On the Radar

City National Rochdale, | Aug. 18, 2020

FAQs on the Markets and Economy

What does a Biden/Blue Wave mean for the market?

We believe the probability of a Democratic sweep in November is now somewhat greater than 50%. While it’s too early to confidently make projections, and much can still change before Election Day, history shows that incumbent presidents tend to get voted out of office when the economy is doing poorly. Polling data, including surveys of consumer attitudes about the direction of the country, suggest the Democrats currently have strong momentum.

With potential rollbacks in corporate tax rates and re-regulation prominent parts of the Democratic Party agenda, the consensus view is that a Biden victory will be a negative for equities. However, there are also reasons not to be so bearish.

Typically there is a big difference between campaign rhetoric and policy reality. History suggests that presidential challengers typically campaign at an extreme only to converge toward the center postelection. Given the current economic weakness, business recovery and job gains are likely to be prioritized by a new Biden administration over policies that could dampen economic growth.

Other Biden policy proposals, including infrastructure spending, trade, immigration and an increased federal minimum wage, could also be net positive for S&P 500 earnings and help offset the corporate tax headwind.

If a Blue Wave does materialize, investors could potentially react negatively at first, but markets have historically performed well regardless of the composition of political party control.

Much of the economic strength we have seen over the past two months can be directly attributed to the unprecedented aid coming out of Washington. Trillions of dollars have already been spent to keep families and small businesses afloat during the pandemic, and it has worked.

While there is general agreement that more aid is needed, the risks of no near-term action have been climbing in part due to better than expected job numbers and new executive actions out of the White House. These steps won’t, in our view, come close to filling the fiscal gap.

The sticking point continues to be reconciling the priorities between Democrats and Republicans, as well as the size of additional spending. Many issues are on the table, including enhanced unemployment payments, another round of direct cash payments, increased assistance to state and local governments, funding for schools and students, hazard pay, and liability immunity.

Our sense is that a compromise will ultimately be reached somewhere in the $1-1.5 trillion range, providing additional relief to businesses, households and states. Both parties have incentive to get something done, and there is room for negotiation.

The challenge on timing, though, is that neither party is likely motivated to strike a deal during their political conventions, which take place over the next two weeks. So, legislating is on hold unless some new pressure point emerges from the market or elsewhere.

The question as to what happens next will likely depend on what the climate looks like afterward — who wins the Washington blame game, how the economy is performing, whether the markets apply pressure and where are the election polls after the conventions.

July’s nonfarm payroll grew 1.8 million, a significant increase, but not as big as 4.8 million in June or 2.7 million in May. It shows the recovery continues on an upward trajectory, but the pace of hiring is slowing (see chart). So far, 42% of the jobs lost from the pandemic have been recovered. Payrolls remain 12.8 million below their pre-pandemic level.

The unemployment rate fell to 10.2% from 11.1% in June.

We are now getting to the stage that the remaining lost jobs will be harder to make up. The economy is facing some headwinds. The PPP loans were capped at two and a half months of payroll, and most were issued two and a half months ago; therefore, several jobs may be at risk of being eliminated again. This may already be happening. A study out of Cornell University has found that about one-third of the workers called back to work were subsequently laid off again. Also, the termination of the enhanced unemployment benefit ($600 per week) at the end of July will reduce household income for the nearly 30 million Americans receiving the aid. Less spending money means less spending, which means less income for those that benefited from the spending.

The Consumer Price Index jumped 0.6% m-o-m in June and July, a reversal of three monthly declines due to the lockdown (see chart).

This jump reflects a recovery in prices of goods and services that were at the epicenter of the pandemic. For example, motor vehicle insurance prices increased by 9.3% m-o-m, airfares are up 5.4% m-o-m, and energy prices are up 5.1%. On the other side of the coin, food prices, which surged during the lockdown, fell 0.4% in July.

The good news about the increase in prices of the past two months is that it has eradicated the fears of deflation that were prevalent in the early stages of the pandemic.

We do not see this sharp jump in inflation as a signal that inflationary pressures will pick up. We see it as just an unwinding of the sharp price declines that occurred when the economy was in lockdown. The fundamentals are not there for higher prices. The economy is about 10% smaller than it was just six months ago; this creates an enormous output gap that limits price pressures. Also, about 30 million people are collecting unemployment benefits. That glut will stay with us for some time, keeping wages under pressure.

