As we write this, no presidential candidate has been declared the winner in a tight race that defied pollsters’ predictions. We could still be days away from clear election results (and months for the Senate race owing to at least one run-off vote in Georgia), but what we can state is that the expected blue wave petered out before making it to its destination and we are heading for a divided Congress.
Historically, a divided Congress has been regarded as positive by investors given the low likelihood of major policy changes. This time around is no different and key overhangs (taxation and antitrust) for equity markets will likely be relegated to the back burner for the foreseeable future; presumably explaining the initial positive response in the equity markets.
Let’s not forget, however, that equity valuations are very extended. The MSCI World’s valuation is in the top decile of its historical distribution. Such a rich equity valuation is in stark contrast to the continuing macroeconomic and health-related uncertainty.
The lack of a strong Democratic majority in Congress reduces the odds the U.S. government will be able to deliver the large fiscal stimulus package investors were anticipating. In our view, this should help keep long-term interest rates from rising from current levels as Treasury funding needs are smaller.
Less money coming from the government combined with the likelihood of a much less cohesive response to the current crisis could lead to a longer and bumpy economic recovery1 if the government fails to implement tough measures to control the spread of the virus. While improved trade relations could reduce uncertainty and spur investment and economic activity, there seems to be little chance of an improvement in this domain as well.
A combination of high uncertainty and falling rates is generally a constructive backdrop for gold as well as for consumer staples and utilities sectors. At the same time, this is also a positive outcome for health care and oil companies. It appears that in recent months, many investors reduced their exposure to these two sectors as they presumably feared the negative impact of policy changes under a strong Democratic government.
At the other end of the spectrum, sectors that are especially sensitive to the economic cycle are the most negatively exposed to a divided congress. This is particularly true given that these sectors outperformed in recent weeks as they priced in the likelihood of a strong Democratic showing in the elections.
Today's very turbulent trading session is not, in our view, justified by significant changes in fundamentals. We continue to follow market developments in order to capitalize on any investment opportunities that may arise.
1 Pandemics Depress the Economy, Public Health Interventions Do Not: Evidence from the 1918 Flu, Sergio Correia, Board of Governors of the Federal Reserve System, Stephan Luck, Federal Reserve Bank of New York, Emil Vermer, MIT – Sloan School of Management, June 5, 2020
Source of all data and information: Hexavest as at November 4, 2020, unless otherwise specified.
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