The prospect of a split US government buoyed equity markets heading into the end of US election week with investors encouraged by the softening risk of higher taxation under a Joe Biden Presidency, but concerns of an obstructed political process weigh on prospects for growth over the next four years.

Global equity markets rallied from the day of the US elections (3 November) through to the end of the week as the likely result became clearer, with the S&P 100, S&P 500 and MSCI World up 4.4%, 3.6% and 3.7% respectively, according to FE fundinfo data.

Healthcare and technology led the gains as the Democratic Party’s failure to achieve the much discussed ‘Blue Wave’ calmed concerns over impending reform and regulatory pressure, while materials, financials and industrials weakened.

The Democrats’ failure to increase their House of Representatives majority and regain control of the Senate saw the unwinding of the so-called “reflation trade”, whereby a significant Democratic win drives major stimulus to bolster growth and inflation, as yields fell lower.

Inflation expectations also fell sharply, with the Federal Reserve’s 5y5y measure of medium-term inflation falling ten basis points within 24 hours of polls closing.

Bad omens
Speaking at Investment Week’s Funds to Watch Conference, senior political economist at Aberdeen Standard Investments Stephanie Kelly warned a split Congress “creates a serious risk of a fiscal cliff”.

“The president has a lot of power when it comes to regulation and trade, but where he is limited is in fiscal policy and we have seen what power this can have,” she explained.

“The environment [is set] to be quite stunted as a result, as we know that Republicans tend to refuse any policy changes when in opposition.”

However, Kelly added a split Congress “would make little difference” on trade policy, and that Biden’s support for “multilateral and bilateral relations” will “likely have a much more positive relationship with the EU and support the Paris Agreement”.

Aberdeen Standard Investments investment director James Athey described a divided Congress and disputed election result as “bad omens for the prospects of a fresh stimulus package”, which “will sooner or later require the Fed to react, and that is worrying”.

The extent of fiscal stimulus in the wake of the election is now expected to be much smaller than the $2.5trn to $3trn anticipated under a Blue Wave, with a range of $500bn to $1trn now more likely.

“The tools the Fed is using have long produced unhealthy distortions in asset prices and markets are becoming ever more programmed to know that the central bank will step in at the sight of trouble. That kind of dependency is not healthy,” Athey said.

Similarly, Unigestion’s cross asset solutions team said in a statement that “large” fiscal stimulus is now less likely.

As a result the group is de-risking exposures and reducing its bias towards growth-oriented assets, such as equities and credit, while “favouring” the US dollar.

“Looking beyond the short term, the lack of significant fiscal stimulus could prove to be a major drag on the US economy and markets,” it said.

“The rotation and/or reflation trades that a Blue Wave would have augured are also off the table.

“We are watching the rising coronavirus cases and hospitalisations in the US, as they could reverse some of the progress made on re-opening the US economy.

“In terms of positive catalysts, a vaccine remains the primary one, and we are closely tracking progress on it.”

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