The moment we have all been waiting for is here … and we don’t know the final results yet. This is not unexpected – markets were primed for a few days of uncertainty – but it is clear that this election was much closer than the polling indicated.
The Presidency is the most up in the air at this point. Counting delays in key midwestern states will continue for another few days (at least). The potential for multiple legal challenges is very real – it could be an ugly few weeks of legal headlines from that standpoint.
The picture is clearer in the Congress. Democrats are underperforming across both houses, and importantly, it is likely that the Senate will stay in Republican hands. This is key for passing any legislation, and points to smaller fiscal stimulus and less of a chance of higher corporate taxes and onerous regulatory changes.
Markets are reacting in a volatile fashion to the overnight news, and while we caution against overinterpreting a few hours of price action in illiquid markets, a few things are evident looking at the reactions in bonds and stocks:
- Interest rates are broadly lower. Bond investors were positioning for a massive fiscal package (possibly up to $5 trillion) under a Blue Wave outcome, and that is now off the table. Expectations for such a large stimulus caused long-end interest rates to increase on concerns about higher budget deficits. As those positions are unwound, lower rates and a flatter curve make good sense. Already the 2-yr/10-yr curve is down about 11 points, on pace for the most flattening since late March. Monetary policy will continue to shoulder the burden of supporting the economic recovery, which means interest rates are not going higher.
- Equities are up but there is a big rotation under the surface. Large cap technology is strongly outperforming small-caps, a reversal of the last month of price action. Similar to interest rate positioning, this recent action was based on a large stimulus package under a Democratic sweep. With that off the table, the market is going back to rewarding those companies that can grow revenue in an uncertain economic environment (favors Large Cap Growth over Small Caps or Value).
Markets hate uncertainty, and we took off the table last night a Biden administration with a substantial mandate for remaking the economy and government. In our view that is good for markets in the medium term, and retains the virus versus stimulus dynamic for the short term. We should get a sense of what kind of stimulus is going to come into focus in the next couple of weeks, but either a Trump/R-Senate OR a Biden/R-Senate is likely to get at least something done on this front.
As a proxy for the likelihood of the dreaded “contested election,” betting markets for the Presidential election have been extremely volatile over the past 12 hours and there are a few states that look very close at this time. Regardless of the outcome, it looks like there could be some legal challenges by the losing party in key swing states. The market can look through one or two of these and focus on the favorable medium-term policy backdrop, but if the legal fights broaden to a point where it requires more than one hand to keep track of the tally, that would probably lead to short-term volatility for risk markets (particularly stocks).
Bottom line: Once-in-a-generation changes in Tax, Regulatory, and Fiscal policy were thought to be a real possibility under a strong Blue Wave scenario. No matter what the ultimate outcome is, the winner of this election is far more likely to be “status quo” than most thought possible – and this is something that markets should embrace.
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