If you haven’t heard Joe Biden is president-elect of the United States of America, you should probably stop reading now. The market had priced in several predictions for the US elections of 2020. We all know the polls were not as accurate as projected but, as usual, the devil is in the details. The Senate and House election outcomes have caused the major moves in the market thus far, not so much the presidential election. And don’t worry, we will obviously get into the Covid vaccine’s effects on the market, too.
First and foremost, the Senate and House election surprises. What this means in market speak is the unwinding of the “blue wave” bet. In the three weeks preceding the election, the S&P 500 fell almost 7% from peak to trough. The market had become increasingly concerned with the probability of Dems flipping the Senate, winning the presidential election, and preserving their lead in the House. A blue government in control of all three branches would increase the threat of tech regulation, the driving force of the stock market (think FAANG) for several years and complicate performance even further amid Covid-19 and shutdown orders. Concern about corporate tax increases was massive as well, if not the biggest market threat.
As you are hopefully aware, the Democrats preserved their lead in the House, but lost seats, and the Senate did not flip as some had anticipated. Now, Democrats need at least two more wins in outstanding races to flip the Senate – three if President Donald Trump were to win reelection (the VP has final say if a Senate vote is tied). Most experts have the probability of a contingent election or any other material challenge to Joe Biden’s win at near zero. And the probability of Democrats winning the two Senate seats that will go to runoff in Georgia is likely less than 20%. Though you can bet there will be millions, if not billions of dollars thrown at those two elections.
In short, the unwinding of the “blue wave” trade was an affirmation of a gridlocked US government. Apparently good for the stock market, but agitating for American citizens.
Oh, the irony.
To elucidate, “good for the stock market” refers to the S&P 500 climbing ~8.5% for eight days from Election Day onwards, November 2nd to November 10th. The aforementioned risks of a “blue wave” were off the table, and with Republicans likely controlling the Senate (the more powerful of the two branches of Congress), any substantial legislation proposed by Democrats, like a reversal of Trump’s corporate tax cuts, should be easily blocked in the Senate. So the next four years should only bring incremental changes in actual government policy as currently priced in by the market. Biden being the President of reform, and not revolution, was perhaps accurate.
So we know the gridlock is good for beta, but what about certain industries, and even specific stocks? Overall, the election was good for tech; the threat of regulation in the US has subsided. Uber, along with Lyft, DoorDash, Instacart and Postmates, won big in California with the passage of Prop 22. The referendum effectively won exemption for said companies from California’s gig-work law known as AB5, with a vote of 58% in favor. AB5 makes it harder for companies to declare that workers are independent contractors instead of employees (if you are further intrigued by this, refer to the San Francisco Chronicle’s recent article on the Prop 22 outcome). On the other hand, it’s hard to say that threats against tech have completely diminished when other countries in the world are taking action. Just this week, on November 10th, Amazon was hit by a second antitrust lawsuit in the EU. Separately, clean energy ETFs are also on the rise, as Dems have made this a policy priority, though much of that was priced in before the election.
As an aside, if you wait for the actual outcome of some future event to occur before buying a stock or an ETF that could be heavily influenced by said event, you are more than likely too late. You have to take risks to make a real return – some might even say, bets.
For risk assets, the blue wave trade has been reversed, as determined by the election, and stocks are up. But wait a second – what about rates!? As someone who works in finance, I love the consistent face of confusion when I tell someone I work at a Dealer/Investment Bank, and when they ask. “Oh, you mean, like, stocks?”, and I answer, “No my friend, more like bonds and commercial loans, and even more specifically, interest rate derivatives.” The conversation usually ends there. But, make no mistake, debt is what makes the world go round.
Below is a Bloomberg graph of the 10yr tsy from 11/1 to 11/13. As you can see, it has been a bit of a rocky road with the 10yr trading in a ~20bp range in November. Rates fell initially on Election Day, as the market noticed Biden was winning but again, without also flipping the Senate. The chances of a large stimulus package is much lower with a divided government- some Democrats wanted a stimulus package over $2 trillion, while Republicans generally didn’t want to exceed $1 trillion. In finance speak, lower probability of a large stimulus means less “new” tsy supply needed, and this decrease in expected supply causes repricing – lower anticipated supply means higher bond prices and lower rates. When Trump started to voice an election challenge and the fear of governmental instability increased, some risk averse investors also fled to treasuries, further factoring into the initial drop in rates. December 8th should be a stark deadline for that trade, as this is the “safe harbor” day in order for states’ election judgements to be automatically accepted by Congress. Moreover, several Trump lawsuits have already been thrown out in key battleground states.
