Q3 2020 Market Update

The markets are concerned about a contested election and the possibility of tax and regulatory increases in 2021 under a Biden presidency. The stock market hates uncertainty and so market volatility should remain elevated until after the election.

The markets are concerned about tax and regulatory increases in 2021 under a Biden presidency and a contested election. The stock market hates uncertainty and so market volatility should remain elevated until after the election. Recently however, the VIX futures have moved lower as the prospect of a contested election wanes and in the hope that even with a Democrat win, the proposed tax hikes and increased regulation will not be enacted until after 2021.

Biden proposes to reverse the tax cuts enacted in 2017, and re-direct proceeds toward green companies and expanding healthcare coverage. Although a Biden win could hinder company profit growth given tax hikes, it appears increasingly likely that any tax increases would not kick in until after 2021. And, if Biden wins the Presidency and the Democrats take the US Senate, it would likely be by a very narrow majority. In that instance, it is possible that several Democrats balk at immediately imposing tax hikes with high unemployment.

Typically, the stock market hits its low before election day and is a buying opportunity at some time in October. In general, a stronger stock market performance between September 15th and Election Day has been positive for the incumbent presidential party. Between September 15th and Election Day, the Dow Jones Industrial Average (DJIA) rose a median of 2.1% when republicans retained the presidency and fallen 1.8% when they lost it. In all six cases since 1900 when Republicans have yielded the White House to Democrats, the DJIA was down between September 15th and Election Day, according to CFRA. As of October 16, 2020, the DJIA is up 1.66% since September 15, 2020.

Whatever your view on who should be in the White House, any dip in the stock market should be bought going into the election. The S&P 500 rallied 30.1% from April through September, its best six months return since 2009. In the 10 previous cases when the S&P 500 gained at least 30%, the index went on to post strong gains three months later. COVID, the economic reopening, earnings expectations, and the election should have a bigger say in market returns moving forward, but history suggests the strong momentum of the last six months is a positive sign.

Corporate earnings are rising now along with guidance as economy opens up. The Q2 earnings season was the best earnings (EPS) season on record when comparing it to actual results and analyst expectations. The percentage of companies beating analyst EPS estimates reached an all-time high, while companies raised guidance at a record pace. Analysts have grown increasingly optimistic and are raising earnings projection for the third quarter. This quarter’s positive revisions spread is the most positive since the Q4 2017, which is a bullish sign of a broadening recovery.

Valuation measures based on both trailing and forward corporate earnings prospects suggest equities are expensive relative to history. But with short-term rates at zero, investors are essentially getting almost no returns on cash investment. As a result, stocks look more attractive when compared with cash and many areas of the bond market, as well.

Government bond yields remain at or close to historical lows, making them even more expensive than stocks. It’s hard to make the case that stocks aren’t the better option when the dividend yield of the S&P 500 is higher than long-term government bond yields. Bottom line, the higher valuations of stocks is justified based ultra- low interest rates, a “V” shape economic recovery, current trend in earnings growth, and additional stimulus.

© 2018 by Aspetuck Financial Management LLC

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