November 20, 2020
Two Weeks Following The Election. Still Many Questions, and Very Few Answers.
A little over two weeks since the election, and it seems that we have just as many un-answered questions today as we did a few weeks ago.
Within my video and article of last month, I drew reference to several economic observations from the years of the Obama Administration. I did that in an effort to glean insight into what we might expect under a Biden Administration if he were elected.
Clearly, the certification of the election results remains in our future, and between then and now we will hopefully have a resolution to matters of re-counting votes in certain states.
As to the subject of last month’s commentary however, I remain convicted in the premises and conclusions that were drawn. History does indeed show that predicting the outcome of an election is often a dicey proposition. I also made the point that markets do not care who is in office. The markets only want to know the rules, and the lay of the economic land. Within those rules, assumptions about future asset prices are made and reflected in current market valuations.
Too often, I believe that we have a tendency to conflate these two things when they are really two mutually exclusive thoughts.
If you have not had an opportunity to view the video that we published last month, please take a moment to find it on the website of the Tribune, or on the Keystone Financial Group website.
Drawing a high-level reference to that video, there is no question that the economic data observed during the tenure of the Obama administration was tepid at best. Changes that were proposed by Joe Biden during his campaign to the current tax code, and policies of economic and fiscal spending look very similar to that which governed under the Obama Administration.
So, why have the markets rallied so strongly in the weeks prior to and after the election? One might expect a negative response from the markets if financial assumptions were changing significantly.
To me, it boils down to three things. First, we have received welcome news from both Pfizer, and Moderna, about the efficacy of their COVID-19 vaccines. If these vaccines, and those that may be available in the near future are as effective as advertised, then such could have a dramatic impact on the psychology of people, and getting back to life as we once knew it prior to COVID-19.
Secondly, we have observed historically strong economic data in recent weeks. For months, we have heard from economists and members of the Trump administration, that such economic data could be very robust toward the end of the year. We are clearly observing that now, and the market seems to be pricing those observations into current valuations.
The third factor that is quietly having an impact on the market, but in my opinion, has yet to be manifest in current values, is indeed the election. Having said that, the election is not over yet. At least, the quest for gridlock is not over yet. Within last month’s commentary, I noted that gridlock is often very favorable for markets.
Even when there is a change in presidential administrations, gridlock at the congressional level tends to keep the rules from changing dramatically. Historically, markets do not favor either party having complete power. There is a runoff election for two Senate seats, to be held on the 5th of January in Georgia. The balance of Senate power will be determined by these runoff elections. I believe that the markets have not yet fully priced into themselves the impact of the election, because gridlock may remain in the Senate, and that depends entirely on the result of the runoff races to be held in early January.
In my opinion, if both incumbents win re-election, then it’s possible that markets continue to reflect the assumption of accelerating economic growth, and boosted by the favorable impact of multiple COVID vaccines, with gridlock in Washington preventing that growth from being curtailed by onerous changes in tax and fiscal spending policies.
However, again in my opinion, if both of those races result with the incumbent senator losing their bid for re-election, the market could reprice the risk of future asset prices being overly valued at the present time. We live in a world of high frequency trading, and driven by algorithms. We know that as market valuations and asset prices approach new all-time record high levels, that buffers around those algorithms become increasingly tighter.
Between the 13th of February and the 23rd of March of this year, we observed what a melting cascade of algorithms looks like. From currently high market levels, if the risk of a dramatic change in the assumptions surrounding tax, fiscal, and economic policies were priced into the market in the form of potentially lower future asset prices, then there is a chance that such re-pricing could occur in a sharp and algorithmically driven, sudden way.
So, am I suggesting that the beginning of the new year might also bring a sharp sell-off in equity markets? Not necessarily, but the risk can’t be ruled out. I am suggesting to all of my clients that we take a critical look at how they are invested, and remain with exposure where it is appropriate for their unique parameters, but to also do that in a hedged manner. Yes, there are plenty of reasons to be invested at this time. Economic data is robustly positive, and we have promising news with regard to vaccines.
However, I would encourage everyone to avoid becoming complacent, and assuming that the market is celebrating the results of the election. Candidly, I don’t believe that is what is happening at all.
There is a 10,000 pound gorilla in the room as it were, and we’ll meet him on the 5th of January. What the market prices into itself as a function of future tax and spending policy remains to be seen after that date. For that reason, I believe that at a high level, investors should remain focused on where they’re going over the long term, and remain invested, but hedged with an eye on the potential for short term volatility.