Saxo Q4 Outlook: The US election is the biggest political risk we have seen in several decades

Saxo Markets, the online trading and investment specialist that connects people to investment opportunities in global capital markets, has published its Q4 2020 Quarterly Outlook for global markets.

This edition of Saxo's Quarterly Outlook focuses exclusively on the impact of the upcoming US elections on the markets, including trading ideas covering equities, FX, commodities, and bonds, as well as a range of central macro themes impacting client portfolios, the firm said in a press release.

Steen Jakobsen, Chief Economist and CIO, Saxo Bank, said: “We fear that the US election is the biggest political risk we have seen in several decades, as the end of the economic cycle meets inequality, social unrest and a market feeding frenzy driven by the policy response to this deep economic crisis: zero interest rates, infinite government and central bank support. The massive official backstop, with guarantees for demand and jobs in a world of state capitalism, means that markets and individual freedoms have never been more under attack.”

“At Saxo Bank Group, we see three distinct paths and probabilities between now and Inauguration Day on January 20, 2021: a contested election (probability 40%); a clean sweep by Biden (probability 40%); a win by Trump (probability 20%).”

“Our main message is that the US election will come with increased volatility and risk. Whoever wins will not change the US direction much in aggregate. Both would spend huge amounts of money; both would lean on the Fed for supporting easy financing conditions and neither of them would seek deep reform. So to a large extent, the two Presidential candidates are the diametric opposite of what the US needs,” Jakobsen continued.

ASIA PACIFIC: Godzilla exits Japan = USD JPY 85-95, Tech Wars & Biden’s Asia Pivot

Japan’s one and only true modern-day Shogun in decades, Shinzo Abe, resigned in Q3 citing health. In addition to being Japan’s longest serving PM, Abe’s legacy will be centred around the orchestrated ‘Abenomics’ from late 2012.

Kay Van Petersen, Global Macro Strategist, Saxo Markets, said: “Firstly, despite what policymakers may say, with debt-to-GDP ratios of over 300% and the BoJ’s BS/GDP ratio of 120%, the bang for yen has expired way past its due date – especially considering Japan’s deflationary forces of a declining population and silver-haired demographics.”

“Negative rates and YCC finally saw the yen cross the line. At 106, USD JPY today is around 15% below its all-time highs, but still some 35% up from the start of Abenomics.  My view (in addition to be a mega-cyclical USD bear) is that for USD JPY, the highs are over, and we are more likely to be below 100 (high 90s) than back above 110 before Q4.”

“Could we see USDJPY in the 85 to 95 range by the end of 2021, as Abenomics unwinds? But the icing on the cake is that having short USD JPY exposure could potentially also be a great hedge if we run into market volatility linked to the US elections,” Van Petersen said.

EQUITIES: Structuring equity portfolios post-US election

Supportive measures following the pandemic outbreak have engineered a strong rebound in equity markets and expectations are high going into Q3.  The US equity market has done quite well under a Trump administration and a Biden victory could bring added volatility and market drag in the form of increased taxes.

Peter Garnry, Head of Equity Strategy, Saxo Bank, said: “Aggressive policy action in the first half of the year by central banks and governments has engineered a strong rebound in equity markets and a general belief that the world will overcome the Covid crisis with less damage than from the 2008 financial crisis.”

“Expectations are high going into the third quarter earnings season, with estimates suggesting a 106% jump in quarterly earnings. If the corporate sector delivers this rebound in earnings, the global equity market will be valued at 19.3x earnings in 2021. Not an unreasonable valuation given the alternatives in bonds.”

“The US equity market has done quite well during the four years with Trump, despite increasing tension between the US and China that has caused friction for US companies around their global supply chains. Market participants are now used to Trump’s persona and the corporate sector has, in many ways, benefitted from Trump’s policies of lower taxes and less government oversight. Even the US-China relationship is to some extent predictable for companies and investors under a Trump administration.”

“A Biden win, on the other hand, could become a headwind for equities as Biden has proposed to hike the statutory tax rate from 21% to 28% on corporate income and increase the Global Intangibles Low-Tax Income tax from 10.5% to 21%. In addition, Biden has proposed to hike the minimum corporate tax rate to 15% and add a social security payroll tax on high earners. Combined, it is estimated that these tax changes would create a 9% drag on S&P 500 earnings – and that is before second-order effects, including change in investor sentiment, potentially hit valuations. These would hit communication services, healthcare and information technology the hardest, as those companies have the lowest tax rates in general and are big users of intangible assets. The open question is whether Biden dares implement the tax changes during a weak economic backdrop,” said Garnry.