Markets were set to finish the week higher until the revelation that U.S. President Donald Trump, and the First Lady Melania Trump, had tested positive for the coronavirus. This development adds yet another source of near-term uncertainty as investors will be left considering the risk of infection to other government officials, the influence this could have on fiscal stimulus negotiations, and the potential impact on the U.S. elections. We expect this bout of unease will eventually settle once some clarity emerges over the days and weeks to come. Until then, we expect more questions than answers.
The past week was characterized by ongoing concern on additional waves of the virus which we address below. Meanwhile, we discuss the most plausible U.S. election scenarios and implications for markets.
Our attention over the past week has been focused on Canada and the U.S. given the former’s second wave and new signs of resurgence for the latter.
In Canada, the rate of new infections continued its ascent over the past week. The 7 day moving average of new cases is over 1500, close to double the level from a few weeks ago. There have been no signs of reemergence in the Maritimes or the Northern Territories. Quebec and Ontario continue to garner a lot of attention as the absolute case numbers are elevated (averages of over 700 and 500, respectively). But the virus is spreading elsewhere too, with Manitoba and Alberta seeing an uptick and new cases per capita in each province are the second and third highest in the country, respectively. Saskatchewan has seen a relatively stable rate of new infections for a second straight week. Lastly, British Columbia has shown some early signs of stability in its rate of infection growth and according to the province’s Centre for Disease Control, the reproduction rate of the virus in the province may be set to decline below the threshold of 1. This indicates that each new infection is less likely to affect another person.
In the U.S., the rate of infection growth looks to be turning higher yet again after a period of relative stability. The growth in infections over the past week has been widespread. For example, there has been a noticeable increase in new cases across previous hot spots such as Texas and California, while some less severely impacted states such as Wisconsin, Alabama, and Pennsylvania are now seeing an acceleration in new cases. Even the state of New York, which had made significant progress since the earlier days of the pandemic, has seen a noticeable increase.
We remain preoccupied with the health risk and the overall threat this resurgence poses to economic activity should governments have to consider more restrictive measures of containment.
Implications of U.S. Elections
It is very unclear how the infection of President Trump may alter the elections. We expect to have more thoughts in time. For now, we focus on the potential outcomes after the elections and the implications for the markets.
The U.S. government is designed purposely so that one particular person or part of the government cannot easily make sweeping changes. Understandably, the presidential election gets most of the attention. But, one aspect that often gets less coverage is the election cycle for the U.S. Congress. Yet, Congress, whose two chambers consist of the House of Representatives and the Senate, plays a very important role as it is the only part of the government that can create new legislation.
Currently, the U.S. government is divided with a President that is Republican, a Senate that is controlled by Republicans, and the House of Representatives controlled by the Democrats. We believe there are three likely election outcomes: 1) the status quo, with Donald Trump being re-elected with a divided Congress; 2) Joe Biden winning the Presidency with a divided Congress; and 3) a Democratic sweep, with Joe Biden becoming President and the Democrats taking control of both chambers of Congress.
We expect the first two scenarios described above could have a relatively negligible impact on the equity markets because they are less likely to result in uncertainty, which is often a driver of market volatility. A status quo outcome would lead to little change on the policy front with respect to taxes, energy production, and trade, among other things. The second scenario would result in some potential changes with Joe Biden as President, particularly around some of the tax cuts, approach to trade, and a renewed focus on issues such as climate change and renewable energy for example. But, a divided Congress in this scenario would certify that policy changes would be relatively modest. The third scenario, in our view, could lead to higher uncertainty, as a Democratic sweep could pave the way to more substantial policy shifts with less legislative hurdles for the new government to overcome.
A fourth scenario has emerged of late. It likely presents the highest risk, albeit for a short period. A contested election, whereby a candidate rejects the outcome due to irregularities or accusations of fraud for example, has become a possibility given complaints about the handling of mail-in ballots. These ballots are not new but are expected to play a bigger role this year because of the pandemic.
A contested election is unusual, but there is some historical precedence. In 2000, the votes in the state of Florida were so close that it led to a contested outcome between Democratic candidate Al Gore and Republican candidate George Bush. The uncertainty that emerged drove higher volatility between November and December 2000, and equity markets declined as a result. A return to more normal levels occurred by January 2001, at which point a clear outcome was already established.
It remains difficult to predict the future, but we are prepared for elevated volatility through the end of the year. While elections matter, the U.S. system is designed to ensure that far-reaching policy changes cannot easily be enacted unless there is sufficient support from both parties. Furthermore, there are other drivers that may arguably be more important for the equity markets. These include the economic cycle, corporate earnings growth, monetary policy and the availability of credit for example. This year, another factor has emerged that has arguably become just as if not more important: COVID-19.
Market Decline and Recovery Results
The peak-to-trough numbers for the current market decline and subsequent recovery are provided in the table below, as of today’s closing prices.