Waiting Anxiously

No one likes uncertainty — markets least of all. If there were a VIX measure for global anxiety it would surely be at an all-time high right now. The usual uncertainty ahead of a closely fought US election is compounded by two extraordinary concerns. First is the real danger of a delayed — or, worse, contested — election outcome. In normal years, uncertainty about who will lead the world’s largest economy is, more often than not, resolved over election night. If this Tuesday’s election delivers a clear winner by the early hours of November 4, there will be surprise and relief. The second worry, of course, is Covid-19. The disease that has defined this year, spreading anxiety and anguish in its wake, is surging again in the US as well as Europe. No wonder that investors are uneasy. The VIX — an indicator of investor anxiety if you like — did not return to pre-pandemic lows even while markets soared in the spring and summer. Last week it climbed further, as equities slid down in the worst week for US markets since the March collapse.
Observations and the takeaway for investors:
1. This election really is historic, and the world is watching along with Americans

Analysts have reached for new adjectives and adverbs to describe the importance of this election. It seems that ordinary Americans agree. Turnout in early voting has been unprecedented. Early voting — whether in person for the 43 states that allow it this year — or by mail or dropbox has far exceeded normal. In two states — Texas and Hawaii — more people had voted by last Friday, than voted altogether in those states in 2016. This may, in part, reflect fears of fewer and more crowded polling places on election day due to Covid-19. But with few undecideds and much at stake, both parties have been making tremendous efforts to encourage their supporters to go out and vote. In the waning days of the campaign, the polls tightened in some key states. In these circumstances, GOTV — or Get Out The Vote — efforts are even more urgent. Whatever the outcome, it will be the result of a more engaged American electorate than we have seen in many years. That is good for democracy.

What is less cheering is the number of legal challenges that we have seen over which votes should count. Without a clear win for one side or the other, we can expect legal challenges only to get louder after election day, potentially straining the institutions of American democracy. Many have been surprised to learn that the effective decider of presidential elections is the loser — with a concession phone call and speech — typically after news organizations have called the outcome based on early results. In the messy 2000 election, former Vice President Albert Gore first called George W. Bush to concede, after news organizations said he had lost Florida and therefore the electoral college. He then called back to retract the concession as more votes came in, shrinking the Florida gap. If the results appear to be going against President Trump, whom most polls still see as more likely to lose than former Vice President Joe Biden, will he concede? He has argued for months that election fraud is likely. Worryingly, he has also commented that the only way he could lose would be through widespread fraud. It seems strange in America, but businesses in downtown Washington, DC started to board up last week to prepare.

Outside the US, the future of American foreign policy does not usually seem to be at issue in a presidential election. The broad strokes of policy towards the rest of the world have been stable for decades. Not so this time. President Trump’s break with traditional diplomacy, willingness to escalate trade disputes and departure from international institutions and agreements, such as the Paris Climate Accord, the Iran deal and the World Health Organization, has left allies and competitors alike more invested in the outcome, even if uncertain about what a Biden presidency would bring. The uncertainty has been all the more as those working on the Biden campaign have refused traditional pre-election engagement overseas

For those wondering how to gauge results as they come in on Tuesday night, Florida will be an important early signal. Votes there are generally counted fairly quickly and polls show the two candidates neck and neck ahead of the election. If Joe Biden wins Florida — and remember to wait for all precincts, including those in the solidly Republican western Panhandle, to be called — an electoral college victory would be almost assured for the former Vice President. If President Trump wins in Florida, the anxious wait will continue.

While uncertainty around an election outcome will create an unknown for voters, it may also spook markets. Investors could be wary of buying on a dip or selling on a rally depending on the results, which may lead to a prolonged period after the election of markets pricing in what the ultimate winner can do for the economy.

2. The economy moves with Covid-19 cases

The battle over government restrictions on business and consumer activity has often been posed as one between jobs and health. Experience over the past eight months, including in Sweden which took a different approach from its neighbors with no mandated lockdowns, suggests that this can be misleading. In the early days of the pandemic, economies were indeed shocked by government actions. The total shut-down put in place in many countries in the spring put their economies into the deep freeze. Reopening led to a bigger rebound than many economists predicted. This carried over into the third quarter GDP figures reported for the US and Europe last week, which showed enormous gains from the previous three months.

A closer look at the data, especially around business closures, unemployment and consumer sentiment, shows that the summer recovery in Europe and the US left living standards far short of a return to pre-pandemic normal. Output was approximately 3.5 percent below the level of end-2019. And the growth momentum has slowed or even stalled in recent weeks in the face of rising Covid-19 cases.

