As we write this on Monday, global stock markets are about to print their first negative monthly performance since April, with global stocks down 5%, back to their July level.
This shouldn’t come as a surprise. Elevated valuations create vulnerability, and there is no shortage of reasons to worry about: the coronavirus is back from its summer holidays, the pace of the economic recovery is fading, and political uncertainty is significant with many important topics being hostages to an intense US presidential campaign.
Let’s start with the elephant in the corridor: the coronavirus. The most important event for market direction is unquestionably the release of an effective vaccine being widely available. The good news is that there are more than 20 potential candidates with positive Phase I/II results, fast-tracking their ultimate Phase III clinical trial, including respected names such as Pfizer, J&J, AstraZeneca or Moderna.
The issue of course is that timing is unknown. Forget rumors and press releases: an official market authorization from a large authority such as the US FDA will be the real trigger, and their standards make it unlikely to get an approval before, at best, the end of this year. In the meantime, the virus will be with us, but we keep on believing that the global economy will not be frozen.
The world can live with the virus. It is a fact, based on the examples of the UAE or Japan, with a very low number of deaths as a proportion of their population. As Europe is experiencing a resurgence, Italy’s remarkable handling of the current second wave also illustrates that we can deal with the pandemic.
The second catalyst is obviously the November US elections. It is a complex one, not just because its outcome is by nature uncertain. Indeed, many potential catalysts are currently suspended because of the campaign. The US Federal Reserve, typically, is not in a position to issue any new monetary measure to support the economy and markets. They made it clear that what is needed now is fiscal stimulus. Alas, a fiscal package from the US Congress requires an agreement between Democrats and Republicans: the political opportunity to blame the other for doing nothing is appealing, while the risk of seeing the other taking credit for any deal is crippling. Washington is in an impasse, and any new topic in the campaign, such as the replacement of a US Supreme Court justice, polarizes the positions further.
Having said that, the House of Representatives passed last week a continuing resolution to keep the government funding through early December. Indeed, the probability of a surprise agreement on some minimal fiscal package, especially to replace the exceptional unemployment benefits which expired in July, is not zero, and this would certainly boost markets. The second complexity of the 2020 US elections is the fact that results should probably not be known immediately on election night, due to the historical proportion of vote-by-mail this year. A month-long legal fight, comparable to what happened in 2000 between Al Gore and G.W. Bush, is possible, and markets won’t like it. The real deadline is set by federal law on December 8th of 2020 for official results to be given by… The US Supreme Court.
At this stage, we think that markets would react positively to any result, as an uncertainty being removed, before looking into more details. Taxed and trade policies are the key differences between the two leading parties.
To conclude, there are all possible reasons to see significant volatility in the coming weeks and months. Having said that, if we exclude the unlikely scenario of an invincible virus, 2021 should provide a mix of economic recovery, especially in the services sector, pushing earnings higher, with ultra-low interest rates, justifying a high valuation multiple and leaving no alternative to risk-assets for investors. The catalysts are known and they are actually positive, and it’s good to remember that institutional investors are far from euphoria: they are underexposed to risk and waiting for an opportunity to put their cash at work. This is why we are more neutral than outright bearish, and would consider any material correction as a potential opportunity to buy. Stay safe!
Any opinions expressed in this article are the author’s own
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