In the last quarter of 2020, investors should not be surprised by near-term market volatility as uncertainties related to the US presidential election, fading fiscal stimulus, new waves of Covid-19 infections, and other key risks, loom large in the background.

If markets turn turbulent, investors should not react out of fear. Those who are well positioned with balanced, diversified portfolios can approach periods of volatility as opportunities to invest prudently with a patient, long term view.

US elections take centre stage

Entering the final week before the US presidential election on 3 November, Democratic presidential candidate Joe Biden continues to lead President Donald Trump in the polls. Given that President Trump has repeatedly refused to commit to accepting the election results, the risk of a drawn-out contested election should be taken seriously, although this is not our base case scenario.

If Biden wins, we will likely see a sweep of Congress by the Democratic Party. This will provide Biden a clear mandate to push through major policy changes. Our view is that Biden’s overall agenda, which includes a significant increase in government spending on infrastructure, healthcare, and environmentally friendly initiatives, would be ultimately reflationary for the US economy. This would be supportive of risk assets over the long term. On US-China relations, we expect Biden to engage China with a more measured approach using conventional diplomacy, providing greater certainty for financial markets.

If President Trump wins a second term, we expect a broad continuation of the policy status quo, given that a Trump victory would most likely mean that Congress remains split between a Democratic-controlled House and a Republican Senate.

US-China conflict structural in nature

Although Biden is likely to take a more calibrated approach with China, the overarching dynamic between the two superpowers will remain adversarial as their fundamental conflicts in the areas of trade, intellectual property protection, technology, and others, are structural in nature and not specific to Trump or the Republicans.

Most recently, the US announced restrictions on technology exports to China’s top chip maker, Semiconductor Manufacturing International Corp, potentially cutting off its access to critical software and equipment. This follows earlier sanctions on a broad range of China’s tech companies including Huawei, and efforts to shut down social media apps TikTok and WeChat in the US.

In turn, China has released more details of measures that would allow Beijing to punish blacklisted foreign entities deemed as hurting China’s national interests. This is widely seen as a warning of potential retaliation against US firms in China.

The expanding spat is particularly worrying against a backdrop of uncertain economic recovery momentum and raises concerns about the reshaping of global supply chains and the associated impact on longer term growth.

Near-term waning of US fiscal stimulus

In October, US lawmakers remain far from agreement on new fiscal stimulus needed to help sustain the economic recovery, with the support from earlier fiscal stimulus already fading. This will likely lead to a waning of US recovery momentum in the final quarter of 2020 until a new stimulus plan is agreed.

However, monetary stimulus remains firmly in place. Federal Reserve policymakers have reiterated that they expect to keep interest rates at current near-zero levels until at least 2023, while other major central banks have also signalled their determination to provide continued support for their economies.

Covid-19 and Brexit risks revisited

In Europe, second waves of Covid-19 have hurt the economic recovery, as governments responded to rising infections with new restrictions on movement and business activity. Adding to the risks is renewed uncertainty over a potential ‘no deal’ exit of the United Kingdom from the European Union when their current trade arrangements expire at the end of the year.

On a more positive note, China’s latest activity data suggest that it continues to lead the global economic recovery, with its strong economic expansion in Q2 and Q3 likely to continue into Q4.

Long term outlook remains positive

Overall, our view is that the long-term trajectory of the post-pandemic recovery remains positive and we see opportunities amid risks.

We believe that the investment environment ahead will be characterised by a moderate economic recovery accompanied by modestly higher inflation, marginally higher US Treasury yields, a weaker US dollar, and persistently low policy rates. This environment is generally supportive of risk assets – but with plenty of scope for short-term market swings.

For investors, exercising discipline in diversification and managing volatility remains key. A sensible strategy to hedge against election-related uncertainties is to tilt portfolios towards high-quality names with growth paths that are not heavily reliant on specific political outcomes. It is also important to maintain exposure to beneficiaries of long-term secular trends, such as persistently low interest rates and structural shifts accelerated by the pandemic, including the increase in remote working and online consumption.