Turbulence and Politics:
More than any other topic, save perhaps the omnipresent pandemic, the US election has dominated airwaves and conversations for the past 7-8 months. We’re no strangers to the conversation – when you consider that it is world’s largest economy and hosts the most active markets, we can’t help but keep our thumb on the pulse of the American machine.
This update is dedicated to sharing some of our insights into what the next few weeks and months might bring for the US and the rest of the world.
The Election:
A comedian recently said that this election cycle feels a lot like watching your two senior citizen neighbors fist-fighting on their lawn while their house is catching fire. It certainly feels like we Canadians are nervously watching what happens over the next few weeks and months while standing outside with the garden hose in case the flames jump the fence.
Ignoring personal politics (with great effort, we assure you), we’ll touch briefly on the three ‘cases’ our more trusted managers & economists are looking at(See appendix *, **, ***)
A Democratic Sweep:
Pollsters and economists are assigning a slightly better than 50% chance that this outcome comes through; this of course is depending on who you listen to. 2016 showed everyone that polls, while useful with a grain of salt, are fully capable of being grossly incorrect. If the Blue team takes the House, the Senate and the Executive (leaving a staunchly conservative Judiciary following the rapid appointment of Amy Coney Barrett and several hundred new conservative Federal judges across the country), there is a strong likelihood that markets will first dip in anticipation of increased taxation/regulation followed by a long, steady rise over time due to planned direct stimulus of American households/small businesses and the potential long-term move towards a single-payer healthcare system.
RBC GAM produced a handy image showing the likely short and long-term impacts of a Blue Sweep:
Biden wins the Presidency, Democrats win the House and Republicans hold the Senate:
As with most of Obama’s 8 years in office, this would likely result in legislative deadlock as the Senate and Judiciary remain uninterested in passing legislation not drafted exclusively by their party. The ‘Republican Graveyard’ of over 300 House-Passed bills (many of which had strong bipartisan support in Congress) is a likely theme until the mid-terms where many more senators and congresspersons come up for reelection. Unfortunately, this is likely to include bills intended to help main street Americans endure the pandemic, including stimulus legislation. This is likely to have fairly dire knock-on impacts on the economy and ultimately the markets. Most pollsters put this scenario at just over a 20% likelihood.
Trump takes the Presidency, Republicans keep the Senate and Democrats keep the House:
This situation achieves a similar deadlock to the above scenario but with a slightly higher chance of legislation being passed. With the House being held hostage by the other 3 branches of government it’s very likely that congress will allow Republican-drafted legislation to pass the House in order to prop up the economy so long as any stimulus is included. Sort of a ‘swallow the bitter medicine’ situation; allowing conservative social and economy policy to pass in the hopes that it can be fixed when and if the Democrats hold the three branches in the future. A roughly 1 in 4 chance of occurring given how frequently incumbents are reelected.
* RBC GAM Macro Memo – Oct 27, 2020
** Invesco Canada – 5 Things to Watch in October
*** TD Economics – Weekly Bottom Line for October 23, 2020
Economies ≠ Markets:
One of the most common misconceptions people have is that the economy and the ‘markets’ are one and the same. We often hear rhetoric from all sides pointing at booming equity markets and stating that successes in one stock index or another means that the economy underlying that market is also seeing similarly positive times. Digging deeper and looking at actual economic data like GDP (the value of all goods produced or purchased within a nation’s boundaries) or personal consumption expenditures (how much people are spending in a household) and we see a more accurate picture of how the economy is really doing.
This ‘disconnect’ between economies that are suffering and markets that aren’t suffering nearly as badly (at time of writing), is a key understanding for how the next 12-24 months might play out across bothmarkets and economies. A great analogy we can make is to compare the situation to a household:
If you as a Canadian household have a portfolio of investments worth $1,000,000 and, in the course of a single year, see that investment drop first to $800,000, then rapidly climb to finish out the year positive at $1,050,000, you might wipe the sweat off your brow and thank your stars for dodging a bullet by finishing the year in a positive position.
However, if your household in previous years had a total take-home income of say $250,000 and in the course of the same year saw that income drop to $100,000 because of economic instability, layoffs, or your employers going under, you might be a little more concerned. Time will pass and the income will likely come back, but it’s going to sting while you as a household ‘tighten your belt’ or turn to debt to help get through the short term.
While a gross simplification, the analogy illustrates the difference between the markets (the aggregate value of ownership of the debt or capital of corporations & governments) and economies (the aggregate productive effort of the nation’s workforce and corporations). People very rarely spend all of their investments at once, so the current state of income/expenditures is far more telling about the health of a country’s economy than the value of their investment portfolios.
In real world terms, it’s the economic harm that will take time to undo as the pandemic continues – while markets are exceedingly volatile and may drop or climb from here, economies around the world are thoroughly beaten up from the impact of shutdowns and strict enforcement of healthcare policy. The US saw Q2 GDP growth of -31.4%1 over the last 12 month period, with Q2 being their sharpest and worst decline in history. While there have been some decent recaptures since the end of July, the US is still firmly in recessionary territory due to record unemployment, the price of energy collapsing and hundreds of other contributing factors.
Canada has, largely due to our heavily resource and export based economy and much stricter economic shutdowns to control the spread of COVID-19, fared slightly worse in terms of annualized drops in GDP with Q2 posting a drop of -38.7%*. However, it’s arguable that the impact on individual households and small businesses has been muted relative to many countries such as the US due to more comprehensive government response to the pandemic. From better public health policy (including effective mandatory mask mandates) to direct stimulus for households and small businesses like CERB and CEBA, Canada has already started to see healthy recapture of lost economic production.
TD’s economists in September put the Q3 recapture at nearly 47.3%, although this is likely to be adjusted lower due to municipalities and provinces increasing restrictions again to control the second wave of COVID infections. Long story short, this pandemic has done a number on the world economies and most forecasts have the impacts on GDP lasting well into mid 2021, particularly for the US.
* Data from the BEA and Stats Can
What do I do with my investments?
The answer boils down to two scenarios, really:
1. If you’re in a short-term income need, your portfolios are structured so that they are less exposed to the sort of volatility equity markets are likely to see over the next 12-24 months as the pandemic and politics play out. Generally speaking, this means well diversified allocations to fixed income to provide a safer ‘cushion’.
2. If you’re investing more aggressively for the long term, we essentially recommend closing your eyes, trusting good management and trying to ignore the next 12-24 months of ups and downs. Short term drops are best viewed as great buying opportunities and over longer terms the market will recover and rise again (with a well diversified portfolio). Consistent automated deposits remove emotion, smooth out returns and take advantage of ongoing volatility.
That being said, we are always here to discuss your assets, their allocation and answer any questions/concerns you have about where you stand.
Cushioning Volatility:
A few tips and tricks for protecting yourself from the short-term ups and downs:
- If you have a spending goal that is coming up in the next 10-12 months, make sure those particular funds are kept conservatively invested so that they don’t experience huge swings if the markets do.
- If you are entering the market with a sizable contribution, it should be spread out over several months to help ease entry into volatile markets
- If you are withdrawing a retirement income, we usually make sure you are set up with the correct portfolio to begin with, but if you have any questions about what this might mean for an investor in the income phase please do feel free to reach out.
Meetings:
As always, we are happy to discuss your plan, your investments or answer any questions you have. We are available for telephone calls and video calls whenever you need.
Thank you for your continued support – we look forward to our next chat!
