In this week’s market update: all eyes on the US after the President tests positive for Covid; stocks rise on further stimulus hopes; and will tech surge to even higher highs?
Perhaps nothing should surprise us any more in this strangest of years, but Friday’s announcement that the Donald Trump has fallen victim to the coronavirus just a month before the US presidential election was a shocking development that had market watchers reaching for the history books.
The news broke too late to have much of an impact on the markets last week, but past form suggests it might not have had too much of an influence anyway. Of 10 major health scares for America’s commander in chief in recent decades only President Eisenhower’s heart attack in 1955 had a really noticeable impact. The S&P 500 fell 7% on the day and was still down three months later.
Even JFK’s assassination only knocked 3% off the US market. When President Reagan survived an assassination attempt and a string of big operations, the market shrugged. The strength of US institutions and the power sharing between Congress and the White House ensures that the system is largely bigger than the person in the Oval Office.
Certainly, by the time markets re-opened this week, investors were taking the illness of the President, his wife and many White House staffers in their stride. A much-criticised drive-by to reassure supporters of the President showed that Mr Trump was up and about and apparently ready to continue with his election campaign. He returned to the White House on Monday evening.
The other positive news for the markets on Monday was the suggestion that US lawmakers may be ready to strike a deal on new stimulus measures for the economy. Fears that further steps to underpin the economy would have to wait until a new administration was in place in January had taken the wind out of the market’s sails in recent weeks.
On Sunday, Nancy Pelosi the Democratic speaker of the House, said that progress was being make on a coronavirus support package that might restore some of the US employment benefits that were cut off in July.
The S&P 500 gained 1.8% on Monday to close at its highest level in a month. The tech-heavy Nasdaq, meanwhile, added 2.3%. In another sign of confidence, 10-year Treasury yields rose to 0.77%, the highest level since June. Asian stocks picked up the mood this morning, with all major markets moving higher.
Even the hard-hit oil market caught a break this week as strikes in Norway threatened supplies of crude from western Europe’s biggest oil producer. The oil price jumped 6% on Monday to trade at more than $41 a barrel.
Although there is plenty of speculation about who might win the election and whether Congressional seats will go the same way as the White House, there is less firm evidence that the result makes a huge difference over the medium to long term.
Certainly, over the first two years of a new Presidency it can matter which party wins and whether Congress is divided or aligned with the President’s party. In data stretching all the way back to the 18th century a Republican president has delivered an average 8.3% return over the two years after an election versus 5.8% for a Democrat.
If the President is supported by Congress then a Republican sweep has been rewarded by a 12.2% average return versus just 3.4% for the Democrats. Interestingly, though, the best result has been for a Democrat White House with a divided Congress (at 12.2%) and the worst for a Republican with the same set-up on Capitol Hill (just 1.1%).
Look forward over four years, however, and the differences all seem to get evened out. No combination has delivered less than an 8.2% return or more than 10.9%.
Historically, the Democrat sweep seems to have disappointed Wall Street, perhaps because it has tended to imply more regulation and higher taxes. This might seem to be a valid concern this time around too on the basis of Joe Biden’s stated policy agenda. But maybe, the unusual circumstances of this Covid year mean that the old rules will no longer apply.
Certainly, the main driver of markets in 2020 seems to be monetary and fiscal stimulus and there is no sign that this will not be forthcoming, whichever candidate is victorious in four weeks’ time. Excess money supply is the jet fuel driving the market higher and this has gone through the roof so far this year.
You only have to go back to the financial crisis to see how this worked last time. The market’s price-earnings ratio nearly doubled from 8.5 to 15.2 on the back of a 12% rise in liquidity. This time around the market multiple has doubled again, albeit from a higher starting point of 12.8 but this has been on the back of more than twice as much liquidity. You might even ask, on that basis, why the market has not gone even higher.
The key longer-term driver of markets, of course, is earnings. Share prices always anticipate higher earnings, which is why valuations soar during the downturn. Prices move first and then wait for earnings to catch up. This is why the third quarter earnings season, which kicks off in a week or two will be so interesting for investors.
Second quarter earnings were a lot better, or rather a lot less bad, than feared. The expectation is that the same thing will happen during the summer quarter too. On the other hand, with share prices back close to their all-time highs, maybe it will need to.
The rally to new highs for the stock market has obviously been driven to a large extent by the technology sector which had a tough run in September as investors booked some of the strong profits they had made in the sector since March.
Some recent analysis by UBS suggests that they may want to start thinking about getting back into the market again soon. If the trading patterns of the past five years hold then the sector may be poised for another rebound.
UBS has showed that between 2015 and 2019, mid-cycle corrections of tech stocks have tended to last no longer than a month on average and to lose 11% from the peak to the trough. However, over the following six months the average rise has been 20%.
This year has seen that process play out in an exaggerated style. In just over a month to the end of March, tech stocks fell by 31% but within six months they were 70% higher. If the same pattern repeats, then the fall in September should be unwound and the sector be hitting new highs by the spring of next year.
To capture that gain, however, might require investors to take a broader view of tech than just the FAANG giants that have dominated so far. Other companies exposed to big secular trends like cloud computing, big data and 5G are also riding a wave but not yet saddled with the sky-high ratings of the biggest companies.
How long the market’s buoyancy can last may well depend on when investors move on from their focus on short-term stimulus and start to focus on the longer-term consequences of that central bank and government largesse.
This week at the virtual Conservative party conference, Chancellor Rishi Sunak provided a hint of what might be to come when he played to the Tory faithful by committing the Government to sound public finances once the pain of the pandemic is behind us.
He used his keynote speech to speak about the party’s ‘sacred responsibility’ to strong public finances and warned of ‘difficult choices’ ahead, seen as code for tax rises on the wealthy. Mr Sunak is able to offer unpalatable messages for now, enjoying as he does a net satisfaction rating among Conservative party activists of +81, way ahead of the Prime Minister or indeed anyone else in the Cabinet.
The Chancellor’s fiscal orthodoxy put him in opposition to the International Monetary Fund, which this week issued a call to the governments of rich countries to worry less about public debt and to instead use historically low borrowing costs to fund increased spending on infrastructure to spark an economic recovery.
Were governments to do this, and to ensure that the cost of borrowing to pay for the spending stays low by artificially suppressing interest rates, they would be following a long-established play book. Back in the 1940s, as the US came out of the Depression and looked to finance a huge war effort, the Federal Reserve increased its balance sheet ten-fold. During this period, it kept interest rates at around 1% even as inflation soared.
And that is perhaps the thing that will ultimately derail the markets. If trillions is indeed spent on fiscal stimulus, facilitated by lower for longer interest rates, then it seems likely that inflation will follow in due course. And that, in turn, might be the trigger for the long-awaited rotation from growth stocks to value and for real assets like gold, property and commodities to have their day.