It is likely true of every federal election over the past 50-60 years, on both sides of the border, but next week’s U.S. election seems to be as publicly debated and prognosticated as any in history. The speed of information distributed via social media and traditional media outlets is a big reason for this as hourly polling data, turnout to campaign events and fresh candidate soundbites are available to anyone looking for up-to-date election news. Through all of this, our role with clients is to maintain an objective and long-term perspective and to weigh the implications of various outcomes on the financial markets in order to provide trusted advice.
Therefore, I thought it worthwhile to outline both what is encouraging about the markets and the economy and also where the risks lie heading in to next week’s U.S. election.
The Positives
The global economy continues on a path of recovery and most leading economic indicators point to further improvements and a gradual return to pre-Covid levels. The following two charts show economic data normalizing after the induced recession earlier in 2020.
Source: U.S. Consensus Bureau
Source: Institute for Supply Management, Haver Analytics, Credit Suisse
The Bank of Canada, the U.S. Federal Reserve and other central banks around the world remain accommodative with historically low interest rates and have indicated this policy is unlikely to change for several years. Their views on inflation have turned tolerant, with a suggestion that the Fed would allow it push higher than prior periods. Also, there is firepower left to deploy, particularly in the U.S. The Fed announced enormous commitments back in March and April to backstop financial markets and keep them functioning. It worked and they have only used a fraction of what was committed.
We are in the midst of third quarter earnings season and business sentiment remains weak but is improving. While it is still early, the trend has been positive so far with the degree of year-over-year earnings decline coming in meaningfully less than expected. Of particular interest are the results from the banking sector as their read-through to underlying business conditions is imperative. The Canadian banks’ results are still several weeks away, however, the commentary from some of the U.S. banks has indicated that the period of building loan loss reserves in anticipation of future credit losses may now be behind them and with higher savings and lower debt among households, the outlook is improving.
The development and approval of Covid-19 vaccines continues, yet not without speed bumps. Two of the leading clinical trials were recently paused due to set backs each by a single participant, but both have resumed and further data is expected to be released in another several weeks. The final timing of vaccine availability and the logistics of distribution are not yet known. However, it is encouraging to know there are several candidates that are expected to be commercialized, and the Canadian federal government has started to secure a supply for Canadians.
Source: RBC Dominion Securities Portfolio Advisory Group
Much of the volatility in the market is a result of uncertainty. With an important event such as the U.S. election and the potential implications for both the world’s largest economy and the rest of the world, it’s no surprise that we’re experiencing an elevated level of uncertainty. Using that same thesis, we can therefore expect some restoration of calm once the election is over and the results are finalized. We can look back in history in two different contexts to get some sense of how a renewed certainty may play out based on various election outcomes.
Source: RBC Capital Markets U.S. Equity Strategy, RBC Wealth Management, Bloomberg
Source: RBC U.S. Equity Strategy, Haver. Includes years since 1933. 50/50 split Senate in 2000 election – Rep Senator became independent midway through 2001 and caucus with Dem.
The Risks
The markets have been hoping for some resolution to additional stimulus and government support programs in both Canada and the U.S. Here at home, many of the mortgage, personal loan and non-retail loan deferrals have ended, suggesting there is some risks to increased loan losses and property foreclosures over the next several quarters. Canada has, however, extended or revamped many of the personal and business emergency benefits that were introduced in April, including the Canada Emergency Wage Subsidy (CEWS) and the Canada Emergency Response Benefit (CERB). The U.S. programs have mostly expired and partisan politics have prevented the two parties from coming to terms on new stimulus and aid for consumers, business, and state/municipal governments. The headline employment numbers and economic growth data are positive, but this is relative to the second quarter figures, one of the worst declines in history. Millions of Americans remain out of work and thousands of businesses remain closed. Without government support to help get them back on their feet, there are legitimate risks to this economic recovery stalling.
A contested election outcome also poses real risks to the market. Remember that uncertainty is not the markets friend. In a tight election outcome that has President Trump not earning a second term, he has indicated that a faulty mail-in ballot system and widespread voter fraud will be the reason for Biden’s victory. Trump has suggested he will take his case to the U.S. Supreme Court to try to overturn the results, should he lose, an outcome that would certainly spook the markets. We can look to the Bush v. Gore Florida recount in 2000 for precedence. A Trump win or a Biden win by a significant margin could avoid any of this.
Source: RBC Wealth Management, RBC Capital Markets U.S. Equity Strategy, FactSet, Associated Press
In Conclusion
Every event over the past century or more that shook people’s confidence in the future – pandemics, world wars, financial crises, terrorist attacks, deep recessions – ended. And within a few months or quarters of them ending the economy was growing again, usually quite strongly to make up for lost time.
The psychological effects of these events cast a long shadow on people’s memories and confidence – we are still talking about most of them today – but they did not cast a long shadow on the economy. There were winners and losers but the economy as a whole adapted and regained its form, driven by the powerful long-term forces of growing global population, rising prosperity and increasing productivity.
We are at another critical moment now, and we continue to maintain a long-term, constructive view. The volume of information to consume is enormous, but it’s useful to be able to step back from it all and consider the bigger picture. The businesses we own are leaders in their industries and their ability to earning profits for their shareholders long into the future is why we own them. There are checks and balances in the market and in our political systems to limit any long-term impairment based on single events. And we will continue to maintain an objective view to ensure the advice we offer can be trusted.