It Takes 270 to Win
Markets have to some extent started to price in the likelihood of a "Blue Wave", albeit with coronavirus cases remaining in focus. Specifically, while the S&P500 has declined by 6% from the recent high (October 12th), US Treasury yields are up by 7 bps to 0.85% and curves are steeper. Moreover, investment grade credit spreads have been broadly stable at 130 bps. Equally importantly, traditional cyclical sectors have overperformed defensives by 2% and Technology stocks have declined by 10%, notwithstanding down from record-high valuations. Last but not least, emerging markets are outperforming developed markets mainly due to EM Asia discounting less trade tensions, as well as the ongoing Chinese economic recovery.
Former Vice President Joe Biden is clearly leading against President Donald Trump in the race for the White House according to national polls, with an average lead of 7 points. In a similar vein, prediction market-based pricing implies that Biden will win the presidency (47% vs. 35% for President Trump), whereas there is a sizeable likelihood (53%) that Democrats will also control Congress (the so-called “Blue Wave”). Democrats remain poised for a potentially strong performance, with Electoral College ratings showing Joe Biden surpassing the required 270 electoral votes to win.
A Blue-Wave scenario would possible mean a meaningfully fiscal stimulus in the short-term with long-term interest rates slightly higher and the USD facing modest depreciating pressures – mainly from EM FX. The prospect of higher corporate taxes could trim any narrowing of election premia suggesting mixed results for the headline equity index, while rotation toward more cyclicals and value segments could accelerate. The conventional wisdom, however, could be tested as covid-19 developments may pose unseen risks (e.g. deterioration of banks’ balance sheets, increased corporate default rates, real economy entering recession anew etc). Having said that, it is not impossible that President Trump will win a second term (lower corporate taxes), despite the fact that his chances are running low. Moreover, a contested US election after which the winner will remain unknown for several days and/or weeks (assuming vote recounts) could lead to elevated equity market volatility as prospects for fresh fiscal stimulus in the short-term will diminish.
Note that global equity markets ended October in the red due to i) rising new Covid-19 cases and increased mobility restrictions, ii) political uncertainty in the US, as the election process enters its final stretch and iii) the absence of any progress towards a pre-election fiscal stimulus. Overall, in October, the MSCI ACWI index was down by -2.5% (-2.5% ytd). Region-wise, the S&P500 declined by -2.8% (+1% ytd), while volatility spiked to a four-month high (VIX: 40% on October 28th, 29% monthly average). The Technology Sector came under pressure (-10%) despite better-than-expected Q3 earnings results, as guidance was bleak. The Energy Sector declined by -4.7% (-53% ytd), due to lower oil prices following heightening concerns regarding global demand prospects, whereas the prospect of a Biden presidency weighs negatively for the sector.
On the other side of the Atlantic, the Eurostoxx fell by 5.8% in October (-18% ytd), recording the biggest weekly decline since March in the past week with Technology (-11%) and Energy (-9%) leading the decline. Given the recently announced partial lockdown in Germany and with a worsening Covid-19 backdrop now starting to impact the economy (Ifo, ZEW, labor market data came out below expectations) the DAX 30 is beginning to look vulnerable. Indeed, it declined by 10% in October, following its superior performance against the SXXE during the past 10 years.
European government bond long-term nominal yields declined significantly (Germany: -11 bps to -0.63%). At the same time, periphery bond yields also fell post the ECB meeting (Italy: -11bps to 0.76%, Spain: -11 bps to 0.14%). The European Central Bank (ECB) stood pat on October 29th, as expected, pointing though to the increased probability of taking new action at its December meeting, which will also be accompanied by the ECB staff’s quarterly economic projections (recalibration). In fact, Ms Lagarde pointed to a near certainty concerning additional measures, albeit refraining from making any presumption regarding the most appropriate mixture of tools that will be employed. Having said that, consensus expects an expansion of the Pandemic Emergency Purchase Programme (PEPP) by €500bn to a total envelope of €1850bn, combined with a 6-month extension of its duration to end-2021 in order to support the euro area economy