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The election looms large as the biggest wild card risk for markets, and there is a real concern that no outcome could lead to a period of uncertainty and turbulence for markets and the economy. On the other hand, some strategists say a clear winner and quick concession by the other candidate could lead to a relief rally. Also a worry is that Senate elections could be unresolved, which means it may not be known which party holds the majority.
“If there’s no clear winner, it will be negative for risk assets…The market is really worried about not having clarity after the election. They’re worried about it dragging out four weeks as the results are contested,” said Ian Lyngen, head of U.S. rates strategy at BMO. “The overall landscape is not a political one. It’s that we’re in a pandemic, and we don’t want an uncertain election outcome that leaves the country concerned about leadership.”
Stocks closed out October on a sour note, with the S&P 500 down 5.6% for the week, the worst performance since March, when the pandemic first shut down the economy. Strategists say the coronavirus is again worrying the market, as major European countries go into partial lockdowns, and the U.S. faces record numbers of new cases.
Lyngen said he does not expect the markets to react as much if it’s only the fate of the Senate that is undetermined. But that is still very important, and if it’s not clear which party has a majority for days or even weeks, that would cast doubt on the ability of whichever candidate wins the presidency to pursue their policy agenda.
Senate key for stimulus
The Senate is also key to how much money will be poured into the economy to help battle the impact of the virus. For instance, if former Vice President Joe Biden wins the White House, but Democrats do not reclaim the Senate, he will likely have to compromise on a smaller stimulus package and would not be able to implement tax increases. If President Donald Trump is re-elected and faces a newly Democratic Senate alongside the Democratic House, he will likely face push back on many issues though they may agree on a large stimulus package.
As of Friday, Biden was leading Trump in the polls by 7.8 percentage points in the RealClearPolitics average of major polls. Democrats also appear likely to take the Senate, but some races are very tight.
Bank of America strategists note that the Senate races are close with a few seats that could flip. Seven Republican seats are currently rated as toss-ups with four in battleground states, where they could be lost if there’s a strong Democratic surge. There could also be a clear majority, but still uncertainty in terms of final makeup.
“The overall composition of the Senate is unlikely to be determined until sometime in January due to election rules in Georgia which stipulates the race goes to a run off if no candidates garners 50% majority in the general election and currently no candidate is projected” to hit that threshold, the BofA strategists wrote.
The strategists say the timing of the results is unclear due to early voting but high volumes of mail-in ballots, which cannot be counted in some states until election day.
“A short delay in the election result should have a trivial impact on the economy but a multi-week contested election could drag down H1 GDP growth by 0.5-1.0 pp,” according to BofA strategists. “Once there is a winner, the focus turns to stimulus.”
Watch bond yields
That could mean bond yields will continue their move higher in the coming week. Yields have been rising on the idea that there will be some kind of stimulus after the election, and it will mean more U.S. debt and higher interest rates.
“We expect rates to shift higher by 5 to 25 bps after the election outcome is known due to expectations for fiscal stimulus and improved growth prospects,” the BofA strategists wrote. The 10-year Treasury yield was at 0.86% Friday.
However, if the election outcome is not known for awhile, the strategists said a contested outcome could push the 10-year yield materially lower.
If there is a contested election, the strategist expect stocks to trade lower, but it would be a buying opportunity since the market typically recovers from headline-related losses within six months.
“We expect a clear outcome to be neutral to positive for the market in the near term, except under a Biden win with a split Congress, which could potentially lead to continued gridlock in fiscal stimulus talks,” the BofA strategists added.
Besides the election, there is also a Fed meeting, expected to end Thursday with no new announcements though it is likely the Fed will emphasize it will keep policy easy for a long time as the economy heals. The October employment report is expected on Friday and is expected to show continued job gains, after September’s 661,000 nonfarm payrolls.
Jonathan Golub, chief U.S. equities strategist at Credit Suisse, does not expect the market to react much if the election outcome is as expected, with Biden winning and Democrats taking the Senate.
“The most likely outcome is already discounted by the market. The best assumption is if you don’t have a big surprise, the market should do nothing,” Golub said, adding the most volatile week could be the one just ending. “This week is the one with the turmoil, and I don’t think the next week is the one where the market’s going to be crazy.”
Golub said investors may be too worried about the election being unresolved and the real issue disturbing the market this past week is the growing spread of the virus.
“There’s no rule we need to declare a victor,” said Golub. “We have four or five weeks. The market may not love that near-term indecision, but the system is set up to allow for it, and as long as things don’t go off the rails, and they really shouldn’t, this concern about a contested election is probably overblown as an investor issue.”
Golub said there’s a greater chance that the winner of the presidency is known before the Senate. “The chances are that we’ll at least know directionally where the power sits, but that could take a little longer and the market may be a little uncomfortable with that,” he said.
Dozens of companies report earnings in the week ahead, and Golub said corporate profits are a bright spot for the market. The third quarter results so far are showing earnings down about 10%, compared to earlier forecasts of more than 20%, according to Refinitiv.
“The reality is the economy is robust. 55% of the market cap of the S&P has higher earnings in 2020 than in 2019. More than half the market is acting like there’s no recession, no downturn,” Golub said.
Golub said both Trump and Biden would push for fiscal stimulus, but while the market is clear on where Trump stands it does not know that much about Biden, if he were to win. “It is going to take some time to get clarity on which of his policy initiatives are going to happen. I don’t believe he’s going to implement these tax increases he’s talking about right away. I think the economy is too frail,” said Golub.
Week ahead calendar
Earnings: Clorox, PayPal, Mondelez International, Estee Lauder, Marathon Petroleum, Wingstop, Waste Management, Skyworks Solutions, Transocean, Rambus, Trivago, Loews Insurance, Ingersoll Rand, Rambus, FirstEnergy, AMC Network, Assurant
9:45 a.m. Manufacturing PMI
10:00 a.m. ISM Manufacturing
10:00 a.m. Construction spending
Earnings: Humana, Fox Corp, Bayer, Sysco, BNP Paribas, Gartner, Eaton, Thomson Reuters, Exelon, McKesson, Bausch Health, Expeditors International, Progressive, Super Micro, Prudential Financial
Light vehicle sales
10:00 a.m. Factory orders
Fed begins two-day meeting
Earnings: Qualcomm, Allstate, Expedia, Hilton Worldwide, Scotts Miracle-Gro, Wendy’s, Perrigo, Zynga, Manitowoc, Public Storage, Pioneer Natural Resources, GoDaddy, Qorvo, Tribune Publishing, MetLife, Fitbit
8:15 a.m. ADP employment
8:30 a.m. International trade
Earnings: Bristol-Myers Squibb, AstraZeneca, Booking Holdings, Square TripAdvisor, Uber. Roku, Electronic Arts, T-Mobile, AIG, Zillow, Live Nation Entertainment, EOG Resources, Tanger Factory Outlet, XPO Logistics, Cigna, Regeneron, Alibaba, General Motors, Cardinal Health, Duke Energy, Papa John’s, ArcelorMittal, Dun and Bradstreet, Murphy Oil, Cardinal Health, Sempra Energy, SeaWorld, AmerisourceBergen
8:30 a.m. Initial jobless claims
8:30 a.m. Productivity and costs
2:00 p.m. FOMC statement
2:30 p.m. Fed Chairman Jerome Powell briefing
Earnings: Allianz, Virtu Financial, Zimmer Biomet, Honda
8:30 a.m. Employment report
10:00 a.m. Wholesale trade
3:00 p.m. Consumer credit