What happened: market relief as a contested scenario is avoided_
- The US election turned out to be tighter than expected and the Democratic landslide did not materialise. At the time of writing, Joe Biden is likely to become the next US President while the Republicans should retain control over the Senate.
- There is still a chance that the Biden victory proves large if he ends up winning Georgia and Pennsylvania, on top of Nevada.
- The margin of victory matters as it reduces the likelihood of the Trump team contesting the outcome in Court. There has been clear relief in the market that this contested scenario is avoided: risk assets have rallied broadly as short-term volatility collapsed.
What it means for the policy agenda: a sweet spot_
The key regarding future policy is a divided Congress. This outcome is interpreted as a sweet spot that will allow to reduce policy uncertainty that had prevailed under the Trump administration while limiting the ability of the Democrats to pass any aggressive anti-business agenda. In detail:
< Any cancellation of corporate tax cuts passed under Trump will be made difficult by a Republican Senate >
< The upcoming fiscal stimulus should be capped by Republican fiscal hawks, implying lower Treasury issuance volumes >
< Most aggressive sector regulation is unlikely to come to pass: these include Tech, Energy and Pharma. >
< Any large-scale infrastructure programme (or so-called ‘Green deal’) has become unlikely. >
Market implications: our views and positioning _
Allocation: pro risk_
- We confirm our pro-risk positioning. Additional positives are lining up through year-end (vaccine, Brexit, central banks). Our model portfolio is overweight in equities and high-yield credit.
- Two key themes in our allocation are postponed: US bond yields are less likely to move higher in the near future and the cyclical rotation may await until next year as tech and the US market look set to outperform for now.
Fixed Income: lower risk premia across the board _
- The US election outcome is in our view the lowest policy uncertainty combination. This justifies lower risk premia across the board.
- Rates: tight range for now_ Long-end Treasury yields have rightly deflated from their recent rise as size estimates of the next US fiscal stimulus package are revised lower and speculative positioning in bond futures was stretched. We expect interest rate volatility to stay low and long-end core yields to stay in a relatively tight range in coming weeks, especially as central banks remain hyper-active. The sanitary outlook will be the first driver of long-end yields and interest rate volatility. We expect the recent trend of USD yield curve bear-steepening to resume in 2021.
- Lower policy uncertainty, extreme monetary/fiscal stimulus, strong technical set-up, a low distress ratio (peak default rate is well behind us) and an expected medium-term improvement in the sanitary outlook keep us bullish on credit. We have recently switched to overweight EUR and USD HY (for the first time this year) and we’ll likely keep this positioning for some time. We also continue to highlight subordinated financials as our most preferred credit market segment for the next 12 months, with strong (and even improving) credit metrics, very attractive absolute and relative valuations and rapidly strengthening technicals.
Equities: favour structural growth _
- The US elections delivered the most friendly outcome for stocks and a perfect cocktail for structural growth strategies.
- The prospects of a Democratic sweep had pushed long-term yields higher on expectations of a jumbo stimulus. This could have triggered a significant rotation out of growth stocks (long-duration assets) into cyclical stocks (short-duration assets). This will clearly not happen now that the “blue wave” scenario is off the table. The market should quickly adjust its playbook:
- Winners: Long-duration assets / bond proxies, i.e. secular growth and specifically mega-cap tech, healthcare/pharma (which looks compelling given P/E discounts to the S&P 500) and stocks exhibiting regulation risk.
- Losers/laggards: cyclicals, banks, small-caps, policy specific trades such as renewables and infrastructure.
- With election risks now behind us, investors will likely put to work elevated cash balances. TINA (“There Is No Alternative”) means this capital will likely be invested in equities, and specifically tech/structural growth.
Nasdaq > S&P 500 > Russell 2000 > Europe / Emerging Markets
- From a volatility standpoint, VIX near-term futures came down, suggesting that the market has enough information to start pricing more certainty. European indices experienced the same trend. It may be just a start though as the vol curve is still slightly inverted and more pressure is expected through the end of the year.
Convertible bonds: positive tailwinds_
- Convertible bonds will benefit from positive catalysts in equities (cancellation of corporate tax cuts and regulation) and credit (central banks).
- The convertible universe has a bias towards high growth segments, especially around the digital disruption, a thematic that we continue to value.
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