiscal package or he could at least raise the minimum wage. This would significantly boost growth and therefore could lead to higher inflation.

Sector selection in equities needs more care than ever

But what does the outcome of the election mean for risk assets such as equities? Once the period of uncertainty during the transition of power is over, the equity markets should in principle remain well supported. However, the impact on the individual sectors is likely to vary depending on whether the ‘Biden split’ comes to pass or if there is indeed a ‘Biden sweep’.

The assumption that conditions for equities will remain upbeat overall in the event of a ‘Biden split’ is based on the likelihood of the President having little room to manoeuvre in terms of domestic policy over the coming years. Without a majority in the Senate, the tax increases planned by Biden have little chance of coming to fruition, which will probably have a positive impact on US companies. Even regulated industries such as the financial and pharmaceutical sectors stand to gain in a ‘Biden split’.

Essentially this means the following for the equity market: the less that President Biden is able to raise taxes in this difficult economic climate, the bigger the uplift for share prices as a result of his dialling down the trade rhetoric.

The area in which Biden would have some scope for action is regulation (stricter environmental standards, tighter regulation of the pharmaceutical and healthcare sectors, limitation of the market power of big tech companies, greater focus on financial market regulation). He is not reliant on a congressional majority here. If he does follow through with these plans, it could put selective pressure on equities from the affected sectors.

Lower potential for growth under a Biden split

It should also be noted that the political tension inherent in a ‘Biden split’ will not boost the growth prospects of the US economy. Majorities in favour of government stimulus in the form of infrastructure programmes or even the much heralded New Green Deal will be almost impossible to organise. That would be bad news for a number of companies, particularly those that specialise in fields such as energy efficiency and electric-powered transport.

It would be different, however, if on 5 January the two Senate seats up for grabs in Georgia go to the Democrats. This would give the Biden administration significantly greater scope to implement its plans for stricter environmental, health and social standards, for example in the financial and energy sectors. Equities from these sectors would probably come under pressure as a result. And because the administration could increase or enforce the minimum wage, shares of companies with a high proportion of labour costs and limited pricing power (hotel chains, restaurants, cafés, bars, retail) would also likely be adversely affected.

On the other hand, companies in industries such as renewable energies, green tech and infrastructure and companies with high ESG ratings (ESG = environmental, social and corporate governance) would enjoy a tailwind. Companies with a low proportion of labour costs and significant pricing power (many multinationals) could benefit as well.

In a ‘Biden sweep’, plans for a very comprehensive and innovation-focused investment package would also become viable. Despite companies having to face a certain degree of hardship, the equity market could, in the long term, benefit from the increased potential for growth in the US economy and wage increases that should boost consumer spending.

Keeping in mind the coronavirus pandemic

In summary, the environment for equities remains favourable. The result of the US election is a key driver here. However, the further course of the coronavirus pandemic should not be forgotten. The difficult transition of power from Trump to Biden could set the US back in its attempts to tackle the pandemic as well as hamper growth. However, the news that two coronavirus vaccines might be effective has already changed the mood in the capital markets. Thanks to these scientific breakthroughs, there is now a great deal of confidence in investing early in the cycle as would be typical under normal circumstances.

Union Investment’s analysts anticipate that the profits and valuations of cyclical shares will rise. It would therefore be sensible for investors to consider a broader allocation encompassing cyclical components. This would allow participation in the shifting profit dynamics among the sectors but without taking on too much risk should there be setbacks in the attempts to tackle the pandemic. After all, we almost certainly still have a long way to go before economic life makes a full return to normality. It is therefore advisable to have a balanced portfolio that includes tech stocks as well as cyclical investments.

 

As at 16 November 2020