The week from November 2nd to November 8th was crucial for US politics and economic stability worldwide. As the United States were waiting for the presidential election results during the week, with Joe Biden and Donald Trump rallying for the White House, markets were waiting for the final polls.
A. The US Presidential Election Week
On the first week of November, the market reacted differently each day, adjusting together with news releases:
- Monday Nov. 2nd: the 10-year US Treasury yield had briefly exceeded 0.9% and had reached its highest level since June, foreseeing a major democratic victory that could increase public spending and potentially inflation.
- Tuesday Nov. 3rd: Trump claimed early victory, asserting, without supporting evidence, the corruption of the election race. Gold price rose almost 4% and the yield on the 10-year Treasury had reached 0.9%, hitting the highest level since June — in anticipation that a big Democratic win could fire up government spending, and potentially inflation.
- Wednesday Nov. 4th: the yield on the benchmark 10-year US Treasury slid 0.13% to 0.77%, its biggest decline since April. Yields fall as a bond’s price rises.
- Thursday Nov. 5th: investors continued to buy longer-term US government debt, pushing yields lower. The 10-year yield was recently down 0.01 % at 0.775%. The dollar index fell 0.8% as Trump seemed to gain ground in the presidential race against Biden and all Wall Street expectation on the $2tn of economic stimulus pledged by Democrats: indeed, investors view the forecast spending as a boost to US growth, inflation and as a stronger currency.
- Friday Nov. 6th: Biden’s likelihood to win the election increased, leading with 253 electoral votes against Trump’s 214. The yield on the benchmark 10-year Treasury note rose 0.06% to 0.82% prompted by better than expected employment data in the US, where the unemployment rate fell below 7% for the first time since March, boosted by the over-expected 638,000 jobs in October added by employers.
The fear of a divided government with a majority of Republicans in the Senate started to spread, as a Republican Senate would limit or block Biden’s new regulatory changes, such as increasing corporate taxes to 28% from 21% from companies with over USD 400k in income, which would hit the top 1.8% of taxpayers, who earn the 25% of US income. In addition, the Democratic candidate claimed his intention to increase taxes on foreign income of many US multinational corporations. This would have a disproportionated impact on the tech sector, since it derives only 43.5% of its revenue from the U.S., compared with 60.3% for the S&P 500 as a whole.
Together, these tax proposals would reduce expected earnings among S&P 500’s companies by 9.2%, according to estimates from BofA Global Research.
Despite non-stop growing Coronavirus cases in the US, exceeding 100k daily cases, US markets on Friday peaked after Biden’s winning announcement: the S&P 500 rose 1.4 % on the same day, exceeding its September 2nd closing record of 3,580.84.
From a political standpoint, the new president’s priority remains to control and limit the impact of Covid-19 in the US. As Democrats’s major objective is putting safety first, whereas Republicans put the economy on top of the presidential agenda, Biden has now to deal with a deeply divided nation, as well as to ensure meeting people’s expectations on an expansionary fiscal policy in the US, in order to help the country regain momentum and go back to pre-pandemic GDP growth.
Biden’s win has brought along optimism on several controversial topics of Trump’s administration: action against climate change and the relationship between Washington and Beijing. The upcoming US President has promised to rejoin the Paris Climate agreement on his first day of office in January, and it does not seem that he would continue Trump’s trade war with China.
Last week’s optimism and euphoria have dominated the market, the results of the presidential election surely had a positive impact on the global trading floors, but Pfizer and BioNTech announcing a new 90% effective vaccine against Covid-19, was the turning point for investors. On Friday 6th, the equity market saw USD 32.5 billion poured into U.S. equity funds, the second-largest weekly inflow of all time.
B. Stock market reaction
The first week of November started with the blue-chip S&P 500 index closing 1.2% higher on Monday, driven by stocks in basic materials and industrial sectors, as investors thought these to be the target areas benefiting from the increased government spending in infrastructure claimed by Biden.
Following Trump’s declaration claiming elections as fraud, US stocks fell nearly 5% on Tuesday, while the Dow Jones Industrial Average closed out its second-best election day ever, with a gain of over 500 points after some losses during the previous week.
On Wednesday the 4th November, the uncertainty of election results and on the win of Joe Biden pushed both government bonds and the shares of big US tech stocks, as investors cut back trades that had assumed a “blue wave” Democratic sweep of the White House and Congress.
The S&P 500 advanced 2.2%, driven by technology stocks, signing the best day for the benchmark index since June.
Overall, the rush of investors to buy healthcare and technology companies on Wednesday boosted US stocks by almost 3%, with healthcare stocks up 5.2% and technology companies up almost 4.5%.
