How to explain investors’ initial positive response?
Historically, a divided Congress has been regarded as positive by investors given the low likelihood of major policy changes. This time around is no different and key overhangs (taxation and antitrust) for equity markets will likely be relegated to the back burner for the foreseeable future; presumably explaining the initial positive response in the equity markets.
Let’s not forget, however, that equity valuations are very extended. The MSCI World’s valuation is in the top decile of its historical distribution. Such a rich equity valuation is in stark contrast to the continuing macroeconomic and health-related uncertainty.
The lack of a strong Democratic majority in Congress reduces the odds the U.S. government will be able to deliver the large fiscal stimulus package investors were anticipating. In our view, this should help keep long-term interest rates from rising from current levels as Treasury funding needs are smaller.
Less money coming from the government combined with the likelihood of a much less cohesive response to the current crisis could lead to a longer and bumpy economic recovery1 if the government fails to implement tough measures to control the spread of the virus. While improved trade relations could reduce uncertainty and spur investment and economic activity, there seems to be little chance of an improvement in this domain as well.
What to expect for equity markets?
A combination of high uncertainty and falling rates is generally a constructive backdrop for gold as well as for consumer staples and utilities sectors. At the same time, this is also a positive outcome for health care and oil companies. It appears that in recent months, many investors reduced their exposure to these two sectors as they presumably feared the negative impact of policy changes under a strong Democratic government.
At the other end of the spectrum, sectors that are especially sensitive to the economic cycle are the most negatively exposed to a divided congress. This is particularly true given that these sectors outperformed in recent weeks as they priced in the likelihood of a strong Democratic showing in the elections.
Today's very turbulent trading session is not, in our view, justified by significant changes in fundamentals. We continue to follow market developments in order to capitalize on any investment opportunities that may arise.
1 Pandemics Depress the Economy, Public Health Interventions Do Not: Evidence from the 1918 Flu, Sergio Correia, Board of Governors of the Federal Reserve System, Stephan Luck, Federal Reserve Bank of New York, Emil Vermer, MIT – Sloan School of Management, June 5, 2020
Source of all data and information: Hexavest as at November 4, 2020, unless otherwise specified.
This material is presented for informational and illustrative purposes only. It is meant to provide an example of Hexavest’s investment management capabilities and should not be construed as investment advice or as a recommendation to purchase or sell securities or to adopt any particular investment strategy. Any investment views and market opinions expressed are subject to change at any time without notice. This document should not be construed or used as a solicitation or offering of units of any fund or other security in any jurisdiction.
The opinions expressed in this document represent the current, good-faith views of Hexavest at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented herein has been developed internally and/or obtained from sources believed to be reliable; however, Hexavest does not guarantee the accuracy, adequacy, or completeness of such information. Predictions, opinions, and other information contained herein are subject to change continually and without notice and may no longer be true after the date indicated. Hexavest disclaims responsibility for updating such views, analyses or other information. Different views may be expressed based on different investment styles, objectives, opinions or philosophies. It should not be assumed that any investments in securities, companies, countries, sectors, currencies or markets described were or will be profitable. This material may contain statements that are not historical facts (i.e., forward-looking statements). Any forward-looking statements speak only as of the date they are made, and Hexavest assumes no duty to and does not undertake to update forward-looking statements. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Future results may differ significantly from those stated in forward-looking statements, depending on factors such as changes in securities or financial markets or general economic conditions. Past performance is not necessarily indicative of future performance. Not all of Hexavest’s recommendations have been or will be profitable.
This material is for the benefit of persons whom Hexavest reasonably believes it is permitted to communicate to and should not be reproduced, distributed or forwarded to any other person without the written consent of Hexavest. It is not addressed to any other person and may not be used by them for any purpose whatsoever. It expresses no views as to the suitability of the investments described herein to the individual circumstances of any recipient or otherwise.