In brief

• Joe Biden is the new President-elect of the US. Democrats have retained control of the House of Representatives, albeit with a smaller majority. The fate of the Senate is yet unclear. With the two Georgia Senate runoff elections to come in early January, it is still possible for the Democrats to flip the Senate. However, it is more likely that the Republicans will retain control.
• Hence, our base case remains that the Republicans will retain control of the Senate while the Democrats control the White House and the House of Representatives. Amid the hyper partisan environment, this almost guarantees another four years of government gridlock and potential dysfunction.
• Yet, a Biden White House and divided Congress might be a positive for markets. In brief, it implies:
• Receding political uncertainty;

1. Lower probability of higher taxes and regulatory changes in the near term, to the benefit of sectors like Technology and Healthcare;
2. The passage of a modestly sized Covid-19 relief bill and infrastructure spending package (relative to that under a Blue Sweep scenario);
3. A more robust response towards containing the current pandemic; and
4. A more systematic and less unpredictable trade and foreign policy environment, to the benefit of businesses in Asia.

• These positives augur well for the outlook of risk assets over the longer term, which underpins our positive view on equities, more generally.
• In terms of regional exposure, we prefer Asia ex-Japan for its marginally attractive valuations versus other developed market regions. We also like China equities for their “first in first out” advantage and better growth prospects. 

By a whisker

A winner finally emerged on the fifth day of the election count. Joe Biden has won the presidential race. The pivotal moment came after news agencies called Pennsylvania for Joe Biden, awarding him 20 electoral college votes – the biggest prize among the uncalled swing states – pushing his vote tally well beyond the 270-threshold needed to win the race.

Nevada was called in his favour shortly after. As it stands, according to the Associate Press, President-elect Joe Biden has won 290 electoral college votes, although other news outlets have not called the race in Arizona for Joe Biden as the vote tallies are still too close to call.

Nevertheless, even without Arizona, Biden’s 279 vote haul is sufficient to win the election. The race in Georgia and North Carolina have not been called by any news agencies just yet. In particular, Georgia is heading for a recount given the slim margin of victory. Should President-elect Biden retain his lead in Georgia, he would be awarded a further 16 electoral college votes, bringing his total to 306, the same number of votes President Trump had won in 2016.

Historic, for many reasons

This was a historic race for many reasons.

For one, the bitter election campaign drew the largest voter turnout in more than a century, during a pandemic no less. With more than 76 million votes to his name, President-elect Joe Biden broke President Obama’s record for the most ballots cast. Yet, in the number two spot is President Donald Trump, whose haul of about 71 million votes still broke Obama’s record. Indeed, record voter turnout was not a one-sided affair.

Neither did it provide Democrats with a landslide victory they so desired. Although Joe Biden won the popular vote, his success across the rust belt states – Wisconsin, Michigan and Pennsylvania – was secured on much slimmer margins. And while he did not carry the states that typically won past presidents the White House, like Florida and Ohio, he managed to flip reliably red states like Arizona and Georgia with razor thin margins. If anything, this was an election won at the margins. We would caution against interpreting the results as an outright rebuke of Donald Trump. After all, a landslide victory is not won on marginal pickings.

In addition, many of the traditional gauges used to predict past presidential races proved less useful this time around.

• For one, to be fair, polls and prediction markets got the final outcome right – they predicted Joe Biden will win. But they also predicted he would win with margins far wider than what was observed. Wisconsin, Michigan and Pennsylvania should not have been as much of a fight for Joe Biden if the polls were to be believed.
• Second, as mentioned earlier, the winner of Ohio and Florida typically carries the White House. The winner of Florida has always won the White House since 1996, while the winner of Ohio has always won the presidential race as far back as 1964. Joe Biden won neither.
• Third, a rising market three months before the election tends to predict the success of the candidate from the incumbent party. Based on data as far back as 1927, this was true about 87% of the time. The S&P 500 index was up about 2.3% three months to the day of the election. In this case, the market predicted Donald Trump would win. He didn’t.

Looking back many years later, this election might turn out to be an anomaly. Perhaps the quality of traditional signals was compromised in a year rife with health, social and economic shocks. What might be more concerning, however, is the quality of polls. We may well face greater uncertainty in assessing the possible outcomes of future races, especially as polls and prediction markets have become increasingly less reliable in predicting the outcome of the US elections.

Election Results

Two out of three ain’t bad, right?

