A stronger than expected showing in initial results for President Trump over Democratic rival Joe Biden caught investors by surprise. © FT montage; Getty Images

Investors are dealing with a delayed and fraught process to determine the future political make-up of Washington with unusual poise.

US stocks and government bonds rallied sharply even though the widely anticipated sweeping victory for Democratic presidential candidate Joe Biden failed to materialise and his party was unlikely to take control of the Senate.

Tellingly, the rally was mostly driven by big technology stocks, rather than the more economy-sensitive corners of the equity market that investors had thought would benefit from a Democratic “blue wave” and resulting fiscal stimulus.

While periods of choppiness erupted overnight, trading was smooth, orderly and relatively subdued in volume, analysts said. The uneasy sense of calm held despite President Trump threatening, without clear explanation, to call on the Supreme Court to bring vote counting to a halt.

Traders’ mostly sanguine outlook reflected the view that a divided legislative branch — whoever ends up winning the presidency — might not be a bad thing, “It’s more like status quo, with less stimulus but no tax hikes,” said Luca Paolini, chief strategist at Pictet Asset Management.

Line chart of 10-year Treasury yield (%) showing Investors piled in to US government bonds as expectations for big stimulus programme dimmed

Tobias Levkovich, chief US equity strategist at Citi, said the lack of widespread unrest around the election was another source of cautious optimism. “We haven’t had a big outbreak of violence . . . and things have been pretty orderly, which is something investors are relieved about,” he said in a conference call with clients on Wednesday.

Underscoring the calm, the Vix index that measures the expected volatility of US equities dropped sharply from a high of 36 points on the eve of the election to 28.1 points by midday on Wednesday.

Some observers warned that the current calm might be misplaced. “We do not think financial markets have so far adequately reflected this uncertain outcome,” warned Ajay Rajadhyaksha, an analyst at Barclays. “We encourage investors to be cautious on risk assets in the very near term.”

Markets were surprised by Mr Trump’s stronger-than-expected showing in the initial results filtering out of various states on Tuesday night. Coupled with the Republicans looking set to maintain control of the Senate, this darkens the outlook for a big fiscal stimulus package to reinvigorate the economy. This spurred a big boost to bond prices, which had fallen in price in the lead-up to the election on the expectations that a spending spree would prompt stronger economic growth and inflation.

Line chart of Rebased (% change) showing US stock market futures were choppy as results rolled in but ultimately rose sharply

Adding to the murky outlook, Mr Trump declared himself the victor on Tuesday night and, without evidence, claimed the election was a “major fraud on our nation”. That stoked simmering fears that, in addition to the fading outlook for fiscal stimulus, Wall Street’s nightmare scenario of a nastily disputed election result leading to weeks of legal wrangling and social tensions could still come to the fore.

“Put on your seat belts,” said Nathan Sheets, chief economist at PGIM Fixed Income. “The markets were prepared to absorb a clear victory by either of the two candidates — but the uncertainties associated with a disputed election were what investors feared the most.” 

“At a minimum, there is a good chance we will be waiting for a verdict in Pennsylvania to determine the election’s outcome, and the final vote count in Pennsylvania is likely to take until the end of the week,” he added. 

Some investors still cautioned that significant legal challenges to the election results could weigh heavily on sentiment. “Any suggestion that the outcome could be contested by either the Trump or Biden campaigns is likely to be viewed dimly by investors, and could give way to a period of renewed volatility in equity and currency markets,” warned Richard Buxton, head of strategy at Jupiter Asset Management. 

Some investors looked to history to inform them on how markets would respond to a more protracted process of determining the presidential vote winner. In the modern era, the 2000 battle between Al Gore and George W Bush looms large, with a victor not declared until December 12, when the US Supreme Court intervened to halt a Florida recount. 

Over that period, US stocks fell nearly 5 per cent, the gold price rose almost 4 per cent and the 10-year Treasury yield dipped 0.85 percentage points to 5 per cent, Invesco data show. “That’s not a great outcome but not a disaster either,” noted Brian Levitt, global market strategist at Invesco, the US investment group.

However, despite the short-term importance of more fiscal stimulus for the US economy and the possibility of a messy transfer of power, investors and analysts stressed that the longer-term market outlook would be more dictated by efforts to contain and roll back the pandemic that has roiled the global economy this year.

“The next president and his administration could hasten the US economic recovery through the right policy mix,” Mr Levitt said. “Nonetheless, I believe that betting against that recovery over the next couple of years, irrespective of the ultimate outcome of the 2020 election, is akin to betting against medicine, science and human ingenuity.”

Amid much head-scratching and scenario-planning after the inconclusive election, Wall Street seemed in agreement on one clear loser from the election: pollsters that had led them to believe the only question was what shade of “blue wave” was coming.

“This is one of the worst opinion polling performances in history,” Jim Reid, a Deutsche Bank strategist wrote in a note to clients on Wednesday morning.


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