Please see article below from Legal & General’s asset allocation team – received 05/10/2020
Our Asset Allocation team’s key beliefs
Prepare, don’t predict
Developments in the US election campaign remain highly unpredictable, so this week we discuss how the team thinks about political risk events and scenario analysis, our latest thoughts on the election itself, and our response in terms of asset allocation.
As with all Key Beliefs emails, this email represents solely the investment views of LGIM’s Asset Allocation team.
What’s the forecast?
We are fans of the Good Judgement Project, so were excited to have a virtual meeting with their ‘Superforecaster’ team this week. The initiative, led by Philip Tetlock and Barbara Mellers at the University of Pennsylvania, has regularly beaten even intelligence analysts with access to classified data when it comes to forecasting geopolitical events.
Their methods teach us how to become better forecasters ourselves, and this year they have released some time-series predictions from their network of Superforecasters on a number of COVID-19 related economic topics. These have helped us navigate the shifting timeline probabilities for vaccines and the likelihoods of fiscal stimulus in the US.
As a team, we have always been very interested in this topic: forecasting is our bread and butter, but we recognise it is not an easy task. We spend considerable time running scenarios for political risk events, macro outcomes and tail risks, as good forecasters are obliged to consider different scenarios. Our team motto is ‘prepare, don’t predict’. We have learnt to quantify our forecast likelihoods, and to update those likelihoods frequently and incrementally, with new information or simply as time passes.
The US election obviously poses our next challenge. It’s interesting to note the gap between the Superforecaster probabilities of a Democrat win, at 80% at the end of last week, and the betting odds suggesting a closer race.
Fireworks on the fourth or fifth of November?
Despite the wide gap in polls and a high apparent likelihood of a Democrat victory, we believe this race will feel tight until the night of the election. Due to an increase in postal voting and tensions between the parties, we see a high probability that no party will concede the election until sometime after the vote on 3 November. We believe the chances of a result by 4 November are below 50%.
The markets are also showing an elevated risk of a contested election, with expected volatility for November unusually elevated, even for an election year. But overall, we believe markets will price a likely winner well before either candidate concedes the election.
What can we say about the state of play for the big day? Well, there are not many undecided voters left in the US as views among voters have become more polarised, meaning voting switches are less likely. This is in contrast with 2016: the ‘decided’ share of the electorate in the US is currently 94%, which is roughly normal by historical standards, but in 2016 that number was 83% at the same point before the election.
There are many reasons to believe Joe Biden has an advantage: incumbents haven’t historically won after recessions, with rising unemployment, and with approval ratings below 48%. Democrats are also more unified than in 2016. Biden is polling well in battleground states, with Florida and Pennsylvania drawing our attention in particular.
Many states don’t start counting postal votes until election day, but Florida starts counting three weeks before then, so we may quickly be able to get a picture of how postal votes stack up to physical votes there. And in Pennsylvania we received interesting anecdotal information from our US-based colleagues about greater numbers of Trump placards and billboards in recent weeks, which may show that the president’s ground operation is paying off compared with Biden’s virtual-focused strategy. Indeed, that is reflected in new voter registration in Pennsylvania. Republicans added a net 135,619 voters from June to end September, while Democrats added 57,985. Back in 2016, Trump won the state by a margin of just 44,292 votes, so these numbers matter.
Fatter tails
After the news of Trump’s positive COVID-19 test, we moved our short-term US Treasury and overall duration outlook to become more negative. We had been looking for an opportunity to reduce duration risk ahead of the election, so the market’s knee-jerk reaction to the news – with perceived safe havens jumping higher – presented us with an attractive opportunity to make our move.
Market pricing in the past week has confirmed the sensitivity of the US Treasury markets to potential stimulus. In our opinion, more fiscal stimulus drives up yields through two channels: more issuance for the market to digest, and firmer near-term growth prospects.
We still don’t know exactly how Trump’s health will impact the election, but it introduces even more volatility into the race. If we think the distribution of potential outcomes is now fatter, then it increases the chance of a Democrat clean sweep of the White House and Congress. That is, in our view, the most negative scenario for US Treasuries.
The main risk to this is the prospect of stalling economic growth in the fourth quarter if fiscal stimulus fails to flow to a material degree. However, we struggle to believe that that will be as important as news on potential vaccines and the election.
A good input from Legal & General giving a view on political risk events and their latest thoughts on the US election.
Please continue to check back for our latest updates and blog posts.
Charlotte Ennis
06/10/2020