As the new administration moves in amid a pandemic, three elements matter for equity investors. First, the policies that a Biden administration will be able to implement. Second, the developments on the Covid-19 front. Closely related to this is the third element, which is the ability of the US economy to maintain and possibly extend its recovery.
With a split Congress, the power of the new administration to implement new policies will be severely curtailed. Past US administrations have become well versed in the art of governing through executive orders. Yet, when it comes to changing legislation, loosening the purse strings, as well as key Cabinet and federal agency appointments, the President needs a collaborative Senate. Given the extreme divide along party lines, we see limited room for bipartisan support.
Hence, the Biden administration is likely to be less about what it will deliver and more about what it will not disrupt compared to a Trump White House. With or without support of the Senate, we expect a Biden administration to be less confrontational on the foreign policy front and less keen to use tariffs as its weapon of choice.
A Biden administration is likely to be less about what it will deliver and more about what it will not disrupt compared to a Trump White House.
This would be positive for international trade and relations, and would improve market sentiment towards Europe and emerging markets. A Biden Presidency is also expected to create far less volatility in investors’ sentiment on China. A Democratic White House would likely be a tough negotiator with China, but also a more consistent one, compared to the current administration.
And while there are unlikely to be trillions of dollars spent on climate change, let alone the introduction of a carbon tax, the focus on sustainability in the US is likely to increase. Biden can rejoin the Paris Agreement on climate change without support of the Senate. And, with or without Congress backing, environmental awareness in the US is rising.
One area where we are likely to see more emphasis from a Biden administration is the regulatory pressure on large internet and cloud platforms. While there is bipartisan consensus on the need to rein in some of the perceived power of large players, disagreement on how such regulation should materialize and the complexity of updating current US antitrust rules mean that it is unlikely that new regulation will be implemented any time soon. Yet, scrutiny on Big Tech is destined to increase and a Biden administration would still be able to pursue Department of Justice lawsuits, occasionally rattling markets.
For equity markets, in the near term the most relevant outcome of a Biden administration with a divided Congress is the absence of a timely and substantial fiscal stimulus package, which will most likely slow down the recovery of the US economy.
This makes the successful management of the Covid-19 outbreak in the US and the timely availability of effective therapies and vaccines even more crucial. And while US investors may feel relieved that much feared financial regulation and tax increases are now unlikely to be implemented, in the end it will be the economic recovery or lack thereof that will set the course for US equities.
‘Our base case remains that the global economy will continue to improve, but the improvement will be uneven among countries’
For us, this means that equity markets outside the US offer more attractive opportunity potential from a cost-reward perspective – in other words, considering valuations versus potential upside. In fact, our base case remains that the global economy will continue to improve, but that the improvement will be uneven among countries. Those where Covid-19 and its impact on the economy is more contained should see a positive effect on corporate fundamentals and on their equity markets.
It will not be plain sailing. It never is. Any news on therapeutic breakthroughs, the speed at which the virus spreads and the likely timing of the distribution of a vaccine can generate significant mood swings. We should also expect some volatile news flow from the incumbent US administration until 20 January 2021.
President Trump is unlikely to gracefully concede defeat and could try to implement last-minute controversial policies. However, barring any unforeseen and irreversible measures, we believe that US and global equity markets are for the most part likely to look through the news flow from the White House over the next two months and trade on the basis of what is expected to come next.
We do not see any reason to change our investment allocations based on the expected outcome of the US elections. We believe that the progression of the Covid-19 outbreak across the world and the likely path of economic recovery ahead will be far more significant for global equity markets than any likely US policy changes.
Our investment teams have continued to selectively take profit from growth/defensive stocks with stretched valuations across global equities and have added to quality laggards that are expected to benefit from recovery in some (but not all) areas of the economy. We see the light at the end of the tunnel. While a second Covid-19 wave is slowing down the global economic recovery, we are now getting closer to the end of the sources of uncertainty, as we see a path towards the approval of Covid-19 vaccines and more therapies.
In addition, the valuation disparity between growth/defensive stocks and their cyclical/value counterparties have reached levels that often appear unhinged from fundamentals. Importantly, stock selection for us remains key as some companies will be structurally damaged by the protracted impact of Covid-related restrictions.
At a regional level, North Asia including China, Taiwan and South Korea is the largest overweight position in our global portfolios, followed by Europe. We have recently reduced our underweight in Japan and have moved to a small underweight in our US exposure.
Within emerging markets, we remain selective at a country level. We have continued to increase our positions in China, Taiwan and South Korea, and we are overall cautious on Latin American and EMEA economies. However, more recently, we have seen some improvements regarding the pandemic in a number of emerging countries outside of North Asia, and this is paired with improvements in the economic data. These developments may warrant a change in investment positioning in the near future.
From a sector standpoint, Technology stocks remain an overweight in many portfolios. This is true also for US technology, although we have been actively reducing the position. The US tech megacaps are still underpinned by strong earnings momentum, but valuations are stretched for many them. The initial activity jolt from the ‘work from home’ phenomenon has now passed and comparisons will become more demanding from 2Q21 onwards.
Since the summer, we have been increasing our exposure to industrial stocks, specialty materials and consumer names across the US, Europe and North Asia. Within the industrial sector, we particularly like the theme of lower climate impact and increased energy efficiency, as we see rising awareness and investments in this area.
We also like the US pharmaceutical sector. Even after the recent improvement in performance, valuations are close to an all-time-high discount relative to the S&P 500 Index, with otherwise healthy fundamentals and solid pipelines.
Our investment considerations are based on our expectation of a Biden administration governing with a split Congress. Such outcome would change if the Georgia Senate run-off turns in the Democratic party’s favor. More stimulus, environmental policies and changes to the US healthcare system than we expect now would be the most likely consequence.
The direction and speed of travel of equity markets, first and foremost in the US, but also globally, would be affected. For now, we see this as a less likely scenario. Yet, nothing can and should be discounted in equity markets. Never a dull moment.
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