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On 29 September 2020, SSGA’s Lori Heinel (Deputy Chief Investment Officer), Dan Farley (Global Chief Investment Officer, Investment Solutions Group), Elliot Hentov (Head of Policy Research), Kathryn Sweeney (Head of Institutional Sales, Americas) and Melissa Kahn (Head of Retirement Policy) shared their perspectives on the investment implications of the 2020 US election. Uncertainty regarding the election outcome is high, and a delayed or even a legally contested result is very likely. In this context, the investment experts outlined the potential election outcomes to help clients prepare for the medium-term investment scenarios. The complete replay is available here.
The US election is another variable for investors to grapple with in the context of the global pandemic. Let us not forget that the global GDP collapsed in the second quarter as a result of COVID-19 and contracted at a pace even more severe than during the 2008 financial crisis. The unknown path of the virus, the resultant stay-at-home orders and the risk of reinfection have all exerted severe pressure on almost every aspect of the global economy.
However, global central banks carried out massive monetary stimulus to support the orderly functioning of markets, in the process creating liquidity and calming anxious investors. We cannot underestimate the crucial nature of the rapid central bank response and the emergency fiscal stimulus in the United States (US) and other major economies around the world. Undoubtedly, these quick actions put cash in the hands of the neediest, allowed businesses to make payroll and consequently helped to avoid worst-case economic outcomes from the pandemic-induced shutdown.
For the past several months, countries around the globe have been moving toward a process of gradual reopening – and the economy is responding. Simona Mocuta, SSGA’s senior economist, coined the term “relay recovery” to describe the recuperation of the economy and the evolution in support required to take it to the next phase. The first leg of support was led by global policymakers and the second leg, the present, is being led by local reopening decisions and the resumption of business activity.
We are encouraged to see that consumer spending and industrial production have been improving around the globe and have been faster in areas where the COVID-19 virus is relatively well controlled. Although the recovery is certainly patchy, the economy is finding a slow path forward.
Next Phase Would Ultimately Require a Medical Solution
The next phase and the ultimate resumption of a more normal economic cycle will require the third supporting condition – a medical solution to the pandemic, which may not be ready until well into 2021. Nonetheless, we see near-term economic momentum developing with mild, if any, inflation as consumers and businesses adjust to the overhang of the virus.
Even before the pandemic, several structural forces were converging to keep the interest rates “lower for longer”. In addition, given extended valuations and questions about whether future earnings would deliver, many investors were reevaluating both the level and the nature of their equity allocations as well as expressing concerns about the length of the economic cycle. As a result, we could see a sharp interest in assets that offered a measure of diversification. These core trends are unlikely to be reversed no matter the outcome of the election.
The US election adds a degree of event risk since a quick resolution is not expected. In addition, dramatic policy changes may be in the offing. Markets are pricing in some risk of a disputed election and resultant volatility in the weeks beyond the election day. We think this is a rational investor response given the critical importance of the swing states (those that could be reasonably won by either candidate) and the potential for a contested election.
Since the Bush-Gore 2000 election, results in a handful of swing states have been determining victory or defeat in the national election, typically by tight margins. At the same time, elections for three or four of 100 seats will set the control of the Senate. The ultimate outcome of these elections is extremely difficult to predict. Therefore, we do not think either party can legitimately claim victory the morning after election day, especially if the outcome is based on narrow victories in two or three states.
While election uncertainty is high, we think it is prudent to prepare for a Biden administration and consider the sector implications stemming from his policy proposals. Backed by a Democratic Senate, Joe Biden should move forward with his agenda including reforming corporate and personal taxes, allocating US$2 trillion of new spending on clean energy and widening access to the Affordable Care Act. The increase in spending would favor fossil-fuel-light technologies, infrastructure and health care stocks (even if the government would restrict drug prices). Non-US equities as well as industrials and dividend-paying companies appeal to us as well.
If Mr. Biden wins but the Republicans hold the Senate, the new administration could still achieve its agenda albeit at a smaller scale. We would still favor fossil-fuel light companies and those with rich dividends, but the health care sector would see a much smaller boost.
Regardless of the sector implications, we expect short-run volatility in the broad market until a clear winner emerges. In an average election, market volatility tends to increase as voting day nears and then quickly resolves once a clear winner emerges. Once investors have a reasonable prediction of the ultimate winner, volatility tends to fade.
The 2000 Bush-Gore election, when results were not available for over a month, is the precedent for the 2020 election. Today, polls are tight, and each party is prepared to legally challenge the results in swing states. Consequently, state officials will be understandably reluctant to certify results until the voters’ choice is clear. The market anticipates volatility as evidenced by the forward VIX curve, which shows an elevation in implied volatility in October, November and early December and a moderation only in January. For sure, markets are expecting volatility and we concur with this prognosis.
