Head of U.S. Fixed Income Greg Wilensky cautions that uncertainty is likely to remain elevated as we approach Nov. 3, and thus it may be prudent to remain diversified and keep risk levels close to long-term target levels.
- As the election draws nearer, we think the increasingly contentious political environment fuels uncertainty to the detriment of both consumers and businesses and encourages financial market volatility.
- Uncertainty is further fueled by concerns the election results could be delayed or challenged and the myriad variables that have competing influences on bond markets depending on which party claims the White House and/or controls the Senate.
- Given all of the unknowns surrounding the election, we think it is prudent to remain diversified and favor a more neutral stance; uncertainty breeds volatility that can detract from returns but it also opens the door for nimble investors to find more attractive risk opportunities.
Elections are synonymous with uncertainty, but the outcome and the effects of the 2020 U.S. presidential and congressional elections are particularly opaque. An already contentious relationship between Democrats and Republicans has been amplified with the passing of Supreme Court Justice Ruth Bader Ginsburg. The fight over when a replacement will be confirmed increases the risk that further fiscal stimulus will be delayed, likely until after the new Congress and/or president are inaugurated. As the election draws nearer, we think the increasingly contentious political environment fuels uncertainty to the detriment of both consumers and businesses and encourages financial market volatility.
It is increasingly likely that we will not know on Election Day who will occupy the Oval Office or which party will control the Senate due to delays resulting from the large amount of expected mail-in ballots or legal challenges to the results. Doubts about the validity of the election are being fueled by both parties, with the president voicing concern about the accuracy of mail-in ballots and some Democrats expressing concern that the sitting president is not above attempting to influence the results in ways that would require a legal challenge to resolve. More than any past election, there is a growing probability that many Americans will view the results as illegitimate in some way.
While forecasting election results in normal times is difficult, forecasting market reactions is just as difficult, if not more so. Financial markets are forward looking, constantly assimilating the latest information to gauge the risks and set bond prices. But looking at bond markets today, it is hard to separate out the relative impact of COVID-19 and the direct interventions by the U.S. Federal Reserve (Fed) on corporate bond prices. Are bond yields, today, priced where they are because of the Fed’s influence, or have they adjusted to the lead that Democratic nominee Joe Biden has in the polls – and would thus be relatively unchanged if he wins the presidency? A more detailed analysis may find that the election is closer than polls suggest insofar as a state-by-state analysis would indicate a smaller probability of Biden winning. Which is the bond market pricing? More immediately, are they pricing the risk of what impact a failure to provide more fiscal stimulus would have on the American economy?
The complexity is deepened by the myriad variables that will impact bond markets depending on which party claims the White House and/or controls the Senate. Most investors agree that a Biden victory would result in more regulatory constraints, which could lower economic growth and/or corporate profitability, particularly in the energy, financial services and health care sectors. However, trade relations generally, and relations with China specifically, may marginally improve with a Biden victory given the tension that currently exists between the respective administrations. Likewise, it is not clear whether the amount and effectiveness of further fiscal stimulus would be better received under Republican or Democratic leadership. Finally, most investors assume the corporate tax rate would rise if Democrats win the presidency and take control of the Senate. But given the current economic weakness – and both parties’ interest in supporting an economic recovery – it is not clear higher tax rates are, or even should be, priced into the short-term outlook.
Given the amount of uncertainty surrounding the election, we think it is prudent to remain diversified and favor keeping risk levels close to long-term target levels. In our view, the amount of risk taken should be scaled to an investor’s level of conviction. With little conviction to be found on the outcome or effect of the upcoming election, we would recommend focusing on the value that can be added through security or industry selection. Uncertainty breeds volatility, which can both increase risk but also create opportunities. We believe it is important to keep risk low when uncertainty is high, providing bandwidth to adjust positions aggressively when markets become more clearly overbought or oversold relative to their outlook.