The Two Handed Economist (Our apologies Mr. President)
I’m a sucker for Presidential history. This is especially true in an election year. Last week, I briefly pondered blowing the dust off of my copy of David McCullough’s biography on Harry Truman. Then the reality set in that it is nearly 1,000 pages and that I am the parent of two small children. Oh well, next election cycle perhaps. For those who haven’t read the book, it’s safe to say that Truman was one of our more colorful (and quotable) residents of 1600 Pennsylvania Avenue. The owner of the iconic desk plaque that read “The buck stops here” was also famous for quips such as “Always be sincere, even if you don’t mean it” and “You want a friend in Washington? Get a dog.” I wonder what he would have thought about Twitter. There’s a story involving Truman and a discussion he was having with one of his economic advisors. The President apparently felt that he was not receiving enough clear direction on the particular issue they were discussing. Truman, growing frustrated with his advisor’s “on the one hand, this” but “on the other hand, that” approach is reported to have snapped “Can’t someone bring me a one-handed economist?” The quote could be apocryphal but the message is clear. While I think we can all appreciate the desire for perfect clarity, we should remember that there are always competing narratives and differing interpretations of data that investors must weigh as they navigate uncertainty and risk. This is especially true in 2020.
The recovery that began in the second quarter continued in July and August, but the markets lost steam after hitting fresh highs in early September. Reopening efforts, low interest rates and the dual prospects of a vaccine and improved corporate earnings in 2021 helped the S&P 500 and the NASDAQ post double-digit gains between July 1st and August 31st. In September, the markets experienced the first correction of this young bull market as investors digested rising cases of covid-19, stretched valuations in the face of potentially slower growth and enhanced political gridlock punctuated by the approach of the November elections.
As the Fed stated in their September meeting minutes, the path of the economy will depend significantly on the course of the virus and there are risks to the downside and the upside. On the one hand, the US did experience a rise in reported cases of covid in the third quarter. The economy has not yet fully reopened and it is likely that any hit to personal income from increasing layoffs and the lack of additional fiscal stimulus will weigh on consumer spending and corporate earnings. On the other hand, mortality rates have come down compared to earlier in the year and the likelihood of another complete shutdown seems low. Additionally, it appears we are moving closer to a vaccine at some point next year as there are currently 11 candidates in phase-three trials. The combination of post-election stimulus as well as the approval and widespread availability of a vaccine will go a long way in supporting the recovery in the labor market and the broader economy.
Attributing sharp market movements to a particular cause can be difficult at times but one of the criticisms of this market recovery has been its narrowness. Concerns about the sustainability of high valuations in those sectors and companies most tied to growth during the height of the pandemic (technology, communication services and consumer discretionary) may have contributed to September’s decline. The technology sector in particular sold off rather strongly, declining by over 7%. With the Fed’s recent shift to targeting maximum employment versus full employment as well as their move toward targeting average inflation of 2% over time, they are sending a strong signal that policy will remain very accommodative for a very long time which should keep borrowing rates lower for longer and serve as a tailwind for the equity markets. On the one hand, sharp pullbacks and rebounds can be uncomfortable to sit through but on the other hand, we think the backdrop remains supportive for stocks and pullbacks present the opportunity to invest for our clients at lower prices or rebalance back to target equity weights.
The upcoming elections are also a source of uncertainty. This may be the reason why there has been a rise in the implied future volatility of the S&P 500 recently. On the one hand, we understand why this is contributing to nervousness in the minds of our clients. Even though this is an exercise, we embark on every four years this election is occurring against the backdrop of a pandemic. Of course, just to add a little 2020 flavor to the mix, there is the possibility of not having a clear winner when we wake up on November 4th. Oh, and we learned that the President himself is battling covid. How’s that for an October surprise? On the other hand, it is important to keep in mind a couple of points. The first is that national polls and betting markets have been reflecting an advantage for former Vice President Biden for many months and the equity markets have been positive. Second, since 1960 there have been 15 presidential elections. A look at the post-election performance for the S&P beginning one day after each of those elections reveals that the index has been positive 10 out of 15 times (67%) three months after the election and positive 11 out of 15 instances (nearly 75%) six months after the election. In the midst of uncertainty there can be a desire to move to cash and wait for bluer skies. We would not advocate abandoning the plan you worked with your Private Wealth Advisor team to create and implement. While elections can contribute to short-term volatility their impact over the longer term is fairly muted because the outlook for corporate profits is a more meaningful driver of equity market returns than election results.
On the one hand, the trajectory of covid-19, its interconnectedness with the health of the economy and election uncertainty do present downside risks and make the short-term outlook a little foggy. On the other hand, the economy is healing, monetary policy remains accommodative and, over the long-term, equity markets will take their cues from the outlook for corporate profits and reward investors who stay the course. Given how the first nine months of 2020 have played out, we have some sympathy for the two-handed economist. Our apologies Mr. President.