A Perfect Result?
The recent US election and the financial market action that followed has been a dramatic affair. While cognizant of President Trump’s refusal to concede and the corresponding onslaught of legal challenges he has initiated, we (and the global investment community) are operating under the assumption that the confirmation of Joe Biden’s victory is all but inevitable. But why such an ebullient reaction from global stocks? Per the chart below, the MSCI All-Country World Index (ACWI) is up almost 10% in local currency terms in the two weeks following election night; which is unparalleled in recent history (whether Democratic or Republican candidate victories).
Firstly, we must acknowledge that a lot more has transpired during the past two weeks than just the post-election theatrics. Both Pfizer and Moderna have released extremely promising test results for their respective COVID-19 vaccines. With significant capital deployed (namely “Operation Warp Speed” in the US) towards vaccine development, investors generally expected drug companies to succeed in relatively short order. However, the test results likely came quicker than generally expected and provide a behavioural “light at the end of the tunnel”. Additionally, a major trade deal was signed amongst countries in the Asia-Pacific region. Whereas globalization has been fracturing somewhat amidst the US-China trade tensions of the past few years, the Regional Comprehensive Economic Partnership (RCEP) helps to reverse some of the damage. Critically, RCEP is the first such deal to unite China, Japan and South Korea.
However, the aforementioned MSCI ACWI had already rallied 5.5% between November 4th (the day after the election) and November 6th (the last trading day before the Pfizer news was released). Clearly financial markets have been cheering the election results. In the September edition of Portfolio Dashboard, we noted that between Trump’s erratic decision-making and communication style and the potential for Biden to unwind the 2017 corporate tax cuts, there was no clear-cut “market friendly” candidate. This likely explains why the election result was so ideal. Biden won the presidency, but the Democrat majority in the House of Representatives was trimmed and although the Senate results still hinge on run-offs in Georgia, there is no way the Democrats (alongside 2 independent senators) can secure a majority. So much for a “blue wave”! The net result is that markets do not have to contend with Trump’s unpredictability, while Biden’s ability to pass legislation will be impaired.
Some concern has been raised that political gridlock will delay or prevent the US from deploying adequate fiscal stimulus to offset the ongoing COVID-19 induced economic fallout. We view this risk as relatively minor. While the two parties may differ in terms of their preferred construction of a government spending package, they are aligned in terms of the necessity of supporting the US economy. From a political standpoint, neither party will want to be viewed as obstructionist during this unprecedented and challenging time. Our base case scenario remains that a US (and global) growth recovery will be propelled by ample monetary and fiscal stimulus. Not having to worry about presidential Twitter storms on a daily basis is just an added bonus.
GLOBAL STRATEGY OVERVIEW
We have initiated a partial hedge on euro currency exposure in client portfolios. We remain optimistic towards Europe from a longer-term perspective (long-awaited pivot to fiscal stimulus, progession towards a fiscal union, etc.). However, in our view, the recent euro rally has outpaced the underlying economic fundamentals; warranting caution.
Chinese bonds are exhibiting numerous tailwinds. The addition of the nation’s debt into bellwether global bond indices in 2019 has led to passive investment flows and boosted their prominence. A growing number of global central banks now hold Chinese renminbi (RMB) amongst their reserve assets (usually in the form of onshore fixed income investments) since the inclusion of RMB in the IMF’s SDR basket in 2016. Lastly, with resilient economic growth and monetary policy orthodoxy, yields have climbed and the spread between the Chinese and US 10 year is the highest it has been during the past decade. We have increased exposure to Chinese bonds in client portfolios.
Global equity valuations have increased markedly, as investors have been willing to look past the transitory effects of lockdowns and “price in” future earnings growth. We expect that higher valuation multiples are warranted, given the substantial monetary and fiscal accommodation being deployed by central banks and governments worldwide, which should be supportive of growth and corporate profitability. Given the above conditions, we continue to view our overweight equity positioning as well-warranted.
Geopolitical considerations aside, Brazilian equities currently have a number of tailwinds. The plummeting Brazilian real has not yet fed meaningfully into inflation, which provides flexibility to the BCB (which has already cut rates by 250 basis points this year) and makes exports more competitive (particularly with a resurgence of Chinese infrastructure-led demand). We have initiated an opportunity position in Brazilian equities in growth-oriented strategies.