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Investors embrace America’s house divided

Delayed result: as the US waits to hear who has won the presidential race, investors have become more settled, as reflected by a lowering of the CBOE Volatility Index (AP Photo/Alberto Pezzali)

After last week’s sell off, markets have since rallied sharply on the back of what will likely be a divided American house. While the US presidency remains up for grabs due to the time delay of mail-in ballot counting, the Republican Party appears to be maintaining its majority in the Senate.

Going into election week, a growing narrative had been that the Democratic Party would take all three pillars of government in a so-called Blue Wave. With this outcome ostensibly off the table, investors are taking comfort that certain anti-growth measures advocated by left leaning members of the Democratic Party now have a much lower chance of being enacted.

Stock market performance is ultimately dependent upon economic growth, and that requires pro-business policies or at least public policies which do not materially inhibit forward progress. In fact, a division of power among the main branches of the US government practically guarantees that regressive legislation will be held up in debates, compromised or dropped completely.

In terms of the presidency, former vice-president Joe Biden has been maintaining a narrow lead over President Trump according to the Associated Press. However, Michigan, Nevada and Wisconsin are yet to be decided as of this writing.

Meanwhile, Pennsylvania remains up for grabs with a large number of mail-in votes needing to be counted. Results from Pennsylvania and other key states may not be known for another day or more.

In the Senate, Republicans have prevailed in South Carolina and Kentucky, but several races are still uncertain. As of this writing, the Republican Party has 47 seats secured in the Senate versus just 45 for the Democrats. So far, both parties have flipped just one seat on either side of aisle.

Heightened concerns over the US election have led to elevated market volatility. The CBOE Volatility Index or VIX for short, rose to record highs last week. It’s recent level of 41.16 is the highest level registered in the past four months. But since Election Day, the VIX has suddenly declined to below 30, likely suggesting a better sense of comfort in the democratic process and belief that we will ultimately receive definitive results.

While the market has rallied strongly in these past few days, much of the run-up is merely reversing last week’s correction. The S&P 500, currently trading around 3482 is now slightly above its October 23 high, but remains about 2 per cent below its September 2 peak of 3588.11. While the near-term trend is positive, some investors will likely remain on the sidelines due to fears of a hotly contested presidential election outcome which may need to be resolved later in the courts.

In terms of forward progress, a divided American house means Joe Biden’s proposed tax hikes are less likely to be implemented, even if he is elected as president. Biden has proposed raising the corporate income tax from 20 per cent to 28 per cent as well as increasing capital gains taxes and income tax on high earners. Overall, he would like to reverse Trump’s 2017 tax cuts which boosted growth throughout much of his four-year term.

Notably, mega cap tech stocks, including Apple, Microsoft, Alphabet and Amazon are staging a substantial rally this week. Without a Blue Wave, the sector should experience less regulatory scrutiny and there could be a lower chance they are broken up or otherwise brought to heel.

On the other siding of the equation, current results fade hopes for a massive government stimulus programme approaching $2 trillion and has led to the recent underperformance of economically sensitive sectors such as industrials, financials and small cap stocks.

At the time of this writing the technology-heavy Nasdaq index is up about 7.49 per cent since bottoming at the end of last month, outpacing the S&P 500 and Russell 2000 small cap indices.

Interestingly, we are also seeing a sharp rally in longer term bond prices as yields fall on today’s results. Money flowing into all parts of the financial markets demonstrates the magnitude of funds which have been sitting on the sidelines as investors await greater certainty.

Bryan Dooley, CFA is Head of Portfolio Management at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.

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Published November 05, 2020 at 8:00 am (Updated November 04, 2020 at 3:55 pm)

Investors embrace America’s house divided

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