Market Strategy 10/26/2020

Key Takeaways

• This week we discuss questions asked of us by both institutional investors and private clients related to the election and our favorite sectors under various outcomes.
• With just 27% of the S&P 500 companies having reported for Q3, some 84% have beaten earnings expectations. Another 184 firms are due to report this week, including bellwether names in a broad array of sectors.
• We’ve updated our Global Asset Allocation model to reflect a broadening of investor appetite for equities on a global basis as bond yields remain at or near record lows and for a weaker dollar. 

Equity markets navigated last week remarkably well considering what has become known as a “third wave” of COVID-19 that has been moving across the world through many locations that are in the midst of economic reopenings. Stateside the major equity indices moved modestly lower last week with stocks churning somewhat as traders and investors rebalanced, rotated and added further exposure to value stocks while others took profits in growth names that had previously run up substantially ahead of what could be higher capital gains and other taxes next year in the event the Democrats win the White House on November 3.

With some 27% of S&P500 companies having reported results in Q3 earnings season, 84% have delivered results that were higher than expected. For a second consecutive quarterly earnings season, results often distinguish the difference between winners and losers tied to the ability of companies to innovate and interact with their customers in a digitalized world in delivery of services and products.

In this final full week ahead of the elections stateside, we look for investors to check a wide array of economic data scheduled to cross the transom including reports on manufacturing activity, housing, consumer confidence, inventories, GDP, Personal income and spending, initial jobless claims and inflation.

In this edition of the Market Strategy Radar Screen we share with our readers our responses to some of the questions we received over the course of last week from advisors, private clients and institutional investors.

Q1) Why did value outperform between July and October?

• Improved performance has not become outperformance by value stocks over growth stocks this year except for short periods (day or days). 
• That said, we believe investor appetite is broadening for equities in anticipation of a point in time in the not too distant future when a vaccine of significant efficacy is approved to stem the spread of Covid-19.
• The market as discount mechanism anticipates that point in time adding justification for a broadening of appetite for equities with an increase in exposure to value with expectations of a global economic recovery process ahead. Growth stocks in a low inflation, low interest rate environment are not likely to underperform value in our view.
• Broadening appetite for diversification amid equities improves the attractiveness of value stocks in our view, particularly with regard to industrials, materials and financials.

Q2) Is there a year we could compare with 2020 that had a lot of events that grabbed investors’ attention and concern?

• On parallel 2009 offers similarities. We recall that in 2009 very few strategists, economists and analysts where in the “bull camp” even as the economy and the markets began to improve as a result of all the stimulus that was introduced by the Federal Reserve at the time.
• One well known and widely quoted economist during that time ventured incorrectly that the Fed was “pushing on a string” and would fail to successfully stimulate the economy. We recall the period clearly as we were among the relatively few who at the time believed that the stimulus introduced by the Fed would work. We shared our opinion with the press (print, digital and television) at the time and often received considerable pushback for our relatively optimistic view based on improving economic data and equity market performance which supported our opinion.
• While there is less skepticism about the possibility of a recovery lying ahead this cycle than there was in 2009, there is in our view enough healthy skepticism now as well as plenty of doomsayers floating negative theories to suggest from a contrarian viewpoint support for a bull case for the economy and for the equity markets to gain traction and recover.
• The Federal Reserve’s magnanimous efforts thus far underscore the case for the economy’s recovery and the equity markets’ resilience and potential from here.
• Recent economic data tied to weekly claims, advanced retail sales, industrial production and service sector activity along with Q3 earnings season also continue to show relative resilience in the stateside economy even in the face of the persistent stalemate and dysfunction on Capitol Hill.

Q3) Is it still your view that if there is a “blue wave” with the Presidency, House and Senate going to the Democrats that the market would sell off between 6- 10%? And do you view that as the most likely scenario based on the polls?

• It remains our view that if a Democratic sweep of both houses of Congress (House of Representatives and the Senate) were to occur the equity market could sell 6-10% lower. Some of the selling would likely come from investors taking profits in 2020 rather than risking higher tax rates including higher capital gains taxes promised by former VP Joe Biden.
• However, we think a Democratic sweep of both the House and the Senate is unlikely. We expect the Republicans to remain in control of the Senate.
• A continuation of split control on Capitol Hill would suggest checks and balances would remain in place that could could ease market worries and avoid a mid-single digit or as much as a 10% correction. 

Q4) What are the best and worst sectors to be exposed to in the aforementioned scenario in which a “blue sweep” occurs and equities correct?

• Near-term the best performing sectors so far this year would likely come under some selling pressure as nervous investors took profits this year ahead of facing higher capital gains taxes next year.
• Reducing the sting or the stickiness of such a downward move for the markets would likely be other investors buying dips created in stock prices by the profit taking actions of other investors.
• We’d also expect some investors after taking profits might within a short period of time take new positions in the very stocks they took profits in considering the current low interest rate environment, prospects for a vaccine and the potential for a post-Covid-19 environment to emerge.
• We continue to favor cyclicals over defensives. Favorite sectors remain: information technology, consumer discretionary, industrials and financials (as a contrarian pick that has recently begun to see some recognition by investors).
• We have a market perform rating on the materials sector, which has begun to benefit and is likely to continue to find support from a pick-up in economic growth in anticipation of a vaccine for COVID-19 arriving on the scene.
• Worst relative performing sectors even as things “get better?” Laggard performance likely to persist within sectors and by those companies that lag in innovation and adaptability to a world that’s digitalizing and “greening” more by the day.
• A victory by former Vice-President Biden could favor companies that have not diversified away from the China global supply chain as it is expected that a Biden Administration’s dealings with China would be less likely to opt for the hard line approach that the Trump administration has deployed.

Q5) How do you think the market will react in what you consider a more likely scenario wherein Mr. Biden wins the presidency while the Republicans remain in control of the Senate and the Democrats remain in control of the House of Representatives?

• The market response in our view would likely be flat to sideways (with a positive bias) and perhaps rising as much as 4% if investors felt some relief at the Republicans’ retention of the Senate.
• However, the longer-term issue for the market could likely be an oft raised concern by political and market observers, “will Biden give in to pressures from the Progressives and pivot towards them?”
• Another concern that has surfaced is that should Biden be unable to complete a full term would Senator Kamala Harris give in to pressure and pivot the Administration in favor of the Progressives. The market might indeed suffer some indigestion were Senator Harris as Presi