2021 is setting up nicely for stocks regardless of who wins.
With the election a week away, we remain overweight equities and bullish on 2021 regardless of the outcome. There are just too many positives lining up for the year ahead: a likely sharp cyclical recovery, an ultra-easy Fed and potentially multiple vaccines, to go along with the eventual end to election uncertainty.
Getting from here to there, however, could be a little bumpy as Covid cases rise, near-term stimulus hopes fade and the recovery shifts to a more muted expansion. We’re getting a taste of that today, and wouldn’t be surprised to see a 5-10% pullback as President Trump makes it closer than consensus expects, prolonging uncertainty. He could even win (more below).
Whatever happens in the weeks ahead, economics typically trump politics and there’s no reason to think it will be any different this time around. So we have closed our underweights to cyclical stocks and intend to add to these positions if the sell-off we are expecting materializes.
Here’s our thinking on three key points:
- Election uncertainty won’t last forever … We will get a clear victor sooner or later that, along with the aforementioned macro positives, would be icing on the cake for the stock market. If it’s a Biden-Blue Wave sweep, we could get a hangover in 2022 and beyond if a growth-depressing agenda (higher taxes and increased regulations) is implemented. But increased deficit spending would, net net, be viewed as stimulative, adding more fuel next year to a budding cyclical recovery that we already are seeing in housing and manufacturing. This is on top of what almost certainly will be a larger Covid stimulus package than currently being debated. If it’s a Biden win/Republican Senate outcome, the market might worry about increased regulatory drag but cheer the likely big fiscal package. In a status-quo election (Republicans hold the presidency and Senate, Democrats hold the House), the markets get a continuation of Trump’s pro-growth agenda on taxes and deregulation and the Democrats push for more fiscal spending; this is probably the most bullish outcome for markets, even while it also is the least expected. You get it. There really seems to be no way to lose for the markets once a clear victor emerges.
- … but it’s unlikely to end anytime soon We think markets have been enjoying a “Biden honeymoon” prematurely; the best measure of this is probably the outperformance recently of the cyclical stocks and the rise in the 10-year bond yield. However, we think the odds are greater than 50% that the markets will be disappointed next Wednesday morning. Most polls in our view structurally under-poll “The Forgotten Man” who elected Trump in 2016, and given his unpopularity, we think the under-polling problem is probably worse this time around. One pollster that got 2016 right (Trafalgar Group) uses a different methodology to try to be sure it is correctly counting the hidden Trump vote. It currently has Trump ahead in several key states that frankly, it’s hard for us to envision him losing: Florida, North Carolina, Georgia, Iowa, Ohio and Arizona. If the president holds onto these six normally Red states, he’d only need 12 more electoral votes from some combination of Michigan, Minnesota, Wisconsin and Pennsylvania to secure the Electoral College. Whether he does or doesn’t, we think there’s at least a 65% chance he comes close enough to be ahead Election Night, before many of the mail-in ballots (which seem likely to lean towards Biden) have been tallied. That will lead to a prolonged period of counts, recounts, reassessments of disqualified mail-in ballots, etc.—not supportive of a market discounting a clean Biden win. But if Trump does finally prevail, much of the 2021 gain we are anticipating could happen in a hurry.
- The value play is setting up Although we’re at the height of earnings season, with a few exceptions, it’s been a bit of a sleeper as earnings take a back seat to the election. In general, tech winners are not responding to beats as they did last quarter, while cyclical beats are getting more traction. This is telling us that for now, the market is buying into the growth-to-value shift that we began discussing in September. But until we get through the election, and get more visibility on the Covid path, we think trailing earnings will carry less weight. Rather, the value indexes are likely to outperform next year as the recovery gains steam and their year-over-year comparison are far better than the stay-at-home tech stocks. Ironically, should Biden prevail, two sectors that Democrats generally dislike, Energy and Financials, are likely to outperform. This is because 1) the Green New Deal agenda is certain to pressure traditional carbon-based supplies such as shale, driving up oil prices and energy stocks and 2) the massive new deficit spending package Biden would implement should steepen the yield curve, which would really help banks. Both these sectors are dirt cheap with single-digit P/E multiples.
When we add it all up, it’s difficult for us to move off our bullish view on stocks. Indeed, the next move we make almost certainly will add to our relatively modest overweight as we see the market winning next year regardless of this year’s election winners and losers.