While Democrats succeeded in reclaiming the White House, they fared far worse in the Congressional elections. As it stands, they are expected to retain their majority in the House of Representatives, but by a much smaller margin than in 2018, as Republican challengers have been successful in flipping Democrat seats. When the House of Representatives convenes in January next year, it is unclear if Nancy Pelosi will remain the House Speaker on account of the poor electoral performance, and even if she does, she would be leading a smaller coalition. Ensuring unity in the party will be an uphill task, especially when the marginal voter has a lot more leverage.

Meanwhile, control of the Senate may not be known until 5 January next year as both Georgia Senate races will be heading for run-off elections. Democrats must win both seats to wrest control of the Senate from Republican clutches. As it stands, Republican candidates are expected to win the Alaska and North Carolina Senate contests, which would give the GOP 50 seats in the Senate. In the event Democratic candidates sweep both Georgia Senate races in January, both parties will carry 50 seats each. With Vice President-elect Kamala Harris being the tiebreaker, this effectively grants control of the Senate to the Democrats.

As such, a blue wave in which Democrats control the legislative and executive branches of government, albeit marginally, is still possible. Even so, controlling all three branches of government with the narrowest of margins would preclude dramatic changes to the tax code, fiscal spending, and other ambitious legislative priorities.

Our base case remains that the Republicans will retain control of the Senate while the Democrats control the White House and the House of Representatives. Amid the hyper partisan environment, this almost guarantees another four years of government gridlock and potential dysfunction. A Republican Senate under the leadership of Mitch McConnell was perfectly content to obstruct President Obama’s legislative priorities and was doggedly focused on confirming judicial appointments and pushing through tax cuts. Under these circumstances, there’s little doubt that the US is on the path of another four years of gridlock.

Is gridlock necessarily bad for markets?

The question is: Is this bad for the markets? Based on the market’s reaction during the fraught election week, it is not. And we tend to agree. Indeed, we see it as a favourable outcome for risk assets.

A less expansive fiscal agenda, but more robust Covid-19 response

The first order of business for a Biden administration would be to contain the Covid-19 pandemic and pass a Covid-19 relief bill. The surging number of virus cases presents a clear downside risk for the US economy. Rising hospitalisation rates and increasing fatalities may force states to implement stricter containment measures, which would inevitably impede the pace of the economic recovery.

President-elect Biden has signalled a strong and credible commitment to contain the pandemic, having announced a team comprising credible scientists to combat the virus. The media has also reported that President-elect Biden intends to rejoin the World Health Organisation (WHO) immediately upon inauguration, to aid in the global fight against the pandemic. Stemming the spread of the virus would go a long way towards improving the economic outlook.

As it stands, while the US economy is still recovering, momentum has clearly slowed. The easy gains in the labour market have been made and the pace of improvement is decelerating as evidenced by recent initial jobless claims and non-farm payrolls data. This is occurring at a time when employment is still far short of its maximum level.

As Federal Reserve Chairman Jerome Powell noted at the recent Federal Open Market Committee (FOMC) policy meeting, “the outlook for the economy is extraordinarily uncertain and will depend in large part on the success of efforts to keep the virus in check.” The failure of injecting additional fiscal support amid a fragile outlook may compound the problem, leading to a slower and weaker recovery.

Fortunately, we expect the Biden administration to pass a Covid-19 relief bill in 1Q2021 in view of the general agreement in Congress that more fiscal aid is necessary. However, amid a divided Congress, the size of direct fiscal stimulus support is expected to be less generous in scale, at about US$500 billion, far less than the US$2.2 trillion package House Democrats had proposed just before the elections.

Where fiscal authorities fail to deliver, the Federal Reserve will likely step in to compensate. Limited fiscal injections may force the Fed to ease monetary policy further to cushion the economy. In this case, the fed funds rate may not be raised until 2024 or 2025 and the central bank could increase the scale and pace of its quantitative easing programme from as early as next month in line with what Fed Chair Powell had recently signalled. This may help to provide a backstop for the economy and is positive for risk assets like equities and Emerging Market high yield bonds, generally.

In the absence of another major fiscal boost, in the vein of the US$3.0 trillion aid package approved at the height of the pandemic in March, US Treasury yields are expected to remain anchored at historic lows. A Biden administration may attempt to pass a substantial infrastructure package, which enjoys some bipartisan support, after the passage of a Covid-19 relief bill. However, a Republican Senate is likely to greenlight a far smaller package to the tune of about US$500 billion, far less than the multi-trillion-dollar package Biden had proposed during his campaign.

