Many investors have decided to wait until the election is decided before investing in the stock market. Based on history, there is a two-to-one chance; this is a bad idea. What an election does is eliminate the uncertainty over who will win. This uncertainty holds stock prices back more than the programs of the candidates themselves.
A recent story in the Wall Street Journal bears this out. It is fashionable to believe that if one party or another wins the White House, there will be some stock market crisis. In reality, even if there are enough electoral votes (270) to name a winner the day after, the next government is not installed until January 20 of next year. This delay leads to all kinds of punditry as to who will be impacted. At the same time, programs that may be affected have time to lobby to minimize, if not eliminate, the adverse impact. For example, people assume if Biden and the Democrats were to carry the presidency and Senate and keep the House, all manner of tax increases would be introduced. With almost three months to lobby, most pushes in this direction will have a chance to be watered down. Also, if the use of the tax increases is to launch infrastructure programs and help pay for the COVID vaccine and its distribution, one could argue that the funds were judiciously spent.
If the Presidency and the Senate were to stay in Republican hands, an assumption would be that taxes would not be raised, and deficits would continue to mount. With interest rates so low, this is not the immediate end of the world were such to happen. The Federal Reserve is on record as not seeing interest rates rise before 2023 or 2024, the latter date in time for the next election. The ultimate can-kicking scenario.
If there is a delayed outcome to the election, the lag in results would not be good for the market. The pre-election uncertainty will not be resolved. The last time this happened was in 2000 when Florida’s outcome was delayed by a recount. This was also the time that the air was beginning to go out of the dotcom bubble. The corresponding decline of the tech-heavy NASDAQ index by almost 50 percent over the following two years also impacted other indexes, to lesser extents.
Longer-term, what will guide the market is earnings, interest rates, and valuations. All three of these factors are intertwined. Earnings depend on economic growth, both domestically and abroad. Interest rates are under the presumed control of the Federal Reserve. However, the dollar’s falling in value as an international currency seems to indicate that, at some point, that control will be questioned. Median valuations are as high as 1999-2000 in part due to the virus-induced contractions in earnings, which is not a good omen for the overall market. Of these three factors, interest rates are the key. When they start to trend upwards, other areas will feel the pressure.
This year has been one of convulsions. The induced shutdown of the economy in March was unprecedented. The funds appropriated by the federal government kept any number of businesses and individuals afloat. However, funds ran out in August, and new funding does not appear forthcoming in the near term. The Federal Reserve has publicly stated that it cannot hold up the economy on its own. Still, the Senate refuses to take up a House bill to continue funding even though it cannot pass one of its own. The issues are political, ideological, and social. It may be asking too much of a single election to resolve all these issues. A vaccine will help resolve the environment, but the other matters are perhaps outside the domain of medicine and public health.
One step to national reconciliation would be to hold the distribution of content on the internet to the same standards of libel as print publications. In the early days of the internet, when it functioned more like a bulletin board, internet content was exempted from site verification on the grounds that the distributors of information were not financially capable of editing what was posted for truth and accuracy. Given the vast sums earned from advertising on the internet, it would seem a matter of public policy to review that exemption.
In the 1800s, so-called “yellow journalism,” essentially the publishing of sensational and misleading information, flourished. Several newspapers in a given market wrote such stories while jousting for readership and advertisers. This largely came to an end when papers were successfully sued for libelously publishing misinformation.
The economy is being sustained by two factors. The first is the previously mentioned government aid, which was sometimes distributed without a test for financial need. The $1,200 per eligible person checks were distributed to all who did not have taxable income over $75,000 as individuals (or $150,000 as married couples filing jointly) – with a steep reduction in benefit above those thresholds – fall in this category. Many families deposited these funds into a bank account or used the funds to pay off debts. Along with the $600 per week Federal Unemployment benefit and whatever state benefit being earned, some people had take-home pay higher than their net paychecks.
Criticism of the higher net amounts helped keep an extension from being passed into law. As time goes on and there is no replacement, the lack of buying power will make itself felt. Forecast of retail spending for the Christmas holidays now estimates a ten percent decline compared to last year.
The second source of economic support is the spending of seniors. As consumers who by and large do not work but who collectively have sustainable investment assets, senior citizens are in effect a private sector economic stimulus program in and of themselves. Further, as Medicare and Social Security recipients, the over 65 group receives government assistance not available to most of those younger.
After hitting new lows mid-year among talk of negative interest rates, yields on US Treasury assets have begun to tick upwards. When the ten-year note hits one percent (currently about 0.74 percent), there will be a wake-up call of some magnitude.
Moving that wake-up call along is the weakness of the US Dollar relative to other currencies. As the dollar falls in value relative to other currencies, the performance of US stocks improves in foreign currency terms. At the same time, foreign goods tend to cost more domestically in dollars, helping to fuel inflation and higher interest rates.
The Federal Reserve has predicted that interest rates will not go up until 2023. However, their ability to hold rates down may be tested by a stimulated economy on the one hand and a falling dollar on the other.
Inflation expectations are being downplayed by the government, who, as the world’s largest creditor, would have the most to pay if they were raised.
The 1.9 percent increase in Social Security to pay for price increases in 2020 is a joke. No one will provide the data as to how the figure came about. This will be a figure of some focus going forward, as those who depend on Social Security cannot keep up with the actual increases in the cost of food and housing.
The Stock Market
Year to date, the market is flat to up ten percent, depending on the index being used. A technology component moves the indexes higher, just as in 1999 and 2000.
The market seems to have great faith and expectations in a massive stimulus program early next year, accompanied by a boom in domestic demand and stronger economic growth. Should this scenario not prove out, the level of the market relative to historic standards makes it vulnerable to a correction.
Warren M. Barnett, CFA
October 26, 2020