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Where do we stand and what lies ahead?
I’d like to hit on three key points: 1) where we stand with the presidential race as of this writing; 2) the state of the US Senate campaigns; and 3) what to watch in the days and weeks to come, including the possibility of a courtroom battle over the presidential outcome.
1. Right now, I think Biden’s easiest path to the White House is to hold Nevada and win Wisconsin and Michigan. I expect he will likely capture those three states (and maybe Pennsylvania as well), which would put him over the 270 electoral votes needed to win the election. Importantly, given the large number of mail-in ballots and the potential for recounts, finalizing the results in those and other states could take days or even weeks. That obviously creates a tremendous amount of uncertainty around the election process, especially considering how tight the vote margins are in some states. Adding to the uncertainty is the lack of a strong legal precedent to follow if this ends up “going to court” (see below).
2. Thus far, Democrats have “net gained” one Senate seat after losing Alabama and winning Colorado and Arizona. I had come into the election believing Democrats had a slightly better than 50% chance of taking the Senate, based largely on North Carolina and Maine. At the moment, both states look unlikely to flip from Republicans. But there are still many votes left to be counted — not only in those two states, but also in several others that will help shape the balance of power in the Senate. Right now, my best guess is that when the dust settles, we will have divided government, with Biden in the White House and Republicans holding the Senate. Again though, there’s still a lot of uncertainty surrounding that outcome, especially with two run-off races in Georgia that will determine the Senate majority.
3. The third wildcard is the prospect of a contested presidential result, potentially leading to a court challenge. President Trump has already questioned the reliability of the voting-by-mail process, particularly relating to late-arriving ballots. The problem is that there’s no real legal precedent to guide the Supreme Court on the matter of ballots that come in late, compounded by the fact that each state has its own rules and regulations concerning mail-in ballots. So, in an extreme scenario where the Supreme Court must decide the presidential winner, we could be (at least temporarily) in a state of maximum uncertainty and polarization — not just in Washington, but in society more broadly.
Beyond the near-term election drama, divided government being the final outcome, one policy implication of that would be a lower likelihood — relative to a Democratic sweep outcome — of significant tax increases or material changes in government regulation (good for markets). On the downside for markets, the fiscal backdrop in terms of domestic spending would likely be less supportive of the economy at a time when it is already vulnerable as a result of COVID-19.
Nanette Abuhoff Jacobson
Potential market and investment implications
The first point I would make is that we can all take a lesson in humility from this extraordinary election cycle and unforeseen “day-after” situation. Consider the closeness of the races, along with the number and complexity of potential outcomes on the table as questions still swirl around the presidential and Senate contests. There are 77 days between Election Day (November 3) and Inauguration Day (January 20) — the so-called “lame-duck” session — with much that could happen during that period. This makes it very difficult to know how to position investor portfolios in the short term.
All in all, consistent with the “maximum uncertainty” that Michael alluded to, I view the current environment and state of affairs as being “risk-off” in nature from an investment standpoint. One thing we can all be very confident about is that markets generally hate this type of uncertainty, so I think the near-term market reactions are apt to reflect that reality — and indeed, already are in some cases. For example, perceived “safe-haven” assets like US Treasuries have rallied, pushing their yields down, as has the US dollar. (The gold price is actually down as of this writing, but mainly because bond yields and inflation expectations have fallen.)
How long this risk-off climate will last is hard to say at this point. However, if we extend the time horizon beyond today and look at likely positives and negatives for the markets in the months ahead, I agree with the potential implications that Michael laid out in the event of divided government. Overall, that outcome would probably be more comforting to markets than a Democratic sweep: The prospect of less in the way of tax increases and government regulation would be well received by markets, while the prospect of less fiscal stimulus would likely be a negative.
Speaking of a Democratic sweep (the so-called “blue wave”), that scenario is looking much less likely post-election than it did pre-election — to the surprise of markets. Starting in September 2020, markets began moving to a “reflationary” type of trade in advance of the blue wave that many pollsters were predicting. Among other things, that trade included higher 10-year Treasury yields and anticipation of a rotation from growth sectors to value and cyclicals. That rotation has now been delayed, if not derailed entirely, to the chagrin of some investors who had positioned their portfolios for it.
What about positioning going forward? Beyond the “relief rally” markets may enjoy once we have clarity on the election, I am somewhat cautious. With the recent COVID-19 resurgence in the US and the specter of less fiscal stimulus in 2021, I think we’re likely to face a weaker domestic macroeconomic backdrop into next year. As a result, I think higher-quality assets and slow-growth trades — US tech stocks, for instance, and fixed income (particularly credit investments) — may continue to dominate markets and work well for investors in the first half of 2021.
However, while my views are more risk-off in the short term, my longer-term outlook is more positive. For starters, as our health care experts have noted, a long-awaited COVID-19 vaccine is likely to arrive sometime in 2021. And although fiscal policy may prove less supportive than hoped, it may be that monetary (Fed) policy picks up the slack and becomes more of an anchor for the US economy. The Fed has scope to expand its existing lending facilities, which could provide a helpful cushion for the economy and markets.
Three geopolitical observations
The US election cycle remains a US-focused event of course, but I’d like to highlight three key points from my global geopolitical perspective as we navigate a period of maximum post-election uncertainty.
1. The elevated uncertainty around the election, which could persist for days or even weeks, heightens the risk of foreign interference by the likes of Russia, China, Iran, and North Korea — not so much with regard to the election results themselves, but rather that a politically divided US society will make it easier for foreign actors to inflame those differences and seek to incite further electoral and societal discord inside the US, particularly if we see an uptick in political violence and/or increased institutional stresses.
The goal of Russia, China, Iran, and other US geopolitical rivals would be to demonstrate to their own societies the notion that US-style democracy simply doesn’t work in practice. They may use this opportunity to portray the US as an unreliable ally that cannot be trusted to lead the international system. The election drama, and the underlying social rifts it has exposed, renders that argument more salient.
As events unfold, I’ll be watching social media traffic, which has so far been the preferred means for state and non-state actors to try to influence developments within the US. I’ll also be monitoring US intelligence reports of foreign meddling, including possible attacks on US election infrastructure.
2. A politically and socially divided (and generally distracted) US ratchets up global geopolitical risk more broadly, as it may tempt other countries around the world to use this period of “election limbo” to their own geopolitical advantage. Prime candidates on this front include China in the Taiwan Strait, the South China Sea, or on the border with India; Russia across Eastern Europe, including Ukraine; Iran and North Korea’s accelerated nuclear weapons programs; and maybe elsewhere as well. These are lower-probability risks in my view, but ones I’ll nevertheless be watching closely in the coming days and weeks
3. As for longer-term geopolitical implications, the presidential election — however it ultimately turns out — is likely to be very consequential for the global geopolitical landscape, as the two potential outcomes represent two very different visions of America’s role on the world stage — the more multilateral approach of Biden, including closer coordination with key US allies, versus another four years of “America First” under President Trump. Either of those scenarios would have distinct, profound implications for US geopolitical influence, global trade relationships, traditional alliance structures and global institutions, and (perhaps most importantly) the US response to China’s geopolitical rise in a new era of great-power competition.
Regardless of the final outcome, I think all this election turmoil puts the US in a weaker geopolitical position overall. I also think it helps fuel an existing trend I’ve observed in recent months, tied to COVID-19 mismanagement and other factors, that shows very low approval ratings of the US globally, particularly among our staunchest allies. The longer the election uncertainty drags out, the “less strong” the US geopolitical position is likely to become.