To be sure, an expansionary fiscal programme will be a reflationary force for the US economy. However, the seemingly modest scale of fiscal injection may not be as potent a catalyst for aggregate demand as was expected of an infrastructure bill under a blue wave outcome. Nevertheless, this is likely balanced with the commitment of the Biden administration to contain the spread of the virus, which in its own way, will improve the economic outlook. As a result, inflation expectations may still adjust higher to account for the modestly reflationary impact of such policies, although only moderately. Longer-term yields may edge slightly higher, leading to some steepening of the yield curve.

A limited legislative agenda

Without an outright majority in the Senate, Democrats will not be able to remove the filibuster. This means major legislation will still require at least 60 votes to pass. Ultimately, this will curtail the ability of the Biden administration to pass major regulatory overhauls.

A Republican Senate will also hold approving authority on Biden’s cabinet picks, and they may not take too kindly to nominees with a hawkish view on regulations. There are possible areas of cooperation in terms of oversight on Big Tech and drug pricing, but the resulting legislation, if any, will likely lack much bite.

In addition, a Republican Senate will resolutely block any effort to roll back President Trump’s signature tax cuts or any fresh plan to raise taxes. Increasing the minimum wage on a federal level will also face intense partisan opposition.

Like Presidents Trump and Obama before him, President-elect Biden is likely to govern by executive orders if Senate Republicans remain obstreperous. Durable change comes from legislation that is passed through Congress. But, if backed to a corner, President-elect Biden may have little choice but to exercise his executive authority. Even then, the areas he can influence is still limited and fleeting.

More predictable trade and foreign policymaking

A key area where the executive branch enjoys plenty of latitude is foreign and trade policy. In this respect, a Biden administration is seen as a stabilising force.

President-elect Biden might still maintain the pressure on China, but fresh punitive tariffs on the region and other key trading partners appear less likely. As it stands, the Biden transition team has noted that repairing relations and building alliances with global leaders is a priority. A Biden administration is largely expected to adopt a more predictable, less confrontational, strategic and multi-lateral approach when dealing with adversarial powers like China and Russia. This should reduce trade and foreign policy uncertainty and underpin business and investment sentiment moving forward.

The bright side of government gridlock

Loose monetary policy, less expansive fiscal policy and the growing US budget deficit will ultimately undermine the US Dollar. The currency is also likely to weaken as a Democrat White House would be less aggressive on trade and foreign policy, reversing the upward pressure on the US Dollar over the past couple of years due to the levying of US tariffs. A weaker US Dollar tends to benefit Asian and Emerging Market currencies, equities and high yield bonds.

In addition, political uncertainty has receded with a decisive election outcome. Government gridlock ensures the spoils of the Trump administration remains intact. Corporate tax cuts and the deregulatory efforts of the past four years will be difficult to reverse. This could lift the cloud of uncertainty for sectors like information technology, energy and financials, although the latter could continue to face headwinds from low interest rates which may remain very low for as long as 3-5 years.

Businesses will also benefit from a more transparent and predictable conduct of trade and foreign policy. In a sense, we could characterise the next four years as the best hits of the Trump administration without the unpredictability of foreign, trade and domestic policy. Stability is largely welcome after the turbulence of the past couple of years.

The expectation that a Biden administration will be more strongly positioned to manage the Covid-19 pandemic than the Trump administration ever was will also boost investor sentiment. Competent stewardship of the federal government is particularly important to ensure the smooth operation of a mass inoculation exercise if and when a credible vaccine becomes available. Indeed, if Biden proves successful at containing the virus and if a safe vaccine is soon found, the prospects of a more sustainable economic recovery could benefit cyclical sectors and see more money rotating from growth to cyclical stocks.

With the election hurdle largely over, financial markets are likely to focus again on the mostly favourable outlook for risk assets underpinned by the global economic recovery, upcoming vaccines, very dovish central banks, low government bond yields and a weaker US Dollar. This will be broadly supportive of risk assets like equities, credit, commodities, and Emerging Markets. In particular, Asia will be a key beneficiary, as the region is broadly a play on value and cyclicals.

