While the transition to the incoming Biden administration has only just begun, U.S. investors are already looking ahead to the impact on the markets.
Shortly after the election, we commissioned a survey of over 150 U.S.-based financial advisers on their outlook for the next 12 months. The results were revealing.
Benign Conditions
Most U.S. advisors were anticipating benign market conditions, alongside rising interest rates and widening spreads in fixed-income and credit markets. They also thought that U.S. equities would continue to outperform non-U.S., developed market equities. And most thought that information technology, health care and financials would beat other U.S. sectors.
In terms of factors, advisors thought that momentum, value and quality would outperform other U.S. factors, while U.S.-based sustainable strategies would outperform the equity market as demand for climate strategies rise. Advisors also predicted that credit spreads would widen across the board, with high yield rising more than investment-grade and municipal bonds.
Our survey also revealed that most respondents believed the U.S. dollar would appreciate relative to other currencies. And almost 80% expected that U.S. equities would outperform international equities over the next 12 months. However, this hasn’t been the outcome — so far —in either case.
Reversal of Fortune?
Since the election equity markets have significantly rallied, but the U.S. market has lagged global equities.
Turning to sectors, in the U.S. the best-performing were energy, financials and industrials. Technology and health care, however, underperformed. In terms of equity factors, value and small cap performed best, while low volatility and momentum have performed worst since the election.
Throughout the period after the U.S. election, interest rates remained unchanged and credit spreads significantly narrowed.
All in all, advisers correctly anticipated the overall rally in equities and the strength in financials and value. But so far their views on bonds and the relative strength of US equities, technology, health care and momentum have not been borne out by realized market performance.
Climate Strategies
President-elect Joe Biden has committed to re-joining the Paris agreement. Further details are sketchy at this stage, but if Biden were to set goals for the U.S. to reach net-zero emissions no later than 2050, it could have a major impact on investors and companies alike. To put this in context, the world is currently aligned with a warming level of more than 3 degrees Celsius. But Biden’s focus on a net-zero goal by 2050 would roughly align with the Paris goal of 1.5 degrees Celsius. For U.S. companies, aligning with this lower target would require very significant reductions in their emissions.
When we applied our Climate Value-at-Risk Model, we found that under a 3 degrees Celsius scenario companies would need to reduce their emissions by around 29% between now and 2030. But under the 1.5 degrees Celsius scenario they would have to reduce their emissions by around 65%. This would have a huge impact on many U.S. companies, particularly those in the utilities, energy, agriculture, transportation and materials sectors.
Reading the Runes
The reaction of bond and equity markets post the U.S. election provides some clues as to investors’ views on inflation, credit and future economic growth. Indeed, the strong rally in equities and the tightening in corporate and municipal credit spreads suggest that markets are anticipating robust economic growth with improving credit conditions.
The majority of our respondents plan to increase their allocations to U.S. equities and they see Treasury yields increasing and spreads widening. This bullish allocation to equities may reflect a belief that fixed-income returns are asymmetric in the current low-yield environment with the possibility of a significant increase in yields being greater than a decline. Respondents caution around credit spreads may be based on the view that the current tight level in spreads was unsustainable given the growing corporate-debt burden.
In summary, these are early days. We have to wait and see whether a Biden administration will be able to add fiscal stimulus to the economy, for example, and how it plans to implement climate change policy. However, the positive market reaction following the election result, and the steady stream of good news around COVID-19 vaccines, are both highly supportive. Over the next 12 months, adviser expectations, as reflected in our survey, suggest a positive outlook for U.S equities, coupled with expectations of rising interest rates and widening spreads in fixed-income markets.
You can also see further analysis on the MSCI Investment Decision Survey here, or learn more about our wealth management solutions here.
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