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Updated: November 12, 2020
Democratic candidate Joe Biden captured enough Electoral College votes to win the U.S. Presidency (subject to recounts and court challenges), with the market now turning its attention to the implications of a divided government.
Whether Biden leads a unified or divided government may not be known until early 2021, meanwhile, President Trump has not yet conceded the election. The safe harbor date for states to certify election results is December 8, while the Electoral College members place their votes on December 14. December 23 is the deadline for the President of the Senate (the Vice President) and designated officials to receive all state electoral ballots, with Congress responsible for counting electoral votes and declaring a winner on January 6, 2021. The inauguration for the next administration takes place on January 20.
In this report, J.P. Morgan Global Research examines the implications for markets of a Biden presidency and a split government.
Biden seems on course to secure about 51% of the popular vote (3% edge over Trump) and 57% of the Electoral College vote, extending a three-decade tradition of a fairly evenly divided electorate (see chart below).
Since the early 1990s, seven of eight Presidential elections have been won with 51% or less of the popular vote and by a margin of 0.5% (Bush vs. Gore) to 8.5% (Clinton vs. Dole). The overall result is consistent with at least 50 years of elections in which no incumbent has been re-elected if he entered the race with a sub-50% approval rating or with a U.S. unemployment rate of 7-8%.
So, despite the criticism of faulty polling data and erratic moves in betting markets on election night, this race is reasonably in line with historical precedents and recent surveys. Biden prevailed, his margin was average (3% of the popular vote) and he flipped most of the swing states he was expected to (Michigan, Wisconsin, Michigan and Pennsylvania and maybe Arizona). Georgia may flip too, which few predicted.
Percentage of popular vote and Electoral College vote for winning candidate in U.S. Presidential elections since 1789. Last observation is 2020 projection.
Source: J.P. Morgan
The more consequential polling surprise is coming in Congress, where Democrats appear to have lost a fraction of their House majority and have yet to take the Senate, though the latter could still result in a 50/50 split after run-off elections for two Georgia Senate seats on January 5. Should the Democrats prevail (Georgia last sent two Democrats to Washington in the early 2000s), then Vice President-elect Harris would cast the deciding vote in the event of ties, effectively securing the Democratic sweep.
“If, by January, it is clear that the U.S. electorate has fired President Trump but not the Republican Party, the historical significance is quite large: in the past 50 years, White House control has only flipped once without the new President also controlling Congress (Reagan in 1980). And by now, most investors are aware of how short the Biden agenda becomes in terms of transformational policy across various sectors if Democrats will lack Congressional control,” said John Normand, Head of Cross-Asset Fundamental Strategy at J.P. Morgan.
A historically wide ideological gap between the major parties and an increasing frequency of close elections means that transformative change is unlikely, with the use of Executive Orders to dictate policy here to stay.
“Executive Orders can be used to cover a range of policies, including energy reform, immigration, trade policy, and anti-trust and regulatory policy,” added Joyce Chang, Chair of Global Research at J.P. Morgan.
President-elect Joe Biden and his transition team’s first announcement on November 9 was the creation of a 13-member COVID-19 task force. This announcement coincided with Pfizer’s announcement that the BNTX 162 vaccine demonstrated more than 90% efficacy in the Phase 3 trial of a COVID-19 vaccine.
Beyond the news on advancements of a vaccine, market attention will turn to whether a mini fiscal stimulus bill can be passed in the ‘lame duck’ congressional session, coinciding with the extension of the government funding bill, which expires on December 11.
“We now see a path toward a significant stimulus package getting done towards the end of the first quarter in 2021, particularly given the recent deterioration in the public health situation. Such a stimulus deal would provide a meaningful boost to growth in Q2 and beyond,” said Mike Feroli, Chief U.S. Economist at J.P. Morgan.
A divided government could temper a more aggressive taxation or regulation agenda that might have materialized under a “blue wave” and bodes well for risky assets, added Matt Jozoff, Co-Head of Fixed Income Research at J.P. Morgan.