Progress in stemming the COVID-19 outbreak, recovering economic activity, and recent political developments have been encouraging, but Europe’s outlook still faces a number of short- and long-term headwinds.

Our concerns have been the region’s weak domestic growth, higher exposure to global/trade headwinds, negative yields that affect banks’ profitability, a less favorable sector representation in the market structure, and the politics that hinder market/economic reforms. These issues, which led to its past underperformance, are unlikely to ease going forward.

While the recent agreement on a European Recovery Fund is certainly encouraging, this is a small step down a long and difficult road toward a common fiscal framework, and we remain hesitant to view this initiative as a definitive turning point in the EU.

Overall, European growth expectations are set to continue to meaningfully lag behind U.S. given structural challenges. Although the initial rebound in the Eurozone economic activity has been a little quicker than anticipated, we think that the economy will likely remain smaller than its pre-crisis level until well beyond 2021.

The challenge facing investors today is how to construct portfolios in a slow and uncertain macroeconomic environment. Given this, we remain overweight U.S. equities due to the greater share of high-quality and growth companies, and underweight Europe due to more cyclical exposure and therefore less resilience to a downside scenario.

Euro valuations, meanwhile, are not cheap on a historical basis and are just as pricey as U.S. equities on a sector-adjusted basis.

After the worst recession outside of wartime in 100 years, high-frequency global indicators are signaling that the world economy is moving past the worst of COVID-19 contraction.

The Global PMI rose above 50 in July for the first time in six months to indicate expanding output across the combined manufacturing and service sectors.

Even so, global activity remains far below pre-virus levels, and beyond an initial bounce back in activity as some businesses reopen, recoveries across economies will likely be slow going and uneven.

Households and firms will remain cautious until a widely available vaccine is developed and the threat of the coronavirus is finally contained, preventing a full V-shaped recovery. While policy is set to remain supportive, the recent huge impetus must ultimately be wound down with adverse effects.

The path of recovery for each country and region will likely be highly dependent on a number of factors, including the path of the virus, the effectiveness of each country’s healthcare responses and degree of government restrictions, each economy’s exposure to sectors most impacted by the virus, and the scale of each country’s fiscal support.

China and emerging Asia are among the furthest along the road to recovery, and we expect them to stay in the lead, while economies in Europe and Latin America lag behind.

In all, it will probably be a few years before the global economy returns to its pre-virus path.

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Important Disclosures

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

There are inherent risks with equity investing. These include, but are not limited to, stock market, manager, or investment style risks. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.

Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability.

Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems, than developed markets.

There are inherent risks with fixed income investing. These may include, but are not limited to, interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond risks. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed income securities and during periods when prevailing interest rates are low or negative.

Investments in below-investment-grade debt securities, which are usually called “high-yield” or “junk” bonds, are typically in weaker financial health, and such securities can be harder to value and sell and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the federal Alternative Minimum Tax (AMT), and taxable gains are also possible.

Investments in the municipal securities of a particular state or territory may be subject to the risk that changes in the economic conditions of that state or territory will negatively impact performance. These events may include severe financial difficulties and continued budget deficits, economic or political policy changes, tax base erosion, state constitutional limits on tax increases, and changes in the credit ratings.

Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets.

Returns include the reinvestment of interest and dividends.

Investing involves risk, including the loss of principal.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.

Past performance is no guarantee of future performance.

Index Definitions

The S&P 500 Index (S&P500) is a stock market index that tracks the 500 most widely held stocks on the New York Stock Exchange or NASDAQ. It seeks to represent the entire stock market by reflecting the risk and return of all large-cap companies.

Dow Jones U.S. Select Dividend Index (djdvy) represents the country’s leading stocks by dividend yield. Index Definitions

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.

JP Morgan Global Composite PMI gives an overview of the global manufacturing and services sectors. It is based on non-opinion based monthly surveys of over 16,00 purchasing executives from 32 of the world’s top economies, including the U.S., Japan, Germany, France and China which together account for over 85 percent of global GDP.

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