While the official outcome of the US election remains unknown, the odds of a Biden win and a divided government (Republicans maintaining control of the Senate) are increasingly becoming the most likely outcome.
This outcome is often seen as the ‘goldilocks scenario’ for financial markets – no radical policy changes (that could hurt corporate profits) and the Fed providing ample liquidity to try to support the economy and financial markets when required.
The market over recent weeks appeared to be positioning for a “Blue Wave” which carried the prospect of a much larger stimulus package which could have exceeded U$5tn in total, ~70% more than our highest prediction under a divided government. With a Blue Wave scenario all but removed, it is very unlikely Democrats will be able to raise US corporate and income taxes for higher income earners and pursue the more controversial aspects of their progressive agenda.
Stimulus and tax hikes are critical policies which the markets in our view have been positioning for. This has led to an increased appetite towards value cyclicals. The market was positioning itself for a ‘reflation trade’ driven by the prospect of higher inflation and therefore interest rates, and, thus style rotation from growth to value stocks. As we recently presented to investors, in an environment of heightened uncertainty we have been planning for three likely scenarios (two of which revolved around the election).
We are now heading towards our first scenario of a split congress which we expected would result in lower stimulus and continued outperformance of growth. Ultimately this means “more of the same”. A divided government will constrain stimulus and tax hikes; we expect this to continue to favour growth stocks and the market heavily traded this way overnight with the NASDAQ rising close to 4% and traditional growth sectors of Healthcare, IT, Consumer Discretionary all rising 4.5%, 3.7% and 3.1% respectively, vs Materials and Financials which fell 1.6% and 0.8%. Inflation expectations were also clearly reduced with the US 10-year Treasury yield falling 13bp from 0.90% to 0.77%.
Within T. Rowe Price’s Australian Equity Strategy, we have been repositioned in favour of cyclical growth such as James Hardie and recovery names such as IDP albeit still holding a healthy exposure to defensive growth (Healthcare) and some extreme growth (Xero). This positioning sees us well placed for the likely outcome of the US election.
We continue to expect an economic recovery, locally and globally, with additional fiscal and monetary stimulus, However, this is likely to be at the more moderate end of previous market expectations. We continue to believe low interest rates will be required for quite some time to support the recovery. The RBA appears to agree, hence its decision to cut interest rates on Tuesday and more importantly extending its yield curve control strategy by announcing a $100bn bond buying program for 5-year and 10-year Government debt.