Democratic candidate Joe Biden has captured enough Electoral College votes to win the U.S. Presidency (subject to recounts and court challenges), with the market now turning its attention to the implications of a divided government. J.P. Morgan Global Research looks at what economic and market conditions Biden is set to inherit and what a split government could mean for markets.
JOYCE CHANG: Hi, I'm Joyce Chang, chair of Global Research at JP Morgan. And it's great to be here with all of you to discuss the post-election outlook and what this means for markets. I'm joined by John Normand, head of Cross-Asset Fundamental Research at JP Morgan to discuss Biden's inheritance and market implications. John, thank you so much for joining me.
JOHN NORMAND: It's good to see you again, Joyce.
JOYCE CHANG: Well, the projection of Joe Biden as the winner of the US presidential elections is turning market focus to the implications of a divided government. President Trump has not conceded the elections, and the court challenges and the recounts may not be settled for days or even weeks, with a definitive outcome for the Senate pushed into early 2021.
So what is the current state of play? Let me discuss the key dates to watch. As we record this video, the electoral college vote is at 298 to 214. President Trump has not conceded the elections. And the safe harbor dates for states to certify election results is December 8th, while the electoral college members place their votes on December 14th. December 23rd is the deadline for the Senate to receive all state electoral ballots, with Congress responsible for counting the electoral votes and declaring a winner on January 6, 2021, with the inauguration set to take place on January 20th.
Now Georgia will have a recount and a runoff for the Georgia Senate elections, which is scheduled for January the 5th. Right now, the election count is at 48 to 48. In the Georgia Senate races, the voting begins on December the 14th. And based on history, the Republicans are seen as having an advantage here. In the House, the Democrats have held the House. There are still 24 seats outstanding, but Democratic control is likely to hold. There will be a record female representation, at least 131 seats for what's already been decided, or 30% of the House.
Looking at the lawsuits around the elections, 15 lawsuits have been brought. 10 have been decided, five are outstanding, more may be filed. But the only state now that looks like it will be recounted is the state of Georgia at this moment.
We have a historically wide ideological gap between the major parties and an increasingly frequency of close elections. That means that transformative change that had been anticipated under a blue wave is unlikely with the use of executive orders to dictate policy here to stay. So what does this all mean for the global economy and markets?
So John, the US election outcome appears headed for a divided government. And we haven't seen a new president with the same Congress since Ronald Reagan was president. Risk markets have rallied since the US elections. And there is this common presumption that a divided government is good and a united government is bad when anticipating asset market trends over a president's term. Is this the right way and the right framework to think about the market outlook? How are you looking at Biden's inheritance and the market tendencies for the next four years?
JOHN NORMAND: So I think that whole idea that united government is bad for markets and divided government is good is certainly one perspective. It seems to be the perspective that is dominating a lot of thinking around what way markets should go over the next few years. It's not the only way to look at things.
Another way to look at things is to realize that every president receives an inheritance, the set of economic conditions and market valuations that greet the president when he comes into office. And because there is a mean reversion tendency in the business cycle, the profit cycle in market valuations, maybe the best predictor of which way markets go over that four-year term is, what was the starting point?
And from that perspective, I'd say Biden's inheritance, i.e, Trump's legacy, is mixed. Biden is not inheriting an economy in recession. He is inheriting an economy that's starting an expansion. But maybe more importantly, he's inheriting a set of market valuations that, to me, give a fairly clear bias he's inheriting an equity market that might look expensive in absolute terms, but is still quite cheap relative to bonds, that inclines equities to outperform bonds over the next two to four years of whatever kind of Congress we see.
And when we look at credit markets, they're at average valuation levels that inclines them, to me, to tighten, but not deliver above average returns. And finally, when we look at the level of the trade weighted dollar, it's expensive relative to history. That inclines it to move lower. So maybe the hand he's been dealt isn't as extreme as the one that greeted President Bush in 2000 with a unified government, where he took over when a recession was just starting, and asset markets were very rich.
