Trump outperforms polling, in for the long haul

Key points

• President Trump has done much better than polls suggested, but as yet the Presidential election outcome is unknown and appears on a knife-edge.
• The close outcome raises fears of a contested election as late-counted mail-in votes are likely to skew towards Democrats. President Trump has already issued inflammatory statements suggesting that “they are trying to STEAL the election".
• The Congressional race has gone as expected: the House retains a Democrat majority, but the Senate vote was much closer – the result still outstanding - but with the bias now appearing towards a Republican majority.
• The immediate financial market reaction appears to have been a pricing out of expectations for a Democrat-sweep and some caution over the prospect of a contested election. This has removed some support for value stocks, but provided some relief to growth stocks. Treasury yields have fallen back and the dollar has gained.
• The economic implications of what we know so far - that a united Presidency and Congress looks highly unlikely – is that fiscal stimulus will be less. This will dampen the outlook for US GDP growth. It will also likely prolong the need for monetary policy support.

Trump outperforms in the story so far

Europe awakens to an as yet inconclusive US election. While we knew we would have to wait for final results – as is always the case – any hopes that results would be clean enough to allow independent newstations to declare winners has evaporated. However, the news so far is that President Trump has done much better than polls were suggesting, both in key states – as was the case in 2016 – and more broadly. This leaves the Presidential election outcome on a knife-edge. The House of Representatives has been declared with a Democrat majority, but the Senate race is much closer, although looks likely to stay under a Republican majority. Whoever eventually wins the Presidential Race looks set to face a divided Congress, which will make the prospect of passing any policy all the more difficult. In turn, this suggests less fiscal support to the US economy, a reduced growth outlook and more focus on Federal Reserve inspired policy stimulus.

At the time of writing, the Associated Press has a ‘declared’ vote count of 238 to Democrat contender Joe Biden and 213 for President Trump. Nevada still looks likely to go Democrat, which would add a further 6 votes. The outstanding States are the usual suspects of Georgia, North Carolina, Pennsylvania , Michigan and Wisconsin with 76 electoral college votes up for grabs between them. At present, the Associated Press shows all of these states to be leaning to President Trump. As previously described, this close outcome could lead to a drawn out and messy result. With Democrat voters voting in greater majority in the late-counted mail-in votes, we should expect these later votes to be skewed more towards Biden. This has led Biden to issue a statement saying that the election is not over until every vote is counted. Meanwhile President Trump has first tweeted and now given a statement stoking fears of electoral duplicity, saying “they are trying to STEAL” the election. This could foreshadow a long and drawn out process. Whatever else happens, the vote count is not likely to be finalised for several days now at least, setting the seen for more uncertainty.

Part of the Congressional race appears more certain and as expected the House is expected to return a Democrat majority with Fox News being one of the first to declare such an outcome, and expectations of a modest (around 5 seat) increase. The Senate race also looks close, but with Democrats underperforming nationally and missing key close States overnight, Republicans look on track to hold the majority here. The Associated Press have declared 47 Republican seats, versus 44 Democrat (2 independent). Of the remaining States, Democrats look on track for Arizona, but Republicans are currently leading in Maine, Michigan and more closely in North Carolina. Taking all three would give Republicans 50 seats, but leave them on track for a majority. 

Initial implications

Financial market reaction to the news so far has been telling. Treasury yields, which had risen significantly these past few weeks initially surged to 0.94%, but as news of Trump outperformance spread, yields retreated to currently trade at 0.80% as market expectations of a Democrat clean sweep and significant fiscal stimulus faded, and potentially as concerns over a contested election have increased. This was mapped in the dollar, which initially rose sharply (+1%) even as yields fell, but retraced 0.6% as more confrontational language emerged between the candidates. Equities also posted a significant swing with futures trading immediately higher – again we posit pricing out the chances of Biden tax hike proposals – before retracing some gains, perhaps as fears of protracted uncertainty emerge.  Value stocks seem to have come under the most pressure, unwinding gains of the last few sessions as hopes for fiscal support have faded, but growth stocks appear better place. US stock future show modest losses on broad indices (S&P and Dow), but tech futures (Nasdaq) are currently higher.

The initial economic outlook is governed by the growing likelihood that whoever is the President, they are likely to face a divided Congress. That is likely to stall the implementation of much of Biden’s progressive manifesto, but would also likely stop President Trump enacting a material second tax cut programme. The former would likely have proven more stimulative to the US economy as it continues to recover from the pandemic shock. It is also likely to weigh on any short-term stimulus package that we still expect to be announced early next year, but of reduced size compared with other electoral scenarios. The result of this reduced fiscal support is likely to be two-fold. First, the overall economic growth outlook is likely to be more subdued than under other scenarios – most notably the Democrat-sweep outcome. Second, with fiscal policy providing less support for the economy, the Federal Reserve is likely to have to provide more monetary policy support. This does not mean we expect the Fed to accelerate asset purchases or extend the maturities of those purchases, but it does mean that asset purchases are likely to be in place and rates on hold for longer than in other electoral scenarios.

Finally, at this stage, it is unclear whether the electoral result will emerge over the coming days or descend into a significant legal challenge. Short-term market reaction will follow this, but in extremis the Federal Reserve is likely to stand ready to provide short-term market support in the event of a material risk-off. We will learn more in terms of the electoral outcome over the coming days. And more from the Fed after its meeting on Thursday.

Investment outlook

There had been a consensus view before the election that a Democratic sweep would pave the way for fiscal stimulus, a stronger cyclical growth outlook, a steeper yield curve and a rotation towards cyclical and value stocks at the expense of growth and mega-technology in the equity market. That consensus has been thrown into doubt. The key considerations for investors will now be:

• What are the prospects for decisive fiscal policy when the political dust settles? This may be some time and there can’t be any conviction about the size or timing of a fiscal stimulus unless there is a last minute swing back towards the “blue sweep” scenario. As such, significantly higher US Treasury yields and a steeper yield curve have been taken off the table for now.
• How does the US deal with the COVID-19 pandemic from now? Case rates have been rising – they might be peaking right now, but at a high level. The Trump preference for opening economies and downplaying the impact of the virus could risk a further acceleration and negative economic sentiment as a result. This could contribute to periods of risk-off in markets. It also suggests that stay-at-home stocks will continue to outperform those of cheap but still constrained businesses in sectors like travel and leisure, retail and hospitality.
• If there is no Biden presidency or a gridlocked Washington, then the prospect of large corporate tax increases and regulatory attacks on big-technology and other large consumer services companies may be less of an issue for investors in US equities. Again, this may favour growth over value and the perpetuation of trends seen through 2020.
• The Fed will be supportive for bond markets. Credit should be well supported by the desire for yield. The rates risk to credit returns will be less pronounced than it would have been otherwise. High yield looks attractive.
• There will be uncertainty around green investing and energy. Another Trump Administration will not have the same focus on the environment and energy transition as a Biden Administration would have had. This may impact on some green investments and technologies.