Barring a successful series of court cases, the Biden-Harris US Presidential victory is confirmed. This week’s Pfizer vaccine announcement has given us a taste of how markets might perform from here.
It feels that a lot of time was misspent in the run-up to the election looking at the performance of the S&P 500 under Republican and Democratic leadership, in an attempt to work out whether the markets will perform better or worse under different leaders. The record books show that US markets compounded at double digit returns under the first four year terms of both Obama and Trump, but the backdrop for every election is a different one. As important, if not more, is the maturity of the economic cycle; is inflation rising or falling, and how much unemployment is there in the economy.
Irrespective of who has won the US election (almost certainly Joe Biden, bar an extraordinary legal U-turn), it feels that 2020 has already undergone a regime change in both monetary and fiscal policy. In August the US Federal Reserve announced a change to its inflation policy, no longer targeting an explicit 2% rate, but instead targeting an average of 2% over the cycle. The length of the ‘cycle’ not being disclosed.
In short, deflation, not inflation, is the enemy and this means that we can expect to see ultra-loose monetary policy until unemployment falls from 8% back to much lower levels, with inflation being allowed to bubble higher in the short term. Interest rates will stay lower for longer, helping consumers finance mortgages at low rates and for companies to borrow at attractive levels.
However to get inflation, the economy is going to need very loose fiscal policy , which both the Federal Reserve (Fed) and European Central Bank (ECB) have been pleading their political counterparts to get on with. Unlike the years after the 2009 global financial recession, it seems inconceivable that any major political party will demand fiscal austerity; the lessons from Europe, which saw the fringe political parties from both the left and right make major inroads over successive elections, seemingly have been learnt.
Instead, fiscal stimulus seems to be the order of the day. The talks between US Treasury Secretary, Steve Mnuchin and Democratic Speaker of the House, Nancy Pelosi, stalled before the election and may well continue to do so until Biden’s inauguration day on 20th January. Following this it is likely that there could be a package agreed in the ballpark of $1tn, with further rounds for infrastructure, green energy and other similar projects. At the same time, tax rises on corporates and households earning more than $400,000 a year may be scaled back due to the failure of a Democrat ‘clean sweep’.
Financing this should put pressure on the US dollar, although it’s difficult to know whether that will lead to a sustained weakening against major Foreign Exchange (FX) pairs. The Eurozone, for example, is very dependent on exports and already has a deflationary problem, therefore any action in the US may have to be met with similar packages in Europe to avoid importing more deflationary pressure via a weak exchange rate.
Looking ahead, from an investment perspective, the yield curve should steepen (although some form of yield curve control should not be discounted), harming holders of long dated bonds who have made exceptional returns over the past 30 years. This points to a possible rotation from growth stocks, which have performed so well, into value stocks. The inference being that the bull market can gradually broaden from here, with leadership changing hands from ‘work from home’ technology platforms to other parts of the market. Gold, inflation linked bonds and other portfolio diversifiers continue to have a role to play in client portfolios.