If anything was clear after Wednesday (a questionable prospect, to be sure) it was that the market is just fine with the notion of a stable presidency and a divided government that won’t let the executive get anything done.
In retrospect, I suppose everyone should have seen this coming, although hindsight is always 20/20. Joe Biden’s victory was not assured as of Thursday morning and neither was a GOP Senate majority, but both outcomes were likely. And markets acted as though both were done deals, although it’s worth noting that there was some evidence of a “blue revival” trade late Thursday (the Russell marginally outperforming the Nasdaq 100 for example).
“The ongoing Presidential election outcome sideshow isn’t a story anymore outside of mainstream headline news (LOUD NOISES / RED HEADLINES), because once the Senate didn’t go hard Dem, that was all she wrote from a markets perspective, regardless of court challenges for recounts,” Nomura’s Charlie McElligott said, adding that “what really mattered was the risk of ‘full tilt’ paradigm fiscal shift under a ‘Blue Wave’ of untethered government deficit spending via shock taxation- and issuance- hikes, along with the negatives of the re-regulation of American industry.”
I like the following simple chart, not because there’s anything (at all) profound about it, but because it illustrates key points with indexes (and one ETF) that everyone is familiar with: Tech and duration are back en vogue, the S&P is somewhere in the middle (it is, after all, ~25% FAAMG), and the equal-weighted S&P is the laggard.
That leaves little doubt about how the market interpreted the election results.
A look across performance for market neutral pairs throws things into even starker relief. As McElligott reminds you, “bull-flattening off the back of a downgrade of either growth- and/or inflationary expectations means enormous impacts on Equities market-neutral thematic long-short pairs.”
He lists a hodgepodge of expressions that are, in one way or another, momentum proxies, before noting that Nomura’s “1Y Price Momentum” factor witnessed “an outrageous” +7.5% one-day move post-election.
There are two crucial takeaways from the price action which I think I’ve done a decent job of emphasizing, perhaps to the point of being obsessive. Let’s review them one more time.
First, investors and the C-suite don’t generally care for rampant uncertainty, let alone foreign and domestic policy that careens down the highway at full speed with the driver wearing a blindfold, mashing the gas pedal, and screaming obscenities at a windshield he can’t see.
Second, investors and the C-suite do like lower taxes and less regulation.
With Joe Biden (assuming he wins) highway patrol finally manages to get the raging, blindfolded driver to pull over on the shoulder. He’s then replaced with a person who, while perhaps exhibiting early signs of dementia, is an experienced driver who’s at least capable of operating a motor vehicle safely for another year or two. If there comes a point when he’s not, there’s a passenger ready to take the wheel at a moment’s notice, and whatever you want to say about her, she’s in full possession of her analytical faculties (you might not like the way Harris sometimes chooses to deploy those faculties, but that’s an entirely different discussion).
Meanwhile, a disappointing result for Democrats in Senate (and House, by the way) races represents the installation of guardrails along every exit marked “leftward turn.” The US is thus destined to drive straight down the highway for four years, which is bad news for “change” but good news for business and investors.
That’s really the long and the short of it, with one addendum. The problem with blocking off all exits marked “leftward turn” is that it materially increases the odds of the post-GFC experience repeating, or at least to the extent pretensions to austerity (likely following the next, slimmed-down stimulus bill) will almost invariably lead to more sluggish growth and inflation outcomes.
That, in turn, means placing more of the onus for sustaining the recovery squarely on the shoulders of the Fed.
Here’s a prediction: Three years from now, everyone will blame Jerome Powell (and his colleagues) for exacerbating inequality, keeping rates too low for too long, and inflating financial asset bubbles, without even so much as a mention of the fact that this outcome was preordained when the public once again decided that America isn’t ready for a more modern approach to fiscal policy.