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Market volatility ahead of the US election

30 October 2020

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Jonathan Marriott, Chief Investment Officer

It has been a volatile week in markets with large falls, particularly in Europe.  For some months, the markets have balanced the stimulus against economic damage caused by measures to reduce the spread of the virus. Rising cases in Europe have seen gradually tighter restrictions, region by region in the UK, and much tighter restrictions in Europe. France has returned to full lockdown and Germany is closing restaurants and other entertainment venues. In many parts of the US, a third wave of infections is hitting with hospital beds filling up rapidly. To counter this, there has been little positive news on stimulus. The Republicans and Democrats are blaming each other for a failure to agree a new stimulus package ahead of Tuesday's election. In Europe, they have agreed a EUR 750 billion recovery plan, but they are still arguing over the details. The European Central Bank did give a clear indication that they are ready to do more in December and called for more fiscal stimulus. The Federal Reserve has also called for more fiscal stimulus but politics is getting in the way. The central banks are supporting government borrowing and telling them to spend more.  Jitters ahead of the US election do not help.  We will see more fiscal stimulus over time, but in the US, it will have to wait at least until after Tuesday.

President Trump hailed the third quarter economic growth numbers, which reflected a strong bounce back in the economy.  However, this is only a partial recovery from the second quarter and given the restrictions, the fourth quarter will no doubt be weak again.  We are in the middle of the company earnings season, which also reflects this bounce, but the outlook remains clouded.  For next week, the focus will be on the US election.

While Trump could still win the election, there is little sign of a late surge in support for him, and Biden remains the clear favourite. Biden is well ahead in national polls but holds a narrower lead in key states. Remember, winning the national poll, does not mean you win the electoral colleges.  Florida will be a key state, as it was in 2000, when George W Bush won the presidential race. Just over 500 votes in Florida made the difference. Florida holds 29 out of 538 electoral colleges votes, only California and Texas have more.  Over 80 million people have already voted. In Hawaii, which only has postal votes, more people have voted already than in the previous election.  With a bitterly divided electorate, a high turnout should favour the Democrats. It appears that in states with steeply rising covid cases there is a swing in favour of the Democrats. President Trump continues to hold big rallies with few masks and no social distancing.  His son-in-law Jared Kushner said the president had taken the country back from the doctors, a policy that many will question.

Assuming Biden wins, he needs to take control of the senate to get many of his appointments and policies confirmed. 35 out of 100 seats are up for election and the Democrats need to gain 3 seats to get a majority. Twenty-three  of the seats up for election this year are currently held by Republicans and it seems the Democrats have a good chance of winning sufficient seats.  If Democrats win the senate and the presidency, it is assumed they will continue to control the lower house of congress giving them a free hand to act.  They would no doubt have tighter restrictions to counter the pandemic, but that would be accompanied with higher fiscal stimulus, which the markets would welcome.  However, higher taxes would be less welcome. Biden is likely to push a green agenda and spend on environmental policies such as electrification of transport, not so good for the oil sector. For the UK, Biden was not in favour of Brexit and supports open borders in Ireland, which could make a post-Brexit trade deal harder to negotiate.

In the short term, US politics may remain complicated even after the polls close. Trump may contest the result so a concession on either side looks unlikely on the night. The new Senate does not start until the 2nd of January and the new Presidential term does not start until the 20th January.  During inter-regnum, the existing senate sits and Trump is still president. It is to be hoped that a further stimulus package can be agreed sooner rather than later

Dispersion between markets remains high, the German DAX equity index is down 8%. The S&P 500 down 5% but Asia has held up better and the Chinese CSI 300 is almost unchanged.  The FTSE 100 is back to levels last seen in April, and down 26% this year, but the S&P 500 is above the low in September and was still up 2% year to date at last nights close.  Even within markets dispersion has been high and even at an individual stock level we see dispersion.  It has been a very good year for many tech stocks, Microsoft is up over 50%, but SAP a European business software company, had poor results and is down 20%.  This has provided good opportunities for stock pickers to take advantage of.

For those who read the weekly brief regularly, we had foretold a period of volatility at this time, but cautioned against trying to trade short-term moves.  We continue to believe this is the right approach.  A vaccine, while not here yet, is likely to be available sometime in the new year and more fiscal stimulus is on the way.  Central banks are keeping rates low and supporting government deficit financing.  Companies that can retain or grow their earning and have good balance sheets will continue to be attractive.  We therefore encourage investors to look through the short-term noise and concentrate on longer-term returns.

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