Please see article below from Legal & General’s asset allocation team – received 10/08/2020.
Legal & General Asset Allocation team’s key beliefs
This week, we take a tour of the United States – taking in the election, the economy, and the risk outlook for markets.
As with all Key Beliefs emails, this email represents solely the investment views of LGIM’s Asset Allocation team.
Biden: his time?
US presidential elections rarely lack drama, but it’s hard to recall one being carried out in such unusual circumstances as this year’s campaign. A few weeks ago it looked as good as it gets for Democratic candidate Joe Biden following months of terrible headlines for President Donald Trump, with polls and betting odds shifting in Biden’s favour. But then the polls stabilised and it seemed Trump was at his polling floor, making it difficult for Biden to gain more voters. With the potential for the news flow to normalise as new virus cases peak, the risks are skewed towards a tightening race.
The betting odds have barely moved, with the market average still giving Biden a 60% chance of winning. But polls have seen more movement, with Biden’s lead falling from an average of nine points to six over the past month. A few more polls in this direction and the narrative could escalate, pricing out some of the risk of a Democratic sweep.
The next major development is likely to be Biden’s pick for vice president. Betting markets suggest the contest is between Senator Kamala Harris and former national security advisor Susan Rice, with Senator Elizabeth Warren the only potentially market-moving – but low probability – option.
The focus then turns to party conventions over the second half of August. It remains to be seen how these translate as virtual events, how the press will cover them, and how voters will respond. Historically, a convention has given candidates a bump in the polls; they are likely to have a smaller effect than normal this time, but remain a wildcard, nonetheless.
The US Senior Loan Officer (SLO) survey released last Monday night showed aggressive tightening across all categories, and by almost as much as during the financial crisis. The SLO survey has historically been a key metric for our economists in tracking bank lending standards, but how relevant is it this time round?
Lending standards tightened 2.8 standard deviations, not far away from the peak tightening of 3.4 standard deviations in October 2008. The tightening was broad based across all categories, with demand also weak for all loan types except mortgages.
But comparisons with 2008 are perhaps unfounded. Thanks to unprecedented support for corporate borrowers, strong bond sales have so far more than offset weak issuance of rated bank loans, meaning we are unlikely to see similar levels of bankruptcy, in our view – at least among companies with access to bond markets.
The key question is whether this tightening is bad news for the future or merely reflects a terrible second quarter. On the optimistic side, auto sales were not far from normal in July despite a huge apparent tightening in auto credit and very weak demand in this survey, while forward-looking housing market indicators look strong despite the tightening in mortgage credit availability in the second quarter.
The tightening nevertheless raises the risk that, without further large fiscal support, there will be economic scarring from bankruptcies as borrowers are not able to roll over loans. At a minimum, it is inconsistent with our most optimistic scenario which now will require some reversal of this tightening for the economy to return to trend growth by the end of next year. Employment data have also been mixed, with Friday’s non-farm payrolls just beating expectations following weaker PMI and ADP prints.
Last week saw us close out two of our more defensive tactical positions – long US Treasuries and short equities – following a cluster of near-term risks that appear not to have played out. New virus cases have slowed both in states that re-imposed harsh restrictions and those that did not, making further shutdowns less likely in the short term. Although we are seeing potential second waves in a number of other countries, nothing is spinning dramatically out of control, and vaccine news has added to a more positive tone of late.
In addition, incoming economic data last week had the potential to change the market’s assessment of what’s possible for growth over the next year, but have not proved to be a catalyst. And finally, concerns about US/China relations have so far failed to ignite. The South China Sea announcement came and went, while the forced sale of TikTok also seems unlikely to escalate tensions further.
This is not to say that all is rosy. Donald Trump may yet choose to fan the flames of Chinese resentment as an election tactic, while vaccine hopes and virus containment measures may not live up to the hype. As mentioned in previous editions of Key Beliefs, we now prefer to express our caution via selling investment-grade credit given the more stretched market positioning in that asset class.
A useful article from Legal & General’s Asset Allocation team on the United States election, the economy and the risk outlook for markets.
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