It's not maybe as good a hand as Obama was given when he took over with markets at near historic lows in terms of equity levels and equity PEs. But it's still pretty favorable towards some [INAUDIBLE] aversion, up still in equities versus bonds, tighter in credit spreads, and lower than the dollar.
JOYCE CHANG: But John, I want to show you what we've seen all year is this disconnect between the real economy and the market's performance. And so I want to ask you, how are you looking at the economic conditions right now versus the market valuations? And which markets do you think actually offer us the best value?
JOHN NORMAND: So I think economic conditions are steady, but still somewhat vulnerable. This is mainly around virus developments, which are very obvious in Europe in terms of the impact on the economy, very obvious in the US in terms of the movement of the virus, and less obvious in the macro data. So there's an issue here that really needs to be settled within the next two to three months, is, is stimulus going to be sufficient to offset the impact of the virus, or is the virus going to dominate?
But I do think if you're willing to look through that uncertainty, which could persist for two or three months, I do think the global economy is set for still another year of above trend growth next year. This is mainly around stimulative monetary conditions. This is around the possibility of some fiscal stimulus early next year, even if it's not as big as the fiscal stimulus that we probably would've gotten under a Democratic sweep.
As we've seen today, the vaccine news is continuing to come online pretty much on schedule.
So there are reasons to think that people should be focusing on a return to normal activity in a couple of years and a lot of depressed sectors in a way they couldn't really have envisioned that before some of the vaccine news came out. So there are definitely reasons to be very hopeful over the medium term.
I think that's why some of these valuation problems that people identify are maybe not such huge problems. Some people are bothered by the level of PEs in the equity markets. Some people are bothered by how much markets have gained share when the economic recovery is incomplete. But basically, a very simple principle of investing is, as long as the economy is growing around trend or probably better, the markets are probably going to retire.
So you can kind set aside your concerns that they might be too rich, as long as you can believe there's economic momentum in the activity data, as long as you believe the policy environment is still stimulative. That doesn't mean you can't have drawdowns over the next two or three months because of some of these complications I've mentioned around the virus and around fiscal policy. But it does mean that the path over the course of, say, the next six months or 12 months is definitely higher.
If you had to choose stuff that was very interesting right now, simply because it's cheap, I would say that's a lot of the EM complex, but it's really that the EM currencies. This isn't an environment where EM broadly is cheap on an equity basis or a rate basis or a credit basis or a currency basis. It's really only on the currency basis. So that's, I guess, the deep value across the big asset classes.
There is also deep value within equities if you focus on style investing, and our equity team has been very positive on that rotation for awhile. It certainly gets a leg up with the vaccine used today. The fiscal story is complicating this somewhat, but I don't think it's a deal breaker, meaning had we had a huge fiscal stimulus of $2 to $3 billion in the offing for the early part of next year, that would certainly amplify the outperformance of value stocks.
But I think even with a smaller fiscal stimulus at some point next year, plus the vaccine story coming online, plus lockdowns easing in Europe, that still is going to deliver. It may not deliver to the full extent that people might have been hoping when the sweep was their base case. So that's the way I would kind of frame things.
And a final thought, though. If I had to flag just a big risk into year end, it's squarely on the virus and how it interacts with fiscal policy. The vaccine new is very important. Today, it's going to be hugely important over the next six months as it starts to be deployed. But it's not really going to be deployed so quickly in the next couple of months that it's going to change the course of activity.
What's really going to impact activity at the year end is, what does the virus? Do how does that motivate lockdowns? To what extent is that offset by fiscal policy? So it's that whole interaction I think people need to watch pretty closely in terms of managing risk into the end of December.
JOYCE CHANG: Well, so it is very clearly, then, a risk on rally, which we have seen in the last few days that still has some momentum to continue in the equity markets with more attention actually now focused on whether emerging markets and some other asset classes with yield can also benefit.
