We are weeks away from the presidential election and there are numerous factors to consider when it comes to our economy and economic recovery. Monetary policy is paramount, and we know from history that markets go up when financial conditions are easing, regardless of politics. Over the last 75 years, the S&P 500 posted an 11% annualized return, telling us the market doesn’t have to like the president or what’s going on in Washington D.C. to perform well. Rather, they are driven by other fundamentals. Also, importantly, investors’ time horizons are much longer than political time horizons.
Who will win?
This is the question everyone is asking right now. The only certainty is that anything can happen. If you look at the data from late September for the 2020 presidential election odds, Joe Biden has a strong lead. However, history has shown us that the odds were in Hillary Clinton’s favor in late September of 2016, but the situation changed dramatically on election day. When it comes to incumbents in a presidential race, there are two critical data points that we consider: job approval rating and the unemployment rate.
An incumbent president’s job approval rating usually needs to be above 50% to win the re-election. President Trump’s approval rating is improving but is still well below 50%. When it comes to the unemployment rate, the trend is what’s important – it needs to be improving, which is currently the case. However, if we have learned anything over the years, it’s that circumstances can change at the last moment, so the race is probably closer than any of the data suggests.
The role of COVID-19 cases
In recent weeks, we have seen more hospitalizations and deaths from COVID-19 in certain states, which begs the question: are we seeing a second wave? The light at the end of the tunnel is that we are getting closer to a vaccine and/or treatment every day.
The labor market and unemployment
Initial unemployment claims give us clues about what might happen to the future unemployment rate. The unemployment rate peaked at 15% in April, and as the economy re-opened, the rate dropped to 7.9%. This recession has been different from the Great Recession of 2008 in that it was generally understood that the shutdown would be temporary and many of the jobs lost would hopefully come back relatively soon. By comparison, it took several years for the unemployment claims rate to drop after the Great Recession of 2008 began.
Confidence in the marketplace
There are three confidence indicators: consumer confidence, small business optimism and CEO confidence. Consumer confidence fell during the shutdown, but it was still nowhere near what we saw during the Great Recession. Now, we are starting to see a recovery in consumer confidence and in small business optimism. CEO confidence, however, remains somewhat low. Overall data suggests a strong recovery at the start of the fourth quarter. The vaccine is truly the light at the end of the tunnel, and without it, there is some risk to fourth quarter GDP.
Impact to personal income
Another significant near-term risk is whether Congress can pass another fiscal stimulus package. If not, this could put economic activity even more at risk for the fourth quarter. If Congress had not passed the first fiscal stimulus package, personal income would have gone down and stayed down for much longer. Instead, personal income was actually up in the U.S. for the first time during a recession.
National Financial Conditions Index (NFCI) and the S&P 500
What drives the markets are financial conditions, and the main drivers of those conditions are the availability of credit, interest rates and lending patterns. When the NFCI is falling, that means financial conditions are softening, which is positive, as it means lower rates and more availability of credit.
There is a correlation between the softening market and the upward movement of the S&P 500. History shows us that after a recession, financial conditions ease, and the financial markets rise. For the past five years, we’ve seen financial conditions ease, and this has supported good equity returns. The Federal Reserve has pledged to keep financial conditions soft for as long as possible, which will support economic activity.
Money supply and inflation
Robust money supply growth due to the fiscal stimulus creates some concern about inflation. Right now, there are a number of factors keeping inflation down, but it could be up for a serious discussion two to four years down the road. The rate at which the money is moving into the economy and spent is critical, and currently, people are saving. The 30% money supply growth rate is being matched by an almost a 30% growth rate in savings. We are also seeing slack in the labor market, which may mute wage inflation.
What’s driving the markets?
From a big picture standpoint, low interest rates and stimulus continue to drive market up. So far in Q4, the market is up 9% as the economy re-opens and consumers anticipate a vaccine. There has been some volatility as stimulus talks have stalled, but the market is less concerned about the election and more focused on the COVID-19 vaccine.
Does the election matter?
As previously mentioned, the market doesn’t need to like the president. The market is more focused on low interest rates and monetary policy as opposed to who sits in the White House. Over the past 30 years, the market return was 10.5% annualized, so data supports the approach of keeping a long-term focus and staying invested rather than shifting strategy due to presidential changes.
Aftershocks – risks
There are a number of risks we will watch closely, as they could negatively impact the economy – there will likely be a second wave of COVID-19, oil remains low at $40 a barrel and could change. Debt continues to mount for both corporations and the government. There is also some short-term risk with the presidential election.
For the remainder of the year, we do expect short-term market volatility around the market, but advise our clients to look through that as we expect the market to grind higher. We do expect an economic rebound in the third and fourth quarter. There is some variance about just how much of a bounce-back we’ll see – the Atlanta Fed suggests a 35% rebound in GDP yet the New York Fed suggests 14%. We believe we will see a recovery in the second half, which will result in an overall GDP contraction of 4.8% for 2020.
Fundamentals of the U.S. Economy:
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