9th November 2020
A fortnightly look at global financial markets by International Investment Strategist Tom Elliot.
Global investors are finding positives in a Democrat presidency and Republican Senate
Risk assets rally: NASDAQ’s best week in seven months
Trump’s legacies: caution on China and a more conservative Supreme Court
U.K and Joe Biden
£150bn more funny money for the U.K economy
U.K stocks and the need for diversification
Market sentiment: Global stock markets ended the week in confident mood following the U.S elections. This may seem odd, given that the results exploded previous expectation of a ‘Blue Wave’ that had helped drive U.S stocks in the preceding fortnight (although notably not Big Tech). However, investors appear to favour the trade-offs that the Biden presidency will have to make in order to work with a Republican controlled Senate. Big Tech is especially relieved, as the risk of significant anti-trust legislation is much reduced, and the NASDAQ has seen its strongest week in seven months. European and Asian stocks have also rallied on the election results. Japan’s Nikkei 225 index -an index that is sensitive to global growth expectations, due to its large weighting of manufacturing exporters- reached its highest level since 1991 on a wave of domestic buying.
A fall in bond yields over the week, as the prospects of a large stimulus package faded, also helped support valuations of risk assets, such as equities. Indeed U.S Treasuries have enjoyed one of their strongest post-election rallies in history.
The trade off that investors like. When the second Covid-19 crisis fiscal stimulus package eventually comes, it will be smaller than the $3.2tr that the Democrats had hoped. Perhaps less than $1tr, if the Republican leaders in the Senate can persuade Democrat-led House of Representatives and the White House that a steadily improving labour market makes very large packages unnecessary. Friday’s October payroll data might support that argument, with a better than expected 638,000 new jobs created.
While business might prefer a large spending package, disappointment at the likelihood of a smaller one has been made up for by the moderating effect a Republican-controlled senate will have on some of the pet Democrat policies. A wave of tax increases, and regulations on industry, that had been proposed by Democrats will be more modest in ambition. The White House will have to pick moderate Democrats to join its administration, in order to get Senate approval. A $3 tr infrastructure spending program policy promise by the Democrats is unlikely to meet resistance in the Senate on grounds of size, more on in-fighting over where the money should go.
Meanwhile on foreign policy, where the President has a relatively freer hand, Biden’s instincts already chime with much of the business community. He is likely to pursue a more measured and multilateral approach on trade, particularly regarding China. This should support a resumption of global trade and investment, that had been negatively affected by Trump’s unpredictable and scatter-gun approach to foreign trade and security issues. There will, however, be nervousness in the energy sector over Biden’s interest in re-joining global climate change agreements. All exporting businesses -but especially the so-called FAANGS- are also wary of attempts by the E.U to introduce a global business tax regime based that reflects the geographical origin of revenues.
It is easy to forget how big the sums being discussed for the stimulus package are. By way of comparison, total U.K central government spending for fiscal 2020-21 was budgeted in March at £928bn, equivalent to $1.2 tr.
Trump’s legacy. President Trump’s most significant legacies may be in highlighting the threat to U.S security coming from China, which has attracted bi-partisan support, and the entrenchment of a 6-9 conservative majority on the Supreme Court with the recent Senate confirmation of Amt Coney Barrett. He failed to push through repeal of Obamacare, he didn’t build ‘The Wall’, he didn’t ‘clear the swamp’ in Washington, and he de-fanged many regulatory bodies by reducing their funding and appointing friends to lead them. He revealed American democracy to be no less vulnerable to populism than European countries.
A third legacy might have been a strong U.S economy, the result of tax cuts and increased public spending (especially on defence), and of de-regulation. It was this that looked likely to secure him a second term. But then Covid-10 struck, and his casual attitude to the virus, and a sense that his response was done through the prism of his re-election, was his undoing. True, the mortality rate per case in the U.S is not that different from the U.K, Italy and Spain. But these are all amongst the highest in the developed world, and healthcare spending per head is around a third less (as a percentage of GDP) in these countries than it is in the U.S. Furthermore, in none of the other countries have there been allegations that government-supplied PPE has been denied to cities or regions because of their voting habits, and that there was a deliberate reluctance by the government to count Covid-19 cases.