JOHN NORMAND: And Joyce, you talked about executive orders and the likelihood that these are going to be used maybe as frequently under Biden as instructed. So what do you think would be the priorities in terms of policy for executive orders? And do you have any thoughts on cabinet positions?
JOYCE CHANG: Thanks so much, John, for that question. Well, neither party is going to get the 60 supermajority that is required. So executive orders were going to be in play in any event. But there's a big difference between what needs legislation and what can be done under executive order.
Now still quite a lot can be done under executive order. The president still has ample policy options in a divided Congress. And executive orders can be used to cover a range of policies, including energy reform, immigration, trade policy, antitrust, and regulatory policies. So you've already seen some of the announcements from President-elect Biden. The first one is about appointing a coronavirus task force.
But if you look at the transition website, many of the proposals do require congressional approval. Biden has also said that he will be rejoining the Paris Climate Agreement on day one. And that is a theme that you will hear from many of the Biden advisors that they want to get back to multilateral processes. Now this is very separate from whether you can get an infrastructure bill through, which is sort of at the centerpiece at the build back better plan.
The other thing that we think will be announced relatively quickly by executive orders are a number of things related to immigration, that limits on immigration would be halted and replaced with policies that are as permissive as possible under the existing laws. So this means the Muslim travel ban, the DREAM Act, all of these things are things that the Biden administration have said that they could use executive order to reinstate some of the policies that had been in place under the Obama administration.
But the bigger things like a corporate tax side or individual tax side, that's something that is very much dead on arrival if you have the Senate remain Republican and under McConnell's leadership. I don't see that going through.
But the other thing I would say is very important is the Cabinet appointments. And this could have a far bigger impact on future policy direction. There are more than 5,000 Cabinet positions to appoint immediately. In the Trump administration, they left many of those positions open, so they were never filled. So investors should pay very close attention to the nature of the nominations and the confirmation process.
Now, many of the key appointments need to go through Senate approval to confirm presidential nominees to the federal courts and to senior positions. But I think you will also see that, similar to what happened under Trump and even under Obama, when appointments were blocked, that you use special advisors that don't need to go through that Senate approval process.
So, John, though, I do want to talk more. We've talked about the executive orders. I want to talk more about the legislative process. And what do you think can happen in this lame duck session that starts today? He doesn't have that many days with a lot on the docket right now, including the government funding bill. How much do you think can be achieved between now and year end?
JOHN NORMAND: I suppose if the hearts and minds are focused enough, it's always possible to have some sort of funding measure passed in the lame duck Congress. I think the complication, though, is that with the balance in the Senate still to play for, given these runoff elections for Georgia in January, perhaps there are incentives to reach a kind of deal before the end of the year, meaning both sides, they feel that they have a greater advantage if they simply wait until January, depending what they assess their own party's prospects for in those Senate races.
And so perhaps there's an incentive more to stall rather than to engage over the next several weeks of the year. So I think this is an interesting respect to consider if you do believe that one of the foreground issues is the path of the virus and certainly the virus, the possibility of some lockdowns at the state and local level, slowdown of the economy to year end. In response to that, maybe the oddity of a Senate race that really isn't decided until January just really doesn't favor any kind of response in the lame duck Congress.
That's the domestic policy side. There's obviously the foreign policy you've mentioned that people are very focused on right now in markets. This is one of the reasons why EM assets are leading in the rally. So Joyce, from your perspective, what do you think would be the big differences between Biden's foreign policy and Trump's foreign policy?
JOYCE CHANG: Well, I think the big difference is that Trump really took a zero sum approach to global relations. And Biden would really look to bring new partnerships and alliances and pursue transatlantic relationships. I do think one of the most important things to watch is actually recreating some of these alliances with Europe. The Trump administration has made it clear that they think the US is better off in these bilateral relationships versus the multilateral ones.