Time to take some risks

The fog of uncertainty has begun to recede with a decisive election result. Nevertheless, President Trump has refused to concede and will continue to challenge the results in the courts. While this will tar President-elect Biden’s win, it is unlikely to reverse the outcome. Yes, Biden’s winning margin in key swing states may amount to less than a percentage point, but it still represents tens of thousands of votes. Vote recounts tend to swing results in the hundreds, far less than what is necessary for President Trump to overtake his competitor.

Biden’s victory was followed days later by the announcement of a surprisingly efficacious vaccine developed by Pfizer and BioNTech. Distributional hurdles aside, this vaccine discovery may signal the beginning of the end of the pandemic. These pharmaceutical companies are unlikely to be the only ones to produce a safe vaccine. The possibility of several safe options being developed and announced soon by Moderna and Astrazeneca could improve the economic outlook meaningfully.

The issue of distribution is a public policy question and it does seem like a Biden administration would have the institutional expertise and experience to manage this monumental task systematically and credibly.

Put together, we see the outlook as favourable for risk taking and as such, we have upgraded our view on equities from neutral to positive. In terms of regional exposure, we prefer Asia ex-Japan stocks for their marginally attractive valuations relative to other regional markets, especially the US and Europe. We also expect Asia to be more sheltered from the near-term tail-risk of a disruptive contest of the election results by President Trump.

Our sanguine view on China further underpins our overweight call on Asia ex-Japan stocks:

• China’s solid economic trajectory will be a key tailwind for Asia growth, and Biden’s more constructive and multilateral approach towards US-China tensions will result in reduced uncertainty for Asian businesses and investors.
• In addition to being first-in and first-out of the pandemic, China’s economic recovery is leading the globe in pace and breadth. The yield advantage offered by Chinese assets will draw global capital allocation.
• Versus global peers, the People’s Bank of China also has a greater policy cushion, in terms of conventional monetary policy, to deal with the next major crisis.

With Biden’s policies potentially being moderately reflationary, we expect the yield curve to steepen somewhat, driven by an increase in yields at the long-end of the curve. To position for a steeper yield curve, we move to downgrade our view on Developed Market Investment Grade (DM IG) from neutral to negative. In addition, with DM IG spreads at its current tight levels, we view the return offered by this asset class to be relatively unattractive and view the risk-reward here to be middling.

While the long-term outlook remains favourable for risk assets, markets may continue to remain volatile as near-term focus shifts to Covid-19 and its attendant ramifications on growth as governments pursue further mitigation efforts to stem the spread of the virus.

In the near-term, market sentiment will likely vacillate between optimism that the vaccine will rid the world of the virus and fears that governments will have to enforce strict containment measures to stem its spread in the interim. After all, even after the Pfizer-BioNTech vaccine receives regulatory approval, it will likely be several months before the vaccine can be distributed and administered at sufficient scale that its effect on the pandemic can be felt. As such, investors should still ensure they are well diversified to ride-out potential turbulence, even as the outlook appears positive for risk assets.

There’s still a possibility of a (light) blue wave

While we stick to our base case of a divided Congress, we should not rule out the possibility of a blue wave entirely. The leadership of the Senate remains uncertain at this point, in view of the runoff elections for the two Georgia Senate seats scheduled for January. If indeed the Democrats win these seats, it would give the party control of the Senate with a 50-50 split.

If they win, much will depend on how willing Democrats are in exercising power, including removing the legislative filibuster so that they can pass legislation with a simple majority. With the filibuster in place, major legislation requires at least 60 Senate votes. An institutionalist like Joe Biden, may not be willing to back a change in Senate procedure without having the security of a stronger majority.

At the same time, even if they removed the filibuster, a narrow majority means the marginal voter will have a large degree of leverage. This means left-leaning progressive policy proposals will unlikely see the light of day as a Democrat Senate must get the buy in of their most conservative or moderate members in order to pass such legislation on a purely partisan basis. Hence, there might be a lot of bark with a blue Congress, but very little bite in the resulting legislations. This would be to the benefit of sectors like financials, energy and information technology, of which a clear and present concern is potential regulatory overhauls under a Blue Congress.

In essence, it is very uncertain how a blue wave scenario might play out, especially in a situation where Democrats enjoy very narrow majorities in both chambers of Congress. It boils down to a willingness to exercise power even in the face of a narrow majority.

A four-year refresh

As we look ahead into the next four years of a Biden administration, it’s not lost to us that after four years of frenetic and unpredictable policy making, the seeming stability of a Biden presidency might seem somewhat boring and bland in comparison. But for investors, this is favourable. Indeed, boring and bland can be bountiful.