Highlights
• Economic growth is slowing, but we expect more stimulus and federal spending in 2021, which should help prevent a recession next year.
• Stock markets are likely to experience volatility in both directions for some time until clarity emerges around a possible coronavirus vaccine that would allow more economic reopening.
• Consider how various election outcomes might affect tax and spending policies and benefit different industries.
Although the news trended in a negative direction last week, stocks held their ground and eked out modest gains, with the S&P 500 Index climbing 0.2%. Coronavirus cases have been rising in parts of the U.S. and throughout Europe, although mortality trends have been improving. At the same time, hopes for a near-term fiscal stimulus package have faded. The political backdrop remains uncertain, but current polling trends show lessening odds of a drawn out, contested election, helping to reassure the markets.
Seven Observations And Themes
1. Strong retail sales should provide economic momentum into the fourth quarter. Sales growth picked up in September, increasing a stronger-than-expected 1.9%.
2. Improvement in the labor market appears to be slowing. The economy has downshifted from a pace of one million new jobs created monthly to around half of that level.
3. New coronavirus cases are rising, especially in Europe. On the upside, therapeutics are becoming more effective and the mortality rate is declining.
4. The pandemic has hurt some areas of the economy more than others. In particular, more than three-quarters of the declines in second quarter S&P 500 earnings came from increases in bank loan loss provisions, travel- and leisure-related businesses and the sharp drop in oil prices.
5. Third quarter earnings are off to a better-than-expected start. While still early, current trends suggest earnings could be down less than 20% from a year ago, which is better than the forecast as recently as two weeks ago.
6. Stock prices have been rising in recent weeks, despite signs that a near-term fiscal stimulus package seems increasingly unlikely. Investors appear to hope that no deal now might mean a larger package next year.
7. Economic momentum is slowing as stimulus effects fade and parts of the service sector continue to struggle. In particular, travel and leisure, small businesses and traditional retail sectors remain under extreme pressure.
Equity Market Resiliency May Be Tested
Equity markets are caught between hopes for a better economic future and signs that the coronavirus pandemic is worsening and economic momentum may be fading. At this point, the pace of the recovery is clearly slowing, and policymakers are running out of options to stimulate growth. Political disagreements stand in the way of a new stimulus package (although we expect that will change after the election) and interest rates are already at historic lows.
From here, we expect the economy to grind unevenly higher, as it hits rocky ground when infection rates surge. Unprecedented policy actions have supported the economy and boosted risk asset prices, but have not triggered a self-reinforcing expansion. Solid growth will probably require successful and widespread vaccines and medical treatment.
Despite the slowing recovery, equity and credit markets have held up surprisingly well. We believe investors are pinning their hopes on vaccine availability that will allow economic reopening to continue. The downside is that this makes markets vulnerable to disappointments.
At present, the equity bull run seems to have reached a consolidation phase. With relatively high valuations, earnings will increasingly drive future price changes. We expect stock markets to remain under pressure and volatility to continue for the time being. However, equities are more likely to experience a sustained uptrend with more clarity around medical breakthroughs and the postelection environment.
Five Election-Related Observations
1. Federal spending would likely rise under a Biden presidency. In particular, pending infrastructure and environmental initiatives would require higher taxes.
2. Biden’s tax plans are designed to raise $4 trillion over the coming decade, chiefly from an increase in corporate tax rates, removing the cap on Social Security taxes and converting capital gains and dividend taxes to ordinary income for wealthier Americans.
3. Federal spending would also likely rise under a second Trump term. As such, regardless of the outcome, we think a recession in 2021 looks unlikely.
4. Regardless of the outcome, Federal Reserve Chair Jerome Powell is determined to keep interest rates at zero for a long time.
5. We envision relative stock market winners and losers in different scenarios. Under a blue wave, alternative energy companies such as wind and solar and infrastructure-related companies should benefit. In contrast, airlines, aerospace and most health care companies (especially pharmaceuticals) would benefit should Trump retain the presidency.
Robert C. Doll is senior portfolio manager and chief equity strategist at Nuveen.
Sources:
All market data from Bloomberg, Morningstar and FactSet
Earnings data from Credit Suisse Research