US Election: Cut through the noise

About the author:

Andrew Tang
Author name:
By Andrew Tang
Job title:
Analyst - Equity Strategy
Date posted:
05 November 2020, 11:04 AM
Sectors Covered:
Equity Strategy and Quant

We are still days, if not weeks, from knowing the outcome of the US presidential election or which party will control the Senate, and, with the President threatening to challenge the outcome, the legal wrangling and uncertainty could drag on for some time.

It is still possible Democrats end up winning the White House and, with Kamala Harris’ tie-breaking vote in the Senate, control of Congress too. But even in that scenario hopes of a major post-election fiscal deal, along with much of Joe Biden’s broader economic agenda, may be dead on arrival.

If Republicans retain the Senate, the odds of another significant fiscal package being passed would be greater under Trump than Biden.

As many had warned, a close fought and highly politicised election process means that the least desirable scenario has played out. But what is clear is that the much-hyped “Blue Wave” failed to materialise. Biden is perhaps favourite to win the electoral college majority at the time of writing, flipping Arizona and only needing two of Wisconsin, Georgia, Michigan or Pennsylvania to win.

Some media outlets have already given him Michigan and Wisconsin. The problem is we might not know the results for days or even weeks.

This suggests that a near-term fiscal stimulus package has become less probable, which is not great news for the market over the short-term. As the experience over the past few months has shown, a divided Congress might struggle to agree on how much and what type of stimulus is required. Even with a slim majority in the Senate, a Biden administration would find it hard to implement much of the ambitious agenda he has set out during the campaign.

When we look at the immediate outlook for the market, it is easy to point to reasons to sit on the sidelines.

We know that markets don’t like uncertainty and there is the potential for a contested US election, which could lead to days, if not weeks, where the outcome is not known.

Additionally, the rise of COVID cases in countries that were thought to have the virus under control could lead to another significant round of lockdown measures and tip economies into a double-dip recession.

While we share the same concerns in the near term, we think equity markets will invariably look past the risks and focus on how the economy can heal. We outline below our reasons for why we believe the market will eventually trend higher over the next 6-12 months.

  1. COVID-19 second and third waves:

    Several promising developments in the fight against the virus are due out shortly. Some re-purposed (non-COVID-19 related) therapeutics are being used to reduce the rate of hospitalisations, lessen the severity of the disease, shorten the recovery time and lower the mortality rate.

    On the vaccine front, the World Health Organisation lists 10 candidates in phase three large scale trials – the final hurdle before they can be distributed to the wider population. And five candidates are part of operation President Trump’s Warp Speed program which promises to have significant quantities of the vaccine available once approved.

    We note Pfizer’s interim trial results are due by the end of November which is likely to lead to authorisation for emergency use. Should even one of these vaccines prove effective, the risk premium priced into the market will very quickly lift.

  2. US Presidential election:

    Predictions about US presidential elections and the stock market often focus on which party or candidate will be “better for the market” over the long run.

    If we analyse the past eight decades of alternating periods of conservative and liberal stewardship of the US economy, the market verdict has been a consistent trend of broadly appreciating equity prices, with brief interludes of negative performance.

    While some aspects of a Trump re-election could arguably be more “business friendly”, we think it is policy certainty that the market craves. A Biden win would still result in policies designed to support an economic recovery.

    Ignore the short-term market noise and stick with equities and other assets that will benefit from the secular forces driving the economy and the business cycle.

    President's Party & S&P 500
  3. An earnings recovery in plain sight:

    Lost in the noise of the 24-hour news cycle are the improving earnings trends that have emerged over the past month. Analysts have progressively increased earnings forecasts as the economic recovery takes on more momentum. For the first time since 2018 upgrades are outpacing downgrades; furthermore, the upgrades are spread uniformly across sectors.

    Of course the key unknown is whether earnings forecasts translate to actual profit over the next 12 months. However, with domestic borders due to reopen by Christmas and government assistance likely to remain in place until the economy returns to full health, it would be hard to bet against it.

  4. Equity returns still compelling against the alternatives:

    The global decline in interest rates remains a problem for an ageing society, and unless expected return hurdles also decline, investors are having to contend with taking on more risk for the same returns they were accustomed to.

    The reach for yield has led investors to non-traditional asset classes and other sources of income. Despite higher-than-average valuations, we think the 12-month earnings yield of 5.4% (expected return of the market) remains comfortably above current interest rates and still compelling against competing asset classes.

    We recently increased our tactical asset allocation to equities as we see the recent weakness as an opportunity to re-weight portfolios.

While the short-term outlook for equity markets is plagued by uncertainty, do not lose sight of the factors that could lead the market higher over the next 6-12 months.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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