Moving on from the election (hopefully), the vaccine announcement by Pfizer on 11/9 was momentous in itself. The timing was a bit peculiar, should I say, but the conclusion is the same. If the vaccine is effective and safe, and the logistics can be properly addressed, we should be back to a normal world within a year (or so).
Immediately after the vaccine announcement, the 10yr tsy jumped approximately 15bps, and the S&P 500 (general beta) also jumped ~4%. The Nasdaq though, interestingly dropped ~2%. What happened on Monday between the 10yr and the S&P 500 is generally considered “risk-on.” Investors exited safer assets like bonds and went back into stocks. But most of this reallocation was into value and cyclical stocks, think of the Dow Industrials – banks and energy were up big. The airlines and hospitality industries also got a nice bump. But this also implies that tech is not as preferable anymore, in a soon-to-be normal environment.
In other words, we probably won’t get to do our conference calls in white button downs and pajama bottoms next year (depending on your industry). In 2021, you might actually regularly go to the store again instead of buying everything online. And, god forbid, you go on a real vacation instead of watching and pretending to like a fad documentary like Tiger King. Bad for Zoom, Amazon, and Netflix – but good for oil, travel, and basically anything else physically involved.
So, where do we go from here – with a new president-elect, a vaccine on the table, and a gridlocked government?
The tradeoff between tech and cyclicals will prolong. It’s not over till the pandemic’s actually over.
- There will likely be some headline risk/reward with the large cap techs (FAANG) related to the vaccine and also a 2nd round of lockdowns:
- Europe and some American cities (e.g.,Chicago) have already gone down the shutdown path again. If more do, expect tech to get another short term boost, but it won’t be as volatile or as large as mid-year 2020
- The vaccine still has a way to go before large-scale government approval. I am by no means a scientist, but to my understanding this will be the first mRNA-based vaccine ever. We do not yet know the long term effects of such a vaccine, unless you have a time machine – kindly share.
- There will likely need to be some added scrutiny given the mRNA base that can cause release days, which might be unexpected by the market, and apparently this vaccine has to be stored at super cold temperatures (-70℃) before it can be administered. This creates logistical challenges that make the late 2020/early 2021 release date dubious, in my opinion.
In general, I believe the prospect of a materially up year for stocks in 2021 is unlikely:
- The S&P 500 is already up ~10% for the year this year, even during the pandemic. This is attributed to massive fiscal and monetary stimulus. But as the pandemic subsides, either by herd immunity or a vaccine, so will those stimulus policies. One should also take into account that the S&P is up 10% annually, even taking into account the ~35% drop in March. In other words, most (if not an excess) of the upside for stocks has already been priced into the market, on a post-pandemic basis. Investors buy stocks expecting one or two-year forward returns, not immediate returns.
- Consequently, I think most of the real stock gains to be made in 2021 will be through timing the gradual reallocation from tech (or growth) back into value and cyclicals, and determining if and when tech is potentially appearing undervalued. That has a long way to go though with beta up 10% on the year, the Nasdaq is up ~30%.
What will the Fed do, and what will Biden do with the Fed (read: Powell)?
- By most accounts, even on a bipartisan basis, Powell has been admired in Washington. The speed, variety, and sheer number of tools utilized by the Fed to counter the effects of the shutdown and pandemic in general were decisive and well-received by voters and politicians alike.
- Powell handled Trump’s continuous ridicule and attacks quite well, and his testimony before Congress exemplifies how he can and will separate the Fed from the current government. He will not politicize the Fed.
- The bigger problem is that Biden will be pressured to appoint a new Fed Chairman. It’s not that this replacement would automatically be a step down from Powell, but Powell has excelled in my opinion. This is a “if it isn’t broke, don’t fix it” argument.
- If Biden nominates a new chairman, the market may try to price in that new Fed President’s willingness to intervene the way Powell has (think Hawkish/Dovish commentary again). Powell’s willingness and execution to intervene, while remaining apolitical will be hard to duplicate, and even harder to exceed. Risk assets could see some pressure there.
- The Fed’s target to increase inflation and even overshoot it, will be tied to the termination of the pandemic. In other words, transient increases in inflation will need to be identified and removed from inflation data, to ensure that increases in production and growth are real and permanent. This will be hard to do, and how Powell (or his replacement) addresses it will be of consequence for rates and stocks as well.
Photo credit: https://www.ft.com/content/4dcb791b-f998-4741-a8b5-63af542e00af