• Technology, digital communications and e-commerce. We view technology and internet companies as big beneficiaries of a split Congress, as the regulatory environment was expected to be much tougher in a Democratic-sweep scenario.
• Growth over value. Given the incrementally tougher interest rate outlook for financials and tailwinds for technology and internet stocks, it’s difficult to envision a regime shift from growth stocks to value, so we maintain our preference for a growth tilt at this time.
• Emerging markets. Pre-election, emerging markets equities had been receiving stronger interest as the US dollar weakened slightly and investors began to position for a potential Biden victory. Foreign policy is largely driven without major input from Congress, and we think a Biden presidency may be less confrontational with China, the dominant weight in the emerging markets equities index.
• Developed international equities. While developed international equities had appeared to be improving toward the end of the third quarter and a weak dollar boosts international market returns for US-based investors, newly implemented lockdowns put considerable strain on economic growth prospects in Europe.
Lower Expectations For Yields
Treasury yields are down sharply post-election as the market digests the narrative that a divided Congress may mean a smaller stimulus package. Treasury yields are strongly correlated with economic growth potential, and the market had appeared overly optimistic over a large fiscal stimulus package’s ability to help the economic recovery preserve its momentum. The decline in yields may also be accounting for softer inflation expectations. Breakeven inflation rates—measured by the difference in the yield of inflation-protected bonds and their nominal counterparts—fell during the week as the odds of a Democratic blue wave declined.
As the prospects of a larger stimulus bill that emphasizes support to state and local governments fade, we expect municipal balance sheets may be under greater pressure, and issuers may have to increase deficit funding, thus increasing bond supply. In addition, potentially taking tax increases for individuals off the table removes a likely positive catalyst for tax-exempt fixed income. Overall, we expect municipal bond spreads to widen as yields relative to Treasuries rise.
LPL Research’s Bottom Line
While we know who the next president will be, we will have to wait for the runoff elections in Georgia to confirm the final composition of the Senate, and a split Congress appears highly likely. Regardless, we believe that both parties feel compelled to pass another stimulus bill, and that we’ll get one soon. Under a Biden presidency and a split Congress, the more moderate policy ambitions may have the best chances of passage, which may yield a more status quo leadership environment for stocks. Stocks historically have preferred divided government, which we expect to be supportive for the market over the rest of 2020 and into 2021.
Jeff Buchbinder is an equity strategist for LPL Financial.