i-Wire: In the eye of the Storm (again)
These continue to be very difficult times for global markets which sold off heavily in the second half of October. They now face a uniquely challenging week as the re-imposition of lockdown restrictions in Europe is simultaneous with the US going to the polls in the most bitter and divisive election for decades. This has the potential to be a volatile few weeks which could test investors nerves to the full. Our counsel, as in March and April, is that at times of severe market stress the best policy is to think long term and only make changes to portfolios when there is more clarity as to the outlook yet good opportunities still present themselves.
At the risk of being overtaken quickly by events, this is our assessment of the current market background
- The severity and magnitude of the Covid pandemic, along with the response from Central Banks and governments, will remain the main driver of market direction for the remainder of this year and next.
- The US election is more of a transient short-term factor in terms of market movement, though one that has the potential to be explosive.
- In the medium term the election result will have a bearing on how quickly the US economy eventually recovers from Covid along with myriad effects on individual stocks and sectors within the US stock market.
- Outside of purely financial market terms the election will be critical in shaping how the US faces up to key societal issues of race, economic inequality, social justice and the environment which are more prevalent now than at any time since the 1960s.
- We will outline in the note how in brief we see the different US election outcomes playing out in the markets
Covid – Fighting the Second Wave
The significant pick up Covid infections, most notably in Europe and sadly here at home, has led to the re-imposition of strict lockdown restrictions which present a significant threat to the recovery in growth and earnings that markets were optimistically pricing in. Policy makers continue to face the terribly difficult choice between protecting public health and supporting the economy. Trying to balance the two is proving awfully difficult with some countries more successful than others. Those that have quickly and efficiently implemented test and trace policies, managed their medical resources best, and been able to rely on (or else impose) strong public compliance have fared well in controlling the pandemic and are well on the way to full economic recovery. China and several other countries in Asia are in the vanguard in this respect, the US, parts of Europe and UK are laggards. The stock markets reflect this, Asian markets have held up well over the last few weeks, Europe and the UK have sold off heavily.
It is not for us to debate whether we should have locked down earlier, this week or not at all. Your thoughts on this are your own and we respect all views and just sincerely hope, like we all do, that the damage to the health, wealth and fabric of our society is as contained as it can be. Our interest for this note is in the direction of markets as we move onto what is in effect the third stage of their behaviour following their initial collapse and subsequent surprisingly strong recovery. Our sense is that the second wave shouldn’t prove as economically harmful as the first with more of the economy remaining open and businesses having learnt how to operate within Covid restrictions. So yes, the new restrictions are obviously a negative and could lead to periods of significant market weakness, but we should not see the magnitude of falls that occurred in March and April
The markets will also be aware that there is a bull case out there, and it is here that the inter-play with the US election is apparent, making this such a pivotal week. If the election delivers a clear result, and in particular a Biden win and ‘Blue Sweep’ in Congress with the Democrats controlling both Houses then this clears the way for substantial fiscal support in the US and a stronger economic recovery. Should, as anticipated, vaccines start to be deployed early in 2021 then equity markets could provide strong returns next year. This is a bit of a wish list of course and we will know the answer to the first big ‘if’ in the coming days. As for the timing and subsequent efficacy of any vaccine (and the path of the pandemic itself), all we can confidently say is we are closer than we were and whilst we remain in awe of the speed of science, markets will remain nervous until firm answers are known. In such circumstances we think it best to think long term, make no rash decisions and trust to the benefits of well-diversified, resilient portfolios.
The US Election – What to look out for
There are a number of outcomes from the election, which I’ve ordered in terms of what is considered to be the ‘most likely’. There is also a worrying possibility of a contested outcome which would likely be the worst result for the markets.
Biden wins with a ‘Blue Sweep’ of Congress.
- Corporate America and the stock market normally favour Republican administrations rather than the ‘tax and spend’ Democrats but Wall Street is comfortable with Biden, being fed up with the instability and unpredictability of Trump. They dislike his aggressive trade policy and that his stance on key societal issues of race, social justice and economic inequality which they regard as increasingly out of step with societal thinking and business behaviour.
- Markets will likely be relieved by this result as it allows Biden a clear path with his legislation and should result in the early passage of a Covid Relief Bill and strong fiscal support for the economy. Higher corporation tax would be deemed a necessary evil, not a huge negative and not an immediate concern.
Biden wins but the Congress remains split
- Biden will find it much harder to pass legislation. The upside is that the markets will like Biden’s more conciliatory tone and the easing in global political tensions alongside the more dovish policy on taxation and regulation he will likely need to get it through Congress. The downside is that a split Congress could lead to a long period of policy impasse and gridlock in an atmosphere of increasing rancour and bitterness, lead to a less robust economic recovery and continue the uncertainty the markets find so unsettling.
- It is difficult to predict the immediate reaction, but we suspect markets would remain nervous and volatile
- This would be a bit of a shock, and the markets would be somewhat confused as Trump has no new policies in his manifesto. So more of the same, government by Twitter and increasing trade conflict. It is difficult to see the markets regarding this as a positive, though at least a fiscal support package would be passed for the economy, with the markets trading nervously within a range and turning their attention back to Covid developments.
Delayed and Contested Outcome
- The huge number of postal votes cast means that the result of the election may not be known for several days. Worse, Trump has made it clear he intends to challenge the result if he loses and it is close, citing voter fraud. The impact of this will be at its highest if the election result is close; if it’s clear Biden has won, expect Republican support to dissipate quickly in the House.
- This is by far the worst case outcome for global equities. Those with long memories will remember the 10% fall in the S&P 500 in the wake of the Bush/Gore ‘hanging chads’ fiasco in Florida in 2000. This could be worse given not only the background of Covid but also the current febrile state of US politics and society with civil disorder likely. Gore did offer his concessionary speech quickly in the face of the Supreme Court decision. It can’t be guaranteed Trump would do the same.
- Markets would recover once some sort of sanity returns and a winner accepted but we could be in a for a torrid few days or weeks as this process plays out
We thus face a week that could be volatile, but with positive as well as negative outcomes equally likely and note that markets have opened today on a firm note despite the increase in Covid restrictions, having already priced in much of the bad news over the last couple of weeks.