Market Update & the USA Election 2020

With the USA election less than a month away we look at the likely impact on the market if things don’t go as expected. The expectation is Joe Biden will win and will naturally control the lower house however the Senate will remain in the hands of the Republicans. That will mean any meaningful “progressive” changes to taxes or regulations will likely be either watered down or won’t happen at all.
 
The markets have expected a Biden/Harris government will not be anywhere near as scary as a Warren or Sanders government would have been. The problems as the market see them are threefold:

1.  Higher taxes
2.  Increased regulation & red tape
3.  Slower growth in the economy, which leads to consumer and business confidence being lower.

 
This results in lower earnings and future earnings uncertainty.
 
On these issues, Trump has delivered, hence the market skyrocketing to all-time highs, even during a pandemic. What really worries the markets, is a “contested election.” The worst possible scenario is that President Trump appears to win the Electoral College but then loses several days later as absentee ballots are counted. Both sides will then contest the presidential election results.
 
If Joe Biden becomes president-elect, the stock market may be hit with some year-end tax selling in anticipation of higher dividend and capital gains taxes.
 
If President Trump has a decisive victory, look for a relief rally. The good news is that even if the worst-case scenario plays out and stocks selloff, we expect they’ll bounce back.

1. Firstly, the US dollar will weaken, which is a windfall for multinationals. Simply put, a weak US dollar means bigger profits for the multinationals, as their products are cheaper outside the USA.
2. Secondly, the US federal government has a major deficit problem – a $3.3 trillion deficit, to be exact. This is three times the deficit from a year ago. So, the US government will need to continue printing money to keep the deficit down. This will provide liquidity for markets.
3. Finally, we remain in a low interest rate environment. The US Federal Reserve recently announced that it would keep interest rates at or near zero until the end of 2023 or until the US economy is on a stronger footing. Even if the Federal Reserve wanted to raise rates, it can't because of the huge federal deficit, as the US government must continue to pay interest on the US Treasury Bonds that are used to fund the deficit.

 
In Australia, it will be the same story. The RBA has made it very clear that Australia’s interest rates are likely to stay exactly where they are for years. Our own deficit blowout due to emergency funding for JobKeeper and JobSeeker will see us with a deficit for at least a decade, if not longer. Deficits are funded predominately by governments issuing Bonds and it’s not in the RBA’s or the government’s interest to raise interest rates until debt issuance is normalised. On top of that, there certainly won’t be any inflation to push rates higher. With higher unemployment, businesses struggling, and other issues associated with the Covid-19 pandemic, we will see inflation low for years. Therefore, we don’t see interest rates raising their ugly head for some years to come.

This provides markets with the one thing they love – Certainty. Investors are certain now that interest rates are no longer a factor in investment decisions. This brings us to the “Elephant in the Room” – Covid19. Not only has the pandemic provided governments around the world with deficit headaches, it has increased geo-political tensions particularly with China.
 
It’s clear that things won’t be back to 100% normal until a vaccine is available and I expect that is not far away. Based on so many potential vaccines in Phase 3 Trials, it’s only a matter of months until we start seeing progress. Around 80% of drugs that make it to Phase 3 trials actually get approval to go to market. Currently, we have vaccines from Johnson & Johnson, Moderna Therapeutics, Pfizer, Astra Zeneca (Oxford University) and Novavax all advanced in Phase 3 Trials.
 
So, with interest rates set to stay low for the foreseeable future, there are two growth asset classes that stand out – Residential Property and Shares. Residential property remains a relatively illiquid asset class, which may be limited by population growth long term. However, investors are buying simply because everything else is so uncertain. As for stocks, Technology and Healthcare are absolute standouts. Everything else is based purely on the quality of the business.
 
Winners & Losers:
 
Cloud storage companies, Wi-Fi providers, semiconductor companies, in fact nearly all the Tech Sector are winners in this “new world". Another winner is clearly online shopping.  MasterCard and Visa are musts, but you could include PayPal, Amazon, eBay & the BNPL group of businesses. Increasingly, retail companies that have a strong online presence will do better than ones that don’t.
 
The losers are also pretty clear. Property trusts and real estate companies involved in CBD office buildings. While companies may retain a “corporate presence” their footprint will be smaller resulting in significant vacancies over time as leases are not renewed. Also losing in this scenario are businesses reliant on CBD foot traffic – cafes, restaurants, retail in CBD districts. Public transport will be under-utilised. On the flipside, businesses in the suburbs will see an increase in business as people remain in their “neighbourhood”. We have also seen people spending money on renovations and buying second homes or moving out of cities as they realise working from home is the new reality. This is why residential real estate prices have remained buoyant despite predictions of huge price falls due to Covid-19. Interest rates are also having a role to play here as well. 
 
The biggest threat right now is the US election and not if we end up with Biden, but if the election is “contested”. If both sides accuse each other of “manipulation or wrongdoing” – that will be a disaster. We need either Trump or Biden to win decisively – the split control of the House and Senate will keep markets relatively calm. A close election and with so many people casting mailed votes could cause chaos, and markets don’t like uncertainty.