Goldman Sachs: Election and vaccine probabilities to drive pro-cyclical performance

Goldman Sachs: Election and vaccine probabilities to drive pro-cyclical performance

Outlook
Markets

Over the past week, markets have continued trading risk-on, supported by a higher probability of a Democratic Senate and Biden win as well as encouraging signs on a Phase 4 fiscal stimulus package. Election and vaccine probabilities drive pro-cyclical performance. This is what Goldman Sachs Research writes in the market commentary below.

As our Global Markets team has highlighted, US elections and newsflow around a vaccine are likely to be the main market drivers into year-end. Our Risk Appetite Indicator (GSRAI), which had been negative since the start of the Coronacrisis, has picked up further and is in positive territory for the second consecutive week. S&P 500 is up 7% since its late September trough, materially outperforming bonds, but rotation into cyclical assets has been limited so far (Exs. 1-2). Compared to the May rotation, the current one shows a similar reflation theme which has been closely linked to an increased probability of a Democratic Sweep as our Rates team observes.

While in May markets were more bullish on the back of economies re-opening - especially in Europe - this time market leadership has been more concentrated in trades that are likely to benefit from a Democratic win and fiscal stimulus. Russell 2000 has been one of the best performers vs. the S&P 500 together with the GS Infrastructure basket, while broad US cyclicals vs. defensives have not seen a major rotation. Nasdaq has not underperformed so far. European assets have struggled to keep up vs. US likely due to rising risks around a second COVID-19 wave.

EM assets and value stocks, which have continued to underperform vs. growth, have been among the biggest laggards. EM should be positively levered to both a Democratic win and a vaccine and could have room to start trading more pro-cyclically. In FX, our strategists iterate the case for dollar weakness and across EM FX believe the Ruble can trade well amid a Biden win.

Odds of Biden winning the US presidency and a majority Democratic Senate have increased to 67% and 64% respectively. Prediction market probabilities for a fiscal stimulus package later this year (but post election) have also increased (Ex. 3). Risky assets have been trading closely in line with those probabilities - pro-cyclical trades correlations to a Democratic win have turned more positive.

However as our US Strategists note, while US elections are an important near-term catalyst, over the longer term a vaccine will likely be the main market driver. Since the equity market trough expectations on vaccine availability and distribution have shifted from late ‘20/early ‘21 to ‘21Q2 according to Superforecasters - our Healthcare analysts think this may be too pessimistic.