The U.S. Presidential Election Still Looms, But Risks of a Wild Night Have Eased

I know enough of the world now to have almost lost the capacity of being much surprised by anything.

Charles Dickens

Election uncertainty, while still elevated, has improved. One of the key risks to investors has been a contested election that drags out the election result for weeks. The odds of this have fallen. Polls and betting markets have widened further in Joe Biden’s favour, while voters have been filing mail-in ballots earlier than expected, indicating a greater share of these ballots will be counted ahead of time (Chart 1). Implied measures of forward market volatility such as the VIX have also normalized, notably for post election volatility. While mail-in votes may still delay the election result, the significant lead in polls and betting markets held by Biden dramatically lowers the chance that the result cannot be called or that it will be contested.

Chart 1: Presidential Victory Odds Widening Further in Biden’s Favour

Chart 1: Presidential Victory Odds Widening Further in Biden’s Favour

Source: Bloomberg, PredictIt, BMO GAM (as of October 15, 2020)

The other risk is a Democrat sweep, given the party’s platform of higher corporate taxes and greater regulation which could shave several percentage points off S&P 500 Earnings Per Share (EPS). These odds are increased (Chart 2). Yet the most likely outcome for tax policy in our view will be limited to an increase in the corporate income tax rate from 21% to 25%, lower than the 28% proposed. A sweep scenario would also imply larger fiscal stimulus and lower trade policy uncertainty, offsetting the negative effects of taxation and regulatory burden. Moreover, Democratic sweeps have generally been positive for equity returns, averaging 9% since the 1950s.

Chart 2: Democrat Lead in Senate Has Also Widened

Chart 2: Democrat Lead in Senate Has Also Widened

Source: Bloomberg, PredictIt, BMO GAM (as of October 15, 2020)

What a Shift in Washington would Mean

By sector, the implications of a sweep scenario are somewhat clearer. A key priority would be Infrastructure spending and green initiatives, benefiting materials and industrials at the expense of the oil and gas industry. Sectors most exposed to higher corporate taxes are financials and consumer discretionary stocks whereas the most insulated is utilities. Anti-trust regulatory scrutiny does leave the IT and communication services sectors more exposed, but we think such oversight is unlikely to derail their performance. If anything, certain initiatives can unlock opportunities for value creation. We think the implications to Canadian equities are positive at the margin, as the policy changes would raise the relative competitiveness of Canadian companies, while a stronger U.S. fiscal impulse would benefit Canadian demand through the economy’s trade linkages.

As noted previously, we expect a Biden victory or Democratic sweep to be USD negative and supportive of Emerging Markets (EM) equities, largely through the trade war channel as tensions would ease. We acknowledge, however, that the election outcome and policy implications are difficult to pinpoint. Given current market pricing, the risk today is if Trump is re-elected, which could strengthen the dollar. But at the same time, a Democrat sweep is also not fully priced. Overall, more cautious positioning around the November election may be advisable, even though the likelihood of a risk-off outcome is low in our view.

Small Businesses Faring Better Than Expected

We have noted before that U.S. and Canadian consumer confidence, while still low relative to pre-COVID-19 levels, has been resilient in the face of rising virus cases and new restrictions. Meanwhile, small business sentiment in the U.S. and Canada has fully recovered, undeterred by new restrictions, as seen in NFIB and CFIB surveys (Chart 3). Since the depths of the crisis, their revenues and cash positions have meaningfully improved, helped by fiscal support and an improving economy. In the U.S., the Paycheck Protection Program (PPP) proved effective in meeting short-term liquidity needs, and forgivable loans have limited bankruptcies, which remain fewer in number relative to large firms. In addition, new business applications have soared. This is important because small businesses employ a quarter of all jobs, while small and medium-sized businesses (SMEs) account for a half. Looking ahead, however, the road will be bumpy as small firms face stricter lending standards, which has already limited their use of credit lines relative to larger firms. Further targeted support will be needed.

Chart 3: Small Business Sentiment Having a V-Recovery

Chart 3: Small Business Sentiment Having a V-Recovery

Source: Bloomberg, CFIB, NFIB, BMO GAM (as of September, 2020)

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