We do not believe that election uncertainty marks the end of the recovery, but rather reflects a number of uncertainties around the path of the virus, and the size and timing of fiscal support to the real economy. With virus cases rising, fiscal support is widely understood to be a key driver of market, style, and sector performance in the coming months until a medical solution is reached.
We are encouraging clients to stay invested with a focus on diversification, balance, and resiliency.
Why it matters: the size and timing of fiscal stimulus
Leading up to election day, a “blue wave” trade had consolidated in the markets – the yield curve had steepened, and the trade-weighted dollar depreciated modestly. At the same time, Investors rotated to the securities that would do well in the event of substantial fiscal spending – small caps, value stocks, and cyclical sectors outperformed.
That trade is now unraveling. While some fiscal support is expected, the size and timing of that support is much more uncertain amid an uncertain election and a divided government scenario.
A Biden victory with a divided government could present near-term speed bumps for the markets and the economy. With Republicans still in charge in the Senate, we’d be surprised to see a stimulus bill early next year much in excess of $500B, far less than the $1.5 – $2T we expected if Democrats had won. Importantly, this scenario also pushes fiscal stimulus into 2021, with more uncertainty over the size and timing of the package. While the ultimate size of a package is uncertain, the risk of under-supporting the economy seems higher at this time.
What might change this story is the resurgence of COVID infections and, even more importantly, hospitalizations. Both are rising as the weather cools, contributing to deterioration in the service sector and in small business employment. A rapid deterioration in health and economic circumstances could prompt further – or faster – fiscal support.
Economic uncertainty could drive a return to pandemic-era trading patterns in the next few months. Companies with stable balance sheets, reliable cash flows, and the capital to bridge the gap created by COVID-19 would outperform. In equities, this would favor growth and defense. In fixed income, this favors high quality credits.
Message to investors: stay invested
Trading an uncertain outcome does not make sense. It is real policy change, not the short-term political dynamics, that drive a durable investment strategy. While divided government reduces the likelihood of major policy change, investors may benefit from lower tariffs and stable tax policy.
Eventually, pent-up demand is likely to generate a wave of post-vaccine spending on discretionary services later in 2021, so long as the U.S. consumer and economy continues to hold on. Until then, any durable economic improvement may depend on further fiscal support.
In the meantime, secular economic trends, such as lower for longer interest rates, slower global economic growth, and an industry-wide push toward sustainable investing will continue to impact asset allocation.
Related: Bye Bye Blue Wave, Dollar Roars Back