US election playbook: navigating the volatility with 40 days to go

US Presidential Election
  • Temporary dislocation
  • Too many variables
  • Bigger risks ahead

Given the once-in-a-lifetime pandemic, the US election is being held in exceptional circumstances. All else being equal though, we can deduce something about how current polling might play out. The market consensus is that a Biden win and Democrat clean sweep will lead to higher taxes and regulatory risk for a large number of corporates, which will hurt equities.

There are however plenty of other ways in which the market might like a Blue-nami, from pragmatic trade policy to combined loose fiscal and monetary policy.

Trade

Could Biden open up trade with China again? The Democrat candidate is taking a hard line on China – which is playing well with both sets of voters – but will he become more emollient once in office?

Tony Blinken, a senior foreign policy adviser to Biden, said fully ‘decoupling’ with China as urged by Donald Trump is ‘unrealistic’ and ‘counter-productive’. Biden will instead reset ties with China while seeking to redress unfair practices on trade and IP. However, it will be difficult for Biden to withdraw Trump’s tariffs immediately, without gaining significant concessions.

Biden has to play the hand Trump dealt, but he might seek to drive greater consensus with China and work out a more pragmatic trade policy.

MMT

Biden may not have expressed much support for Modern Monetary Theory – in fact he was once a fiscal hawk in the old style – but under a Democrat Congress and White House there would be no rush to reduce the deficit.

In fact, Biden’s economic stimulus plans entail more borrowing. Whilst it is a stretch to suggest that Biden is a supporter of MMT, the economic and social backdrop has changed drastically in recent years and it is gaining traction in more corners of the Democrat machine.

Moreover, the Fed’s recent average inflation targeting shift opens up a new front for MMT proponents in explicitly pushing full employment as the primary goal of monetary policy.

The Fed

At Jackson Hole the Fed announced a policy shift that ought to have a material impact on expectations around rates and inflation. The Fed is taking a more practical approach than in the past when it has been guided by theories about maximum employment, the Philips Curve and inflation.

Instead of saying that the economic outcomes need to fit its models – which have always been nothing more than a best guess – it will let the outcomes drive the policy. Some would say this is a step towards fully embracing MMT, even if Powell has been against this approach in the past.

The fact is that the crisis has thrown MMT from economic theory to economic practice without any real debate. Powell has embraced a central tenet of MMT – why should millions of people be thrown on the economic scrapheap and left unemployed as the price to pay for low inflation.

Under a Democrat-led Congress and White House, MMT proponents will gain a louder voice, with implications for federal economic policy.

Overall, whilst Biden’s tax policy might be tougher on Wall Street, trade and monetary policy could be easier. But it is not quite so straightforward as that. With polls close in the key battleground states and huge uncertainty over the potential impact of postal votes, it is currently difficult to put a price on any outcome, which in turn makes it hard to trade the election per se.

Going long or short based on the outcome is far too simplistic and you could just as easily call it wrong as get it right. What we can say is that the pandemic, the economic recovery and the monetary policy response are longer term going to matter much more. And so, all else being equal is far too simplistic a view to take in what’s a very complex situation.

Will the election outcome be contested?

The only thing the market wants is to get the election out of the way – the only real danger would be a long period of legal disputes post-election, but again this ought only to create volatility at the time and would eventually be forgotten once it all shakes out.

Veiled threats by Trump to not accept a Biden win are probably over-analysed. The Supreme Court (and Secret Service) would see to that. It turns out the most antagonistic election in a generation for the people of America might well end up merely a short term ripple when it comes to markets, given everything else they have to contend with in the long term.

With 40 days to go, the race is tight and in the major battlegrounds it is too close to call. Markets will be volatile and dislocations will occur that present opportunities. The best approach is to be agile enough to contend with both outcomes and no clear winner on the morning of November 4th.

You can follow our election coverage here.

Global equities up on vaccine, trade hope

Morning Note

You just can’t keep ‘em down: Stocks surged again as vaccine hopes and positive language around US-China trade lifted the boats. The S&P 500 closed at a new record high at 3,431, led by Energy and Financials, two of the most beaten-up sectors, with Technology and Healthcare were at the bottom.  European stocks caught a strong bid with the major bourses rallying around 2% on Monday. Asian markets followed the lead overnight, with Tokyo up more than 1% and although Shanghai and Hong Kong were a tad weaker.

Germany Q2 GDP slump revised, European stocks firm

Today, the narrative is much the same as yesterday. European stocks continued to advance with gains of around 1% as risk sentiment remained robust after official figures showed Germany’s economy shrank less than previously thought in the second quarter. The numbers are still terrible: output declined by –9.7%, but this was an improvement on the –10.1% drop in the original release. Germany’s Ifo business survey showed sentiment is on the rise too.

The euro caught some bid after these two releases to advance above 1.1830 and test trend resistance having come under a bit of pressure yesterday evening again as the near-term downtrend remains the dominant force. Yesterday’s high at 1.1850 is the bulls’ target and this needs to be cleared to suggest the bears have lost control.

The DAX rose above 13,200 to take it near the post-trough high at 13,313 hit on July 21st. The FTSE 100 advanced towards 6,200 with beaten up travel & leisure stocks among the leaders. Both pared gains after the first hour of trading however. US futures point to further gains on Wall Street.

Apple continues to surge, US and Chinese officials discuss trade

Apple shares rose over $500 as investors continued to pile in and analysts noted that its forward earnings multiples are not that rich after all, and certainly not as expensive as rivals. Apple has transformed itself from a pure hardware manufacturer to a full service led tech platform and therefore the stock has rerated.

Top US and Chinese officials discussed the phase one trade agreement after a meeting scheduled for earlier this month was postponed. Both sides are seeing progress in areas like the increase in purchases of US products by China.

The two sides also discussed how China will ensure greater protection for intellectual property rights, remove impediments to American companies in the areas of financial services and agriculture, and eliminate forced technology transfer, the US Trade Representative said in a statement. This came after the US and EU agreed to reduce tariffs on some goods.

AstraZeneca begins antibody trials, economists concerned over double-dip recession

Meanwhile vaccine news is still helping rather than hindering risk sentiment. AstraZeneca said today it has begun the phase one clinical trial of its monoclonal antibody combination for the prevention and treatment of Covid-19. However, Hong Kong has reported its first confirmed coronavirus re-infection, with a man found to have been infected months apart by different strains of the virus.

Economists remain concerned about the double dip: according to the National Association for Business Economics, there is a one in four chance the US economy could fall into a double-dip recession. Two-thirds of economists surveyed think the world’s largest economy remains in recession.

Republican convention kicks off with warnings of election rigging

President Trump got the Republican convention off to a belligerent start as he warned of a rigged election as he sought to cast doubt over the voting process ahead of the election. I don’t think the market really needs to worry about there not being a smooth handover of power, but I would think that a close result could see Trump launch multiple legal challenges which would create the kind of uncertainty markets don’t like.

Elsewhere, gold continues within the near-term downtrend but is yet to make a new low since the $1911 trough last week and is catching support from the longer-term rising trend line. US real rates (10yr TIPS) slipped further into negative territory again.

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