There are lies, damned lies, and then there are presidential polls. Before the election, many pollsters predicted that there would be a “blue wave”, with Democrats taking not only the presidency, but also both the Senate and the House of Representatives. However, the day after the election, the U.S. presidential race was still too close to call. This election had an unprecedented amount of mail-in voting due to the pandemic, which required significantly more time to count. These mail-in votes dramatically favoured former Vice President Biden, and as the week progressed, it became apparent that he would surpass the 270 electoral votes needed for a win.
President Trump has alleged that voter fraud was the cause of his loss, which is consistent with his messaging in the lead up to the election. However, the results show that Biden is significantly ahead and that neither a re-count nor any voter fraud claims are likely to change the outcome.
Although the Democrats have probably won the presidency, their chances of winning a Senate majority are still too close to call. The election shows that no party is significantly dominant in terms of general public opinion, and the polarization in the U.S. is unlikely to dissipate anytime soon.
The market appeared to favour an outcome of neither party winning a strong majority. Historically, a split house has meant that the government could do and change very little, which markets enjoy as the status quo reduces uncertainty. Thus, as the likelihood of a majority fell away, risk assets such as stocks and credit rallied in the first week of November, while Treasury bond yields fell.
Prior to the election, the expectation of the blue wave meant that the Democrats would have been able to pursue their agenda of fiscal spending, health care reform, climate change initiatives, and rolling back the Trump tax reductions. The amount of fiscal spending under this scenario was perceived to be significant, increasing the risk of higher debt and inflation, which would have pushed interest rates higher.
A split government, on the other hand, will likely mean that it will be hard to produce a large fiscal stimulus package, as Republican fiscal hawks (specifically the Tea Party) will come out of their four-year hibernation and argue the merits of fiscal restraint and demand a balanced budget. There were already signs of this as expectations moved towards a Democratic presidential win prior to the election. With lower odds of excessive fiscal spending, the supply of new Treasury debt will be limited. With lower supply of debt, the price of Treasuries rally and yields fall. We also expect it will be difficult for the Democrats to roll back Trump’s corporate tax reductions.
With respect to global trade, President-elect Biden is expected to be less confrontational. We also believe he will be less aggressive and volatile when it comes to trade tariffs and trade wars, except possibly in the case of China as stated during his campaign and because being tough on China remains popular among Americans. In our view, this calmer measured approach should be positive for risk assets.
With a Biden presidency we believe we will see a better handing of COVID-19, more political certainty, less focused on breaking up of technology companies and fewer trade wars, which are all positive for risk assets. On the flip side, it is unclear what the infrastructure spending and “greener” deals that Democrats favour will look like without a Senate majority, which may mean less fiscal stimulus.
Overall, the election was a distraction; whether the stimulus is $1 trillion with no tax hikes or $2 trillion with a tax hike, is likely have the same net effect – a Ricardian equivalence, in economic terms. The main driver of the markets will remain the pandemic.
As we enter the second wave of the pandemic, there are many questions about the outlook of the economy and the long-term effect of the COVID-19 virus. The lock-down for the second wave has thus far been, and will continue to be, better thought-out. We believe it will be more targeted rather than broad-based, as the infrastructure for handling the virus improves day-by-day.
Furthermore, while the number of cases appears larger in this second wave, the mortality rate has so far been far lower, which is likely due to the denominator not being accurately measured in the first wave; i.e., there were probably a lot more cases that were not reported in the first wave due to lack of knowledge and testing capabilities.
The most significant effect of the pandemic thus far is not the contraction of GDP, but rather the loss of jobs, especially in the service sectors. Jobs in retail trade, transportation, arts & entertainment, accommodation and food services are all much more labour-intensive and have been hit the hardest by the pandemic.
We are optimistic but remain cautious. The second wave of the pandemic is still underway, in much the same way that the second wave of the Spanish flu was more devastating than the first. However, we are more knowledgeable this time and that bodes well for overall management. In addition, the prospects of a vaccine in the near term could lower the odds of a double-dip recession.
In our fixed income portfolios, we consequently remain short duration and long risk assets. While corporate spreads have narrowed, the dispersion within the sector remains broad. As a result, we continue to be selective and strategic with respect to where we allocate clients’ capital. As the odds of a vaccine to combat the pandemic increase, we believe spreads will continue to narrow. Pent-up demand should eventually lead to strong growth and cause government bonds to rise. If this continues to play out, our portfolio allocation should perform well.
 “Ricardian equivalence is an economic theory that says that financing government spending out of current taxes or future taxes (and current deficits) will have equivalent effects on the overall economy.” Investopedia (https://www.investopedia.com/terms/r/ricardianequivalence.asp)
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