And so I think the Trump administration versus the Biden administration, Biden's going to say we need to abandon taking isolationist approaches. We need to partner better. We need to use multilateral organizations. So, rejoining the Paris Climate Agreement, the World Health Organization, the World Trade Organization, and also setting some priorities for rules of the road. And this is particularly true on things like digitalization, some of these issues where Europe has been at the forefront.
But I think the US-European alliance is going to be a key one to watch on trade issues, as I believe the US administration thinks the US and Europe have a lot of common interests. These would be China, when looking at technology, looking at national security issues, and looking at the human rights and democracy agenda. I don't see rapid things like the tariffs that are in place being overturned. I see the message being very much the one that Biden offered over the weekend when he did his speech, where he basically said he wanted to promote more unity.
So he will look at partners that have the same type of objectives and [INAUDIBLE] look at the multilateral organizations. And many of the advisors that he has in place had come from those organizations and working with them over a period of decades. So that's my expectation on foreign policy, is that you will just see a very different approach taken and away from isolationism.
Well, John, thank you so much. There's so much to monitor as we look to the weeks until the inauguration. But that wraps up our discussion for today. It's great to chat with you. Thank you so much for sharing your insights.
JOHN NORMAND: Thank you, Joyce.
JOYCE CHANG: And for our listeners, please stay tuned for more videos and updates from the Global Research Team.
Despite the recent uptick in market volatility, the outlook for U.S. equity and credit markets is constructive, even with a divided government.
“For U.S. stocks, this is likely the best of both worlds,” said Marko Kolanovic, Head of Macro and Quantitative Derivatives Strategy at J.P. Morgan.
“A potential Republican Senate majority should ensure that Trump’s pro-business policies stay largely intact, particularly the tax code and the direction the country has taken is toward the center,” added Kolanovic.
J.P. Morgan Research U.S. equity strategists now expect to see the S&P 500 surpassing its longstanding price target of 3,600 before year-end and reaching 4,000 by early next year, with a good potential for the market to move even higher (around 4,500) by the end of next year.
“The equity market is facing one of the best backdrops for sustained gains in years. After a prolonged period of elevated risks which include the global trade war, COVID-19 pandemic and U.S. election uncertainty, the outlook is significantly clearing up,” said Dubravko Lakos, Head of U.S. Equity and Quantitative Strategy at J.P. Morgan.
J.P. Morgan Research has also revised up its 2021 earnings per share (EPS) estimate by $8 to $178 (consensus $168.26) and introduced 2022 EPS of $200 (consensus $194.69).
Apart from U.S. equities, emerging market (EM) equities have been upgraded to overweight versus developed markets (DM).
“We believe that markets are primed for a broadening in leadership, having seen record ever bifurcation so far this year. Style-wise, growth has dramatically beaten value and regionally the U.S. and China have strongly outperformed Europe and EM excluding Asia,” said Mislav Matejka, Head of Global and European Equity Strategy at J.P. Morgan.
“We have been overweight tech vs financials, but have recently taken profits, upgrading banks. Regionally, we think that a Biden victory will result in lower trade uncertainty and potentially stronger EM foreign exchange. We have been overweight China through this year and now add other EMs, moving EM vs. in aggregate to overweight,” Matejka added.
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Source: J.P. Morgan Strategic Research
As it has become clear that split control of government is the most likely outcome, so too has the possibility for higher levels of overall policy uncertainty which tends to be higher when election margins are tighter.
“This is bullish for medium-term volatility, particularly in longer maturities less anchored by Federal Reserve (Fed) policy, through several channels: event risk pricing, term premium, and policy uncertainty,” said Josh Younger, Head of U.S. Interest Rate Derivatives Research at J.P. Morgan.
In bond markets, the J.P. Morgan U.S. Fixed Income team sees spread products outperforming Treasuries in the months ahead as Fed policy remains supportive and sponsorship is extremely positive, with Fed support and banks’ demand for bonds likely to stay strong.
“Treasury yields traversed a wide range during the week after elections, and we look for modestly rising long-term rates,” added Alex Roever, Head of U.S. Rates Strategy.