We must hope that Trump does leave the white house peacefully, without inciting violence.
U.K and Joe Biden. Joe Biden is said to regard Boris Johnson as a mini-Trump, and is hostile to the Brexit project. While there will be a meeting of minds on climate change, and perhaps on relations with China, Biden is unlikely to use his political capital in Washington to push a U.S/ U.K trade deal. The influential farm lobby agriculture must be included if Congress is to pass a deal, but this is toxic politically for the U.K government due to a perception that American animal husbandry and food quality are both poor. In this sense then, little will change. For all of Trump’s pro-Brexit rhetoric, he too did little of substance for the U.K on trade, or Brexit (‘…he just bullied us into cutting out Huawei’, The Financial Times quote from an unnamed government official, 7/10/20).
But Biden may do more than simply be inactive in promoting a U.S/U.K trade deal. It is thought that he will give U.S backing to French President Macron and Brussels’ attempts to water-down the controversial Internal Market Bill, that the U.K government passed in September. By necessitating a border between the Republic of Ireland and Northern Ireland, in order to allow Northern Ireland to benefit from the same state-aid policies as the rest of the U.K, the bill effectively does away with the agreed Irish Sea border that Boris agreed to in December’s Withdrawal Agreement. Joe Biden has Irish Catholic roots, and in common with many in Congress on both sides of the political divide, is determined that an internal border will not happen, in order to protect the Good Friday Agreement.
£150bn more funny money for the U.K economy. The country’s second lockdown begun on Thursday, and with it renewed efforts to prevent a long-term increase in unemployment and a wave of business closures that will impair future economic growth. The Treasury announced an extension of the furlough scheme until March, and the Bank of England announced a further £150bn dose of quantitative easing (QE). This is intended to keep commercial borrowing rates low, such as car loans and mortgages, and to ensure full take up of new government debt issuance. The Bank of England is now buying government debt directly from the Treasury.
This takes Covid-19 QE programs up to £550bn, and the total asset holdings on the Bank’s balance sheet -which includes legacy QE programs from the financial crisis and the Brexit vote- will now go up to £845bn.This is a large monetarisation of government debt. Fans of Modern Monetary Theory (MMT) might argue that current very low inflation, despite record post-war budget deficits in much of the developed world, demonstrate that government budget constraints on spending do not exist when a central bank buys up debt issued by a government that can repay by printing money. More conservative voices are wary of this method of money creation, pointing out that monetising government debt has a poor track record in history.
U.K stocks and the need for diversification. Covid-19 and Brexit pose formidable problems for the U.K government and its economy. Corporate U.K has been increasingly biased towards people-facing services in recent decades, which have been particularly hurt by Covid-19. Meanwhile over 50% of U.K exports of goods goes to the E.U, with whom there may be no comprehensive trade agreement in place (what Boris calls ‘an Australian deal’) in January. Furthermore, several large sectors on the main stock market look fundamentally unloved from a long-term global perspective, (eg, financials and energy). The relative discount of U.K stocks to overseas markets therefore appears justified.
But, as argued in this note last month, a change in investor attitude away from highly priced growth stocks and into value, could radically change the picture. The trigger might be a Covid-19 vaccine that allows us to travel and socialise as before, creating a surge in demand for travel and hospitality services. A pick up inflation as economic growth recovers will steepen bond yield curves, helping banks to increase profits. Energy consumption will rise.
The best way for investors to prepare for this possibility is to have a broad spread of investments, and not to try to second guess the market. Retain exposure to the U.K, but also play the tech stocks of Silicon Valley, and perhaps the cyclically sensitive Japanese and continental European stock markets. As we saw last week, trying to predict market trends can confound investment professionals. Putting all your money on one bet can be compared to gambling, not investing.