Election Results, COVID Uncertainties and the Markets

By Ketu Desai

Writing about markets a few days ahead of an election is at risk of being quickly obsolete, so I will try to focus on more lasting themes. The economic data continues to show improvement. One of the most notable releases during the month was retail sales. Retail sales have now grown for five consecutive months, driven mostly by goods spending, as opposed to services, growing double the expectation in September, up 5.4 percent from a year ago. Housing continues to be a bright spot and should continue to be. Building permits rose 5.2 percent in September, with single-family rising 7.8 percent. Pulte reported a 36 percent increase in net new orders from the same time in 2019. Similarly, auto demand is also picking up 10.9 percent from a year-ago, according to the latest retail sales report. While we have seen some improvement in the service sector, in things like air travel (TSA throughput above a million for the first time post-COVID), we are still down considerably for most service-related indicators.

Globally, the data out of China has been impressive. The Chinese economy has now recovered from the COVID recession and is growing. Manufacturing has been particularly strong; the latest industrial production numbers were up 6.9 percent. We are also starting to see the Chinese consumer emerge, retail sales up 3.3 percent in September. Emergence of the consumer combined with manufacturing strength should propel the Chinese economy to drive global growth in 2021.

The past decade can be characterized with falling rates at the long-end, a strong dollar, low inflation, a strong service sector relative to manufacturing and goods, and monetary policy as taking the policy lead. As we get clarity from the election and a vaccine, it feels like 2021 will be an inflection point, where in moving forward, the reverse may be true. Regardless of the outcome of the election, it is likely that we will see significant fiscal spending. The election, however, will determine the magnitude and the nature of spending. The Fed balance sheet and the existing fiscal stimulus amount to nearly 50 percent of GDP.

The next fiscal bill is likely to be 10 percent or more of GDP. Record stimulus and liquidity will eventually be inflationary. Money supply is up more than 20 percent YTD, but inflation has been kept in check because velocity of money is at a record low, that should change as we get more clarity. The markets are starting to prepare for this. We have seen the 10YR yield up more than 30 bps since August, continued dollar weakness, strength in certain emerging markets, rallies in commodities such as gold, silver and copper, and finally bitcoin rallying. It feels like you want to remain in these long inflationary trades of emerging markets, commodities, TIPs, while selling duration risk.

With that as the backdrop, equities, which yield 6 percent more than real yields, remain attractive. However, equity leadership appears to be shifting from high duration tech names to more value cyclical names. High growth names were severely punished this earnings season if they missed on metrics or guided lower. The valuation of many of these leaves little margin for error. We got a glimpse of what can happen in a number of situations during the month, most notably Fastly. Fastly guided sales down to between $70 million and $71 million, from its prior range of $73.5 million to $75.5 million. This relatively small guide down cost the stock 50 percent during the month. Nasdaq 100 forward earnings versus the S&P peaked over the summer. The Microsoft CEO said earlier this year that COVID accelerated years of tech adoption. Such acceleration makes comps for next year extremely tough, and a minor miss can cause an outsized reaction as we saw with Fastly, and then again with SAP, Twitter, and Chegg. Tech insiders are also selling; the top five insider sales this year are all from tech companies, Salesforce, Crowdstrike, Datadog, Zoom, and Okta.

On the value side, the opposite is happening, earnings got delayed, expectations are low, insiders are buying, and comps are easy to beat. Further, cyclical value benefits from the macro backdrop of more inflation, higher rates on the long-end, steeper yield curve, weaker dollar, a goods and manufacturing economy, and global growth. Election related volatility could be a good time to reposition your portfolio for 2021.

Looking forward the market will focus on election results, COVID, earnings, and economic data.

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Ketu Desai is the Principal of i-squared Wealth Management Inc. ( www.isquaredwealth.com ), an investment management firm based in New Jersey. ketu@isquaredwealth.com