Thursday’s Wall Street stocks rally was broad, with all industry sectors of the S&P 500 rising. The Nasdaq Composite index rose 2.6% after Wednesday, tech-heavy index increases of 3.9. The blue-chip S&P 500 closed 1.9% higher. Both indices were on track for their best week since April.
After the best week for US stocks since April, elections seemed to be near conclusion: Wall Street’s blue-chip S&P 500 index remained flat on Friday, gaining 7.3% over the week. Also, the Nasdaq Composite, which has enjoyed some of the largest gains since polling day, has risen 9% over the turbulent week.
The Volatility Index (VIX), known as the “Fear Gauge” of the equity market, showed its biggest weekly decline since April during the US election and on Thursday the 5th November it dropped almost 2 points to 27.8, although above its long-run average of 20. Despite the uncertainty of the outcome of the election, the tension of the stock market was quite low during the counting of the votes. “Investors are continuing to get more comfortable with the political setup,” though results for the U.S. presidential election and several congressional races remained unclear, said Christopher Murphy, co-head of derivatives strategy at Susquehanna Financial Group.
Looking at the equity market as a whole, the impact on performance is relatively small. However, what about specific sectors?
President-elect Joe Biden stands for a more environmentally friendly policy (return to the Paris Climate Convention, promotion of climate-friendly projects, and restrictions on fossil-fuel energy). This would have tremendous effects on oil companies, such as Exxon Mobil or Chevron, which do not have any carbon-reduction goals, making them less prepared for a climate transition.
For our analysis, we have compared the performance of the S&P 500 Oil & Gas index with the whole S&P 500 index. As it can be seen on the chart, the S&P Oil & Gas index massively underperformed the whole S&P 500 index when the probability of a Biden presidency was rising.
C. The impact on Markets
Fixed Income Market
The above chart is presenting the yield spread between 2y and 10y US Treasuries in basis points, a higher spread describes a steeper yield curve which is caused by different reasons like a dovish interest rate policy (falling interest rates) or rising inflation expectations.
During the US election, there were large fluctuations in the spreads of two-year and ten-year US government bonds. But what is the reason for this and what does the FED have to do with it?
The slope of the curve shows what inflation is expected in the US. A shrinking spread would implicate a low inflation expectation and vice versa. As it became more and more likely that Joe Biden would win the election, the curve rose sharply. This shows that inflation expectations have increased. Due to the Republican Senate, the proposed massive fiscal package of USD 2bn by the Democrats has become less likely. In order to ensure a recovery of the US economy because of the corona crisis, the FED will have to intervene more strongly in the market. This is likely to be achieved by lowering interest rates and expanding the money supply. Due to an expected reduction in interest rates, the yield curve for short maturities will adjust accordingly. Yields for the 2-year term have thus fallen, with the result that the spread between the 2-year and 10-year bonds has diverged.
Additionally, the expected change in the interest rate policy of the FED is not only reflected in bond markets but also in currency markets. The expected reduction in interest rates or expansion of the money supply will lead to a depreciation in the value of the US dollar. This can be seen very clearly in the performance of the USD Index spot which is comparing the value of the USD to other major currencies like the Euro, British Pound or Chinese Yuan. The USD index stood at 94.2 before the election. During the counting of votes, it was very obvious to see how the market had priced in the likelihood of Donald Trump’s re-election.
The highest probability of a victory for Donald Trump was on the morning of November 4th when Donald Trump was ahead of Biden in many Swing States (Pennsylvania, Georgia, Michigan) and already declared his election victory in his speech. Looking at the dollar index spot rate one can see how the USD index spot moved up from 93.4 to 94.3.
When the election outcome changed and as it became more probable that Biden would win the election, the value of the US dollar fell further and further to its lowest level of 92.1 on November 9th as Joe Biden was announced as President-elect.
In summary, the US Presidential election was consistently positive for the US stock market, which in the end was mostly independent from the outcome of the US election itself.
Donald Trump’s threat that “If I don’t win, you’re going to see a crash like you’ve never seen before”turned out to be false. Looking at different industries, it is clear that environmentally friendly companies, in particular, will benefit from a Biden Presidency and environmentally harmful companies, especially the oil industry, will suffer under a Biden Presidency.
The market is already pricing in a further easing of monetary policy in the USA. This is evident, among other things, from the falling yields for short-term US Treasuries and the decline of the US dollar. The reason for this is the lower probability of a huge fiscal package that would be highly probably blocked by a Republican senate.
Authors: Cecilia Tognini, Niklas Ortmann
Bloomberg Intelligence: U.S. Elections Impact on ESG Funds (Shaheen Contractor, James Blatchford)