Markets poised for US election uncertainty

Morning Note
US Presidential Election

Lockdowns across Europe seem fully discounted now – markets haven’t really reacted massively the UK government’s caprice. Stocks hugged the flatline in early trade Monday as all eyes shift now to the presidential election, with some bid actually coming through after the initial downtick. The elephant in the Oval Office is Donald Trump: a victory in the election this week for the incumbent would surprise just about everyone. I say this since strategists everywhere seem to be discounting the possibility. Some of the pre-election selling we have seen could be more about an expected Biden win and what that would do to tax and regulation. Polls show a healthy Biden lead for sure but are tighter in the battleground states. Moreover, there is likely a silent group of shy Trump supporters who would never admit to voting for the president. On the other hand, Biden has a clear lead in four key states – Wisconsin, Pennsylvania, Arizona and Florida, a new poll shows, which would see the Democrat through with ease. It’s still a contest though, and with states being called or mis-called on inaccurate exit poll figures throughout the election night we ought to prepare for some significant volatility over the course of the evening.   

 

The main thing Wall Street wants is to get the election out of the way and get some clarity. As such a contested election would present the greatest near-term risk to equities, which may be reflected partially by the Vix going above 40 last week. This is a level that needs to be watched, though returns post a spike like this tend to be positive. 

 

But investors may not get the result on election night. The sheer volume of mail-in votes in those states which require counting to only start from Nov 3rd (Michigan, Pennsylvania), could delay the result even without the risk of legal action. Donald Trump is clear he’s going to fight where he can, saying in reference to Pennsylvania: “The night of — as soon as that election is over — we are going in with our lawyers.” Now there is a very large difference between a delayed result and a contested result, but the latter would almost inevitably ensue from the former as it all centres on the legality of postal votes. The worry for investors is that neither side accepts defeat.

 

As detailed in our election playbook, in the event of a Democrat clean sweep, whilst it would generate a large amount of fiscal stimulus (+ve for stocks) the expected hike to corporate taxes and capital gains tax creates policy uncertainty and could generate additional volatility into the year-end as investors liquidate positions to realise returns prior to the tax rises. There is also chatter about a financial transactions tax, which would be a negative for risk. 

 

And, moreover, there is a key question that will remain unanswered this year if Biden cleans up: Will the gigantic stimulus that the Democrats will unleash flood the US economy with too much liquidity at a time of strong economic recovery, creating inflation and leading to monetary policy uncertainty? In other words, do we get so much fiscal stimulus that the Fed becomes cornered and is forced into hiking rates much sooner than planned?  

 

Stocks closed out a bad week on Friday in the red again, with the S&P down 1.2%. There was a decent bull rally into the close though to leave it 36pts above the low at 3,270. European stocks were mixed in early trade on Monday.  

 

The new lockdown in England is a big problem for some and good news for others – the slow recovery from the crisis just took a giant step backwards, but online will do well. Primark owner Associated British Foods warned it will suffer £375m in lost sales as a result of stores being closed here and across Europe in November, but this assumes Dec 2nd will be the day restrictions are lifted. If I were a betting man, I’d say it’s more likely to later, despite what the chancellor says. Shares fell 3%. Meanwhile Ocado shares jumped 8% as it raised its full year earnings guidance to £60m from £40m. This should be a positive for MKS but it’s lower this morning. Just as the first lockdown accelerated online shopping habits, the second lockdown will undoubtedly offers some additional near-tern support for Ocado stock. 

 

The US dollar remains well bid above 94 after breaking out of the October range and it looks to test the upside of the sideways channel formed by the September peak at 94.82. Dollar strength pushed cable back to 1.2860, with Brexit barely being mentioned right now despite the very tight timetable. Expect some headlines this week on that front to disrupt. We also have the Federal Reserve and Bank of England meetings to contend with. Lots of chatter around negative rates but the MPC is much more likely to deliver a QE boost to support the economy. The decision to lock down the economy in November gives all the cover the central bank needs to do more. Data like the nonfarm payrolls and global PMIs this week can be largely ignored now we’re clearly into a new phase of the pandemic lockdowns and the election will dominate.