The equity market is facing one of the best backdrops for sustained gains in years. After a prolonged period of elevated risks (global trade war, COVID-19 pandemic, US election uncertainty, etc.), the outlook is significantly clearing up, especially with news of a highly effective COVID-19 vaccine. We expected an imminent vaccine outcome and a rotation out of COVID-19 beneficiaries /
Momentum and into Epicenter / Value stocks including Vaccine Tactical Short (JPAMVACS <Index>) and COVID Recovery baskets.
We view a confirmed Biden victory with a likely legislative gridlock as a goldilocks outcome for equities, a “market nirvana” scenario. With an even balance of power in the legislature, major tax increases and regulatory changes will be difficult to pass, while at least some easing of the global trade war should be expected. Global central bank policy remains very supportive (rates to remain at zero with ongoing QE).
The prospect for another round of fiscal stimulus has improved as well, though scope and size should be narrower. Corporate earnings (i.e. 3Q, see details below) and labor market recovery (i.e. October jobs) continue to come in ahead of expectations. This recovery process should remain underpinned by easing of COVID-19 restrictions (i.e. US QMI has entered business cycle expansion phase, see below). USD continues to normalize, acting as an earnings tailwind for US multinationals. S&P 500 cash balance is almost back to record highs, with potential for increasing buyback and M&A activity in 2021.
Equity positioning remains at below-average levels with ample room for mechanical re-leveraging as volatility levels subside (Volatility Targeting ~10th percentile, HF equity beta ~20th percentile, and CTAs ~40th percentile, see report).
…with a good potential for the market to move even higher (~4,500) by the end of next year.
…the most significant short-term risk we see for equity markets remains the Georgia Senate races…as the GOP is expected to capture at least one of the two senate seats in the Jan 5th run-off. Indeed, it is possible that vote recount for one of the seats may settle the outcome in GOP’s favor even before the run-off. Plus there is a chance that John James in Michigan may recapture the lead, giving GOP an additional Senate seat.
Add the vaccines for more bullishness.
The key risk for us is none of the above. Rather, it is what happens as the stimulus unwinds? Central banks are out of the way for several years at least, having declared that they will let the cycle run hot. But fiscal stimulus will fall and the rules that govern capitalism will return (no more loan deferrals, rent holidays or trading insolvent etc).
I don’t think that governments will just pull the rug out. It’s more sensible to expect an incremental return. But COVID has reversed the regular order of things. Normally the end of cycle shock develerages, adds creative destruction and a big productivity push. This time we have added mass debt, kept the zombies alive and killed productivity.
This will land on earnings before too far into the cycle so it is not going to be a long one, nor durable when interest rates do start to lift.
For now, it’s a bullish phase as we come out of the trade war and COVID-19 with catch-up growth ahead for GDP and earnings. A 2022 earnings boom is a reasonable proposition with JPM forecasting $200 on the S&P500 so some upside for stocks is fair enough. That gives us an almost acceptable 18x forward earnings two years away which Wall St is sure to inflate.
Beyond 2022, I reckon we bog down into the COVID-19 undead economy and would not be at all surprised to see a double-dip scenario play out relatively quickly as the virus stimulus chickens come home to roost.
But that is a problem for another day.