Talk about burying the lead. The BCA Research report on which this article is based, deeply researched and thorough as always by Chief Global Strategist, Peter Berezin, is entitled Doubts About the Reflation Trade.
But about halfway through are two striking charts that show BCA’s Geopolitical Strategy team and its quantitative model, which combines polling and economic factors, predicting not only a narrow Donald Trump victory but that the Republicans will maintain control of the Senate.
Naturally, a Trump victory runs contrary to the vast majority of nation-wide and, more importantly, state-wide polling.
Here are some excerpts from BCA’s report.
Doubts About the Reflation Trade
Hi-Lights
- A surge in the number of Covid cases worldwide and the failure of the US Congress to forge a stimulus deal has cast doubt on the “reflation trade.”
- European governments have responded to rising case counts with a urry of restrictions. While not quite as extreme as those introduced in March, the new lockdown rules will still weigh on growth over the coming months.
- The good news is that progress on a vaccine continues, with the vast majority of experts expecting one to be widely available within the next 12 months.
- The degree to which US scal policy will turn stimulative again depends on the outcome of the election.
- A “blue wave” would produce the most scal stimulus, while a Biden victory coupled with continued Republican control of the Senate would produce the least.
- However, even in the latter scenario, popular support for further fiscal easing – including among Republican voters – will help catalyze a deal.
- The near-term picture for stocks is murky. Nevertheless, investors should remain over-weight global equities on a one-to-two year horizon, while shifting exposure to non-US markets and value stocks.
Worries About the Sanguine Narrative
Investors have become increasingly concerned about the viability of the so-called reflation trade.
Stocks rallied in the spring and summer on hopes that the worst of the pandemic was over and that fiscal stimulus would continue to prop up employment and spending.
Now, both assumptions are being challenged. The number of coronavirus cases continues to rise worldwide (Chart 1).
In both Europe and the US, the daily tally of confirmed new cases exceeds its March peak.
The only saving grace is that the number of deaths has not risen by as much as many had feared.
There has been less movement toward shuttering the US economy in response to what is now the third wave of the pandemic.
This may be partly because the latest cluster of cases has been fairly localized, concentrated mainly in the central north of the country.
So far at least, the heavily populated south and coastal states have been spared the brunt of the wave.
However, if more states start seeing rising case counts, stricter restrictions could be introduced across most of the country.
What Would the Stock Market Prefer?
From the equity perspective, stocks would likely rise if Trump won and the Democrats took over the Senate.
If re-elected, President Trump would block any efforts to raise taxes or tighten business regulations.
However, unlike a number of Republican senators, Trump is not averse to increasing government spending.
Earlier this month, the President proposed a $1.8 trillion stimulus bill. Senate Republicans have offered only $500 million for pandemic relief.
The stock market would welcome both easier fiscal policy and the implicit guarantee that taxes will not rise.
The stock market would also be content with a Democratic sweep, provided it did not result in a blowout victory.
A narrow Senate victory would still allow the Democrats to pass a fiscal stimulus bill through creative use of the “reconciliation process.”
However, it would curb the influence of the party’s more left-leaning members.
The quant model developed by Matt Gertken and BCA’s Geopolitical Strategy service, which elevates recent economic data over polling numbers in its computations, gives Donald Trump a 51% probability of remaining president and an equivalent chance of the Republicans picking up the Senate (Chart 4).
Subjectively, Matt thinks Trump has a 45% chance of winning.
While lower than his quant model, this is still above the 39% probability that betting markets assign to a Trump victory (Chart 5).
Investors would likely deem a continuation of the existing political configuration in Washington – where Donald Trump remains president and the Republicans maintain a slim majority in the Senate – as neutral for stocks.
On the one hand, such an outcome would take the prospects of tax hikes off the table.
On the other hand, it could prolong the trade war and extend the stalemate over a stimulus bill.
Stock market investors might frown upon a scenario involving a Biden victory and continued Republican control of the Senate.
Of all the scenarios mentioned above, the prospects for a major stimulus package would be lowest for this configuration of political outcomes.
This is because Republican senators would have even less incentive to accede to more spending if Joe Biden, rather than Donald Trump, were pressing for it.
Investment Conclusions
While governments have understandably tightened restrictions to control the latest surge in COVID cases, they are unlikely to fully revert to the extreme measures taken in March.
Back then, there was considerable uncertainty over how fatal the virus was, with estimates for the mortality rate ranging from 0.5% to over 5%.
The latest research suggest that the true number is near the bottom of that range, and perhaps even below it.
Progress continues to be made on a vaccine. Close to 95% of professional forecasters surveyed by The Good Judgement Project expect a vaccine to be widely available within the next 12 months (Chart 6).
The combination of a vaccine and further fiscal support against a backdrop of ultra-easy monetary policy should be enough to lift global equities by about 15% towards the end of 2021.
While the near-term picture for stocks is murky, investors should remain overweight global equities over a one-to-two year horizon.
As a countercyclical currency, the US dollar is poised to weaken next year. Typically, non-US stocks outperform when global growth is strengthening and the dollar is weakening.
Value stocks also tend to do better in such macro environments.
Once the latest wave of the pandemic crests, as it inevitably will, investors should look to shift their equity portfolios from stocks that benefited from lockdowns towards those that will benefit from re-openings.
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