Another way to look at investor expectations is through our Market Regime Indicator, which helps us to monitor whether investors overall are in a risk-seeking or risk-avoiding mood. Critical inputs to the model are implied volatility in currencies, implied volatility in equities and spreads on risky debt. This proprietary metric more recently backed-off the March and April crisis levels to the upper end of a normal risk regime. In other words, although risk sentiment improved, it remained modestly elevated compared with the longer-term trend.
Considering macroeconomic and market environments, we are broadly neutral in our active asset allocation (on a directional basis) and prefer to take relative-value positions from a six to nine-month time horizon. In equities, we are overweight US large cap companies at the expense of US small caps. Large cap stocks enjoy strong earnings and sales expectations and until very recently had a strong momentum tailwind. However, we are underweight real estate investment trusts given the impact of COVID-19 on the lodging, office space and retail sectors. We also are a bit overweight in European and emerging market stocks.
From a relative value fixed income perspective, we are underweight core bonds, recognizing low yields on government securities, in favor of investment grade credit and high yield bonds. We like the stability of coupon income in a low yield environment and are encouraged by the improving macroeconomic backdrop. One caution on high yield, however. Be mindful of exposure to energy credits since the presidential campaigns take distinct views on future fossil fuel policies. Details on our current positions may be found here.
Policy issues on Environmental, Social, and Corporate Governance (ESG) and equality in retirement plans’ tax structure simmer below the headlines. We expect to hear more from policymakers on the use of ESG in retirement plans during the year ahead. Reaction to the Department of Labor’s proposal has been very negative since it effectively precludes the inclusion of ESG funds in retirement plans due to, among other barriers, significant new governance procedures and documentation requirements. Many industry experts were surprised at the restrictive proposal, noting that it was at odds with the more permissive guidance on private equity.1 A Biden administration may be more receptive to ESG since it may become one aspect of a larger focus on climate change initiatives.
More likely, a Biden administration coupled with a Democratic Senate would enact tax increases on highly compensated employees to pursue income equality in retirement plans. Several items are under discussion, including changing the tax treatment of defined contribution plans from a tax deferral to a tax credit system. This idea had little traction in the past but now opens the door for other tax increases for highly compensated employees – for example, capping benefits, limiting catch-up contributions, reducing compensation limits or prohibiting Roth conversions – i.e., moving all or part of the balance of a traditional IRA into a Roth IRA. We will be monitoring proposals for plan design under a possible Biden administration.
Actions for Investors
Considering all the economic, pandemic and election-related uncertainties, our advice to investors is to separate the immediate risk of market volatility from longer-term implications. Specifically, some investors will want to take protective action or raise liquidity in the next 90 days, and some will want to focus on the medium- to long-term view. As we see it, both perspectives are valuable and are in the best interest of plan participants.
If volatility or liquidity is an issue for your portfolio as the year-end approaches, we think Treasuries will provide good liquidity as well as act as a good tail-risk hedge. Gold, defensive currency pairs and cash equitization may also be good strategies in the very short run. With the long term in mind, we believe the considerations described in Figure 1 are important to evaluate. We welcome the chance to discuss these issues in your context.
1Under a letter issued in June by the US Department of Labor, a retirement plan may include private equity investments as part of a multi-asset solution, subject to other limits. This guidance could also be modified in the months ahead.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without State Street Global Advisors’ express written consent. The views expressed in this material are the views of Lori Heinel, Dan Farley, Elliot Hentov and Kathryn Sweeney through 06 October 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All information is from State Street Global Advisors unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
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Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).
Bonds generally present less short-term risk and volatility than stocks but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
These investments may have difficulty in liquidating an investment position without taking a significant discount from current market value, which can be a significant problem with certain lightly traded securities.
Investing in commodities entail significant risk and is not appropriate for all investors. Commodities investing entail significant risk as commodity prices can be extremely volatile due to wide range of factors. A few such factors include overall market movements, real or perceived inflationary trends, commodity index volatility, international, economic and political changes, change in interest and currency exchange rates.
This information is for informational purposes only, not to be construed as investment advice or a recommendation or offer to buy or sell any security. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. There are no guarantees regarding the achievement of investment objectives, target returns, portfolio construction, allocations or measurements such as alpha, tracking error, stock weightings and other information ratios. The views and strategies described may not be suitable for all investors. SSGA does not provide tax or legal advice. Prospective investors should consult with a tax or legal advisor before making any investment decision. Investing entails risks and there can be no assurance that SSGA will achieve profits or avoid incurring losses.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted.
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