We expect fiscal stimulus and the rollout of a vaccine to drive the economic recovery and outperformance for mid-caps and select cyclical sectors, relative to large-caps. The US dollar will depreciate, in our view.
Over 50% of investors are planning to make changes to their portfolio in light of the US election result.
At the time of writing, it looks likely that we will see a divided government, with a Democratic President and House along with a Republican-led Senate. This is likely to mean a smaller-than-anticipated, but still sizable, fiscal stimulus package. Political gridlock could also have some positive effects. Republican control of the Senate would make significant tax increases on businesses or individuals unlikely in the coming years. It would also reduce the probability of aggressive new regulation on healthcare or fossil fuel companies. More broadly, divided government lowers the potential for significant policy changes, reducing the potential for policy-induced market volatility.
We identify three key effects:
Stimulus to boost mid-caps
We think the new administration will be able to enact another coronavirus aid package worth between $500 billion and $1 trillion, or roughly 2.5%–5% of GDP, which should bode well for consumer spending and business confidence, and help drive a shift in market leadership away from large-caps and toward mid-caps. Mid-cap earnings are more lever- aged to an economic recovery, and we expect them to grow at around twice the pace of large-cap earnings in 2021.
A higher deficit to weaken the US dollar
We expect higher fiscal spending to be funded by a rising deficit, rather than additional taxes. Although spending can largely be funded by private domestic savings in the near term, as the economy begins to recover in 2021, we expect the private sector to increase spending, widening the current account deficit and requiring a weaker dollar to attract external funding.
A more predictable China rivalry to emerge
We think the Biden administration will renew the US’s approach to foreign relations, a tack that should improve relations with Europe in particular. Although the fundamental US-China geostrategic rivalry won’t change, we do think the new administration will be less likely to use tariffs as a tool of foreign policy. Reduced trade tensions should support the economic recovery, reinforcing our preference for cyclicals such as industrials.
What’s next for US tech?
After a rally of over 50% in 2020, the top five US technology firms alone now represent around one-eighth of the MSCI AC World equity index, more than China, the UK, and Switzerland combined. We expect the technology sector to continue to benefit from strong secular growth in digital advertising, e-commerce, cloud computing, and the 5G rollout.
However, valuations have increased, and we think other segments of the market will see stronger earnings growth in 2021 as they recover from depressed levels. Anti-trust scrutiny also bears monitoring, although a divided government would reduce the probability of new regulations, and in any case we would expect judicial proceedings to take years to reach resolution.
How should I think about my country allocation?
The US equity market now represents 58% of the MSCI AC World equity index, up from 51% five years ago. Even though the US market has outperformed global stocks in 10 of the past 11 years, out-performance doesn’t last forever.
For US-based investors, home bias is another important factor. If the US stock market does poorly, this may be coincident with other financial challenges, such as higher unemployment, lower wage gains, or less home price appreciation. The equity allocation should take into account these other assets and future liabilities. Investing globally can help to diversify portfolios and protect investors against the inherent risks of such correlations.
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