Time to Decide

361 Capital Market Commentary | November 2nd, 2020

The market is as anxious as many voters are today. The S&P 500 VIX tapped forty last week, while the market retreated another high single digit percentage off its previous high for the second month in a row. But after tomorrow, uncertainty will turn to certainty, the VIX should retreat and investors will place some new bets on the results of the election. If the polls and massive early voting turnouts are to be believed, this could mean a 46th President and a Democratic Congress.

As I have written in the past, here is how I would position for the blue wave. Expect interest rates to continue to rise and the U.S. dollar to continue to fall as fiscal plans to spend on additional COVID aid, plus a massive infrastructure plan begins to take shape. Rising rates and spending dollars allocated to infrastructure will help many cyclical stock sectors including financials, industrials, and basic materials. Look for the acceleration in economic activity to even help out the energy sector as oil prices rise. Alternative energy companies will also have a wind at their backs, but that has not gone unnoticed this year as many stocks have already gained 2-3x. Fiscal stimulus and new infrastructure plans will allow those in trouble to make their mortgage and rental payments helping the real estate sector stay afloat and reducing failures within the banking system. This will help the credit markets and keep spreads tight. Gold and commodity prices will benefit from the falling U.S. dollar and various inflationary pressures that ripple through the economy as shortages pop up in damaged industries or jammed supply chains. While stocks should benefit from a collapse in uncertainty, some sectors will lag not because of fundamental deterioration, but instead because investors will be looking for other areas of the economy to outperform. Don’t be surprised if the leading stocks of the past (like technology and consumer defensive) become laggards as their profitable gains are redistributed into depressed value cyclicals.

Enjoy watching the election returns Tuesday night. This one should go down as the Super Bowl of Super Bowls.

Agree strongly…

Tweet from @dailydirtnap

J.P. Morgan agrees that technology stocks could underperform from here…

JPMorgan Chase & Co. strategists are dropping their longtime preference for technology stocks one day before the U.S. elections as they forecast a change in market leadership, no matter who wins the vote.

After being overweight tech for almost two years, strategists led by Mislav Matejka slashed to neutral the sector that has driven the recovery rally since March and raised their recommendation on banking and insurance stocks to overweight. Their call comes after the Nasdaq 100 Index has tumbled nearly 9% since Oct. 12.

“We believe the markets are primed for a broadening in leadership, having seen record-ever bifurcation so far year-to-date,” write JPMorgan strategists, including Prabhav Bhadani and Nitya Saldanha, in a Monday note. “The sector and style rotation is likely to get underway irrespective of the U.S. elections winner, while the regional rotation would be more dependent on the actual election outcome.”


And there also is a potential future tax impact that could impact past winning sectors like technology stocks…

The other side of fiscal expansion is tax reform. The potential for higher corporate tax rates following a Democratic sweep represents a broad risk to corporate earnings and equity prices. However, the specific reforms proposed by the Biden campaign also appear likely to support a rotation within the market. The 2017 TCJA tax cuts had the largest impact on the earnings and share prices of cyclical stocks, and many investors expect that a corporate tax hike following a Democratic sweep would weigh disproportionately on these same sectors. However, in addition to a higher statutory rate, the Biden plan also includes proposals including a minimum corporate tax rate and a higher tax on low-tax foreign income not tied to tangible assets (known as the “GILTI” tax). Including these proposals, the combined earnings impact of the Biden tax plan would likely be greatest for the Growth-y Communication Services, Health Care, and Information Technology sectors. Our political economists’ expectation that eventual legislation would include a smaller statutory rate hike than currently proposed further tilts the likely impact of tax reform in favor of market rotation.


Potential impact of select tax proposals on sector earnings

Most important to many who are out of work will be the new fiscal aid under a change in the government…

And it won’t just be the individuals in need, but also the retailers, restaurants, and service industries dependent upon those without paychecks. Holiday shopping could be make or break depending upon when the next stimulus checks are mailed out.

In a Democratic sweep scenario, we would expect a much larger fiscal package, including a second round of stimulus payments to individuals in Q1 and more generous unemployment insurance benefits supporting income throughout the year.

This should boost disposable income significantly, in addition to our expectation of further recovery in the labor market. Exhibit 7 presents our updated DPI forecast, which incorporates both our fiscal outlook and labor market projections, under both a divided government and a Democratic sweep scenario. We expect that after declining in 2020Q3 and Q4 from the Q2 peak, disposable income will rise again starting in 2021Q1, and significantly more so in a Democratic sweep.


Further Fiscal Support After the Election

GDP has taken a big hit. It is going to take much work to get the U.S. back on track…

So far during the pandemic, Americans have avoided such a sharp blow to living standards: The average American was about 5% worse off in the third quarter than if the economy had continued growing in line with the 2017-19 trend, compared to about 11.5% worse off in the second quarter. The gap could close completely by the end of 2022 if the U.S. economy grows at an average annual rate of 4.5% a year from now through then.


The Return to Normalcy

If you are long the housing sector, keep an eye on this gap…

Rising rates and falling affordability will begin to erode at the outperformance of homebuilder stocks unless average incomes begin to accelerate.

Tweet from @ISABELNET_SA

There was a lot of protection being bought going into the election…

Assuming a stable election result, volatility should collapse and the many out of the money puts bought should expire worthless.

Tweet from @hmeisler

Looks to me like a great place to short the VIX…

VIX spike similar to last two corrections
(Cannaccord Genuity)

Another reason to get long this market?

Not many instances where a strong market stumbles for two months in a row.

Tweet from @carlquintanilla

More important to stock pickers will be any upcoming sector shifts…

Energy stocks clearly have no fans among mutual funds or hedge funds. If the economy were to pick up and oil prices were to rise, there could be a sling shot higher in the group.

Where do long-only funds and hedge funds agree
(BofA Global Research)

The value factor is also a very stretched rubber band…

@jsblokland: Is #value investing dead? Biggest value drawdown since 1826. Chart by @FT

Two centuries of value drawdowns

Even as COVID cases run higher in Europe and the U.S., global manufacturing is not giving up its bounce…

Tweet from @RenMacLLC

In fact, China seems to be accelerating…

Tweet from @C_Barraud

Goldman wants you to pay close attention to China’s A shares…

“The economic resiliency and respectable equity market returns amid the Covid-19 disruptions and continued external pressures reinforce what we view as an underappreciated investment case for A shares as one of the largest, most liquid, growthy, dynamic, underowned, and strategically important asset classes in a diversified global portfolio, in addition to the index inclusion and financial market reform tailwinds that should drive allocation and portfolio flows over time.”

(Goldman Sachs)

One of the simpler things that I have learned in 30 years of investing…

When companies hand out more disclosure about an operating segment, it typically means very good things for that business in the future. This also works very well in reverse.

Tweet from @borrowed_ideas

The veterinary market must have one of the strongest v-shaped recoveries that we have witnessed…

@bluff_capital: $IDXX Idexx covid impact/market trend update

Veterinary Market U.S. Companion Animal Practice Growth Update

Time to buy a Harley…

The name Harley-Davidson conjures images of middle-aged men astride hulking motorcycles. But on Tuesday, October 27, the company announced a new project: an electric bicycle brand called the Serial 1 Cycle Company.

With the global pandemic leading to a cycling boom this summer, on top of growing environmental concerns around gas-powered vehicles, this could be the move that saves the brand.


Harley bicycle

Finally, the one thing that we could all agree on this weekend…

No man was cooler than Sean Connery.

Sean Connery


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