Markets are already pricing in a Biden victory and fiscal spending spree, explains Tom Bailey.
Earlier in the year, in response to the pandemic, most governments turned on the spending taps on an unprecedented scale. In particular, despite some initial disagreements, US politicians agreed to a stimulus package worth roughly $2 trillion.
Alongside an extremely dovish monetary policy from central banks, this helped to restore the confidence of markets, allowing for the strong equity market rally evident since the end of March.
Since then, however, political deadlock has taken hold in the US. Despite a broad consensus among markets that the US economy needs more fiscal stimulus, the US government has, so far, failed to pass any new major spending bills. And it seems that there is little hope of any fiscal stimulus passing anytime soon. The Republican-controlled Senate is broadly opposed to more spending, while President Donald Trump has suggested that he is not interested in more fiscal stimulus before the election.
As Paul Donovan, chief economist at UBS Wealth Management, notes: “Hopes for a US pre-election fiscal stimulus are quietly fading to nothing. There might be something for the airlines, but no big package looks likely given the language (and amount of time available).”
However, despite this absence of fiscal stimulus and the potential resulting damage to the US economy, the US market has continued to perform relatively well. The reason is simple. Markets are forward-looking and try to price in news and events ahead of time. Right now, markets are increasingly pricing in the likelihood of a Democrat victory November’s election, with Joe Biden winning the presidency and his party taking control of the Senate. That, it is assumed, will result in a significant increase in fiscal spending.
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As Florian Ielpo, head of macroeconomic research and a multi-asset portfolio manager at Unigestion, notes: “Over the past three months, a growing connection between stock-market performance and voting intentions for Joe Biden has begun to dominate financial markets. This relationship became increasingly evident from 25 September, when markets rebounded as voters expressed a growing readiness to elect Biden. What seems to explain this relationship is the fact that a Democratic takeover in the US would help open the door to a new wave of stimulus.”
Analysts at Goldman Sachs have also noted the same phenomena, pointing out in a recent research note that the odds of both Biden winning the presidential election and the Democrats taking the Senate are increasing. This, they say, means that markets are increasingly positioning for a sizeable stimulus package after the election.
If this does turn out to be the case, what does this mean for investors? Mobeen Tahir, associate director of research at WisdomTree, says a good starting point is to consider what happened when the US government turned on the spending taps back in March in its initial response to the virus. Tahir notes: “When a $2 trillion fiscal stimulus was announced in the US at the end of March, it became an important driver in causing markets to turn. Equity indices bounced back strongly even at a time when the damage of the pandemic was at its worst for the real economy.”
Tahir notes that there are “three positioning” lessons investors can take from March when thinking about stimulus now.
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First, Tahir says: “Think equities, but think carefully.” By this he means that not all parts of the market are likely to rise. He points out that the rally in equities since the end of March has not been universal across all sectors and factors. “The clear winners until now have been technology companies and those that qualify as ‘high quality’ businesses, i.e. companies that have maintained strong profitability through the crisis,” he says. This trend, he argues, will continue until the virus is meaningfully overcome.
Second, Tahir encourages investors to stay diversified. While a Biden victory and resulting stimulus looks likely, it is not guaranteed. Moreover, there are other headwinds that markets will have to contend with. Tahir says: “Risks and uncertainties still abound for equity markets – the course of the pandemic and the economic recovery remains perilous, and the outcome of the US elections and what bearing it will have on critical issues, including trade, is yet to be seen. If diversity was desirable and fruitful, after the previous stimulus earlier in the year, it should still be as necessary now.”
Third, Tahir argues that investors should keep inflation in mind. He notes: “Fiscal stimulus can produce the good kind of inflation – demand-pull inflation – which is driven by a rise in aggregate demand in the economy. This is accompanied with gross domestic product growth and unemployment falls.”
If there is an inflation uptick, it makes sense for investors to have some exposure to the sort of assets that perform better when prices are rising. This, says, Tahir, includes cyclical assets such as equites and industrial metals, which can “provide a natural hedge against this type of inflation as demand grows as the economy gathers steam”.
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