Before the imposition of new controls in the UK, the IMF last week revised down its projections for growth from those published just two weeks earlier, citing the impact on behavior of rapid spread of disease. For Europe as a whole, IMF former Managing Director and current President of the European Central Bank (ECB), Christine Lagarde, warned that the outlook was worrisome in light of the second wave surging across the continent. In the US, recovery was initially stronger. But with a second wave hitting in July, economic activity began to slow sooner. The Chicago Fed’s National Economic Activity Index rose by 4.2 percent in May and nearly 6 percent in June before slipping steadily to growth of just 0.3 percent in September.

The US is now in the grip of a third surge of infections. Last week, the daily caseload surpassed its July peak, averaging over 82,000 new infections per day and topping 99,000 by Friday. For investors, the cloud of uncertainty from rising Covid-19 cases on top of the closely fought election overshadowed news of a better than expected third quarter earnings season and record-breaking GDP numbers. No surprise. In today’s uncertain and volatile world, backward-looking data is not so helpful. The New York Fed GDP Nowcast is expecting an annualized 3.24 percent rate of growth in Q4 while the Atlanta Fed’s GDPNow estimates a 2.25 percent rate of growth for the same period.

3. Investor Takeaway

Investors are also waiting — perhaps foolishly — for next week’s results to see if some clarity and discernible trends will be introduced into markets. Last week was a good example of the competing forces driving prices. Rising Covid-19 cases, increased lockdown measures and stalled stimulus discussions competed against generally encouraging news on the corporate earnings front. Over a third of S&P 500 companies (186 companies) reported Q3 results this past week. Of the 63 percent of the S&P that has reported earnings, 88 percent have beaten expectations — the largest percentage of beats going back to 2005 according to Morgan Stanley and 77 percent have surprised to the upside on sales. No surprise to anyone, financials, real estate and energy — laggards in the markets this year — have seen the smallest percentage beats for earnings.

Investor expectations are being tempered by reality on Covid-19 winners. Tesla is a good case study on the volatility in stocks that has been carrying the market for much of the year. The company dramatically exceeded revenue and Q3 earnings expectations this week, but the results were not sufficient for a stock that has risen more than 400 percent year-to-date. Tesla was down 8 percent in the days after its earnings report. Ford and GM, which have had much more muted returns compared to Tesla this year, were among the market leaders in October. Even a Covid-19 winner like Tesla can’t be asleep at the wheel with competition coming from GM and its upcoming Hummer EV and Super Cruise autonomous driving technology. If indeed the Covid-19 playbook is getting thrown out, industries that have been ignored such as banks, autos/auto components, household products and retailing may be increasingly on the minds of investors looking for a bargain — regardless of the US election outcomes.

EU Monetary Policy. All eyes were fixed on the ECB’s meeting this week as investors hoped for further monetary easing to fight the new wave of Covid-19 cases and lockdowns in Europe (see our discussion in last week’s letter). While there was no official policy change announced, the central bank communique and subsequent press conference seemed to satisfy investors. The monetary policy statement contained a new paragraph that pointed toward action, as appropriate, out of the bank’s December meeting since the Governing Council will have adequate time between now and then to assess the impact of the recent virus wave and resulting lockdowns on Europe’s economy. Currently, expectations are that the size of the emergency bond buying program (PEPP) will be increased to €2 trillion, and net purchases will be extended until the end of 2021 or mid-2022. The Euro weakened on the news, driven lower by poor growth prospects due to lockdowns and the possibility of increased monetary stimulus. A potential increase in Central Bank purchases did tighten peripheral spreads immediately following the announcements before giving some of those gains back on Friday. The net effect was for spreads to widen slightly as yields on Bunds fell further during the week driven by risk-off sentiment.

European Markets. We spoke much about Europe and the resurgence of Covid-19 cases in last week’s commentary, and European markets continue to have a negative reaction. Markets have not recovered and with projections for the euro area Q4 GDP numbers falling along with a weaker Q1 2021, it seems unlikely to see a strong recovery in the short term. Longer-term, Europe presents a puzzling dilemma for investors. While many have been caught on the other side of shorter-term rallies in European markets, there is a case for being cautious. Technology is a global trend and the impact of technology on companies, supply chains and future growth prospects is challenging for the older economies that dominate European indices. Looking for European companies that are ahead of the curve and trying to create value through investing in technology and its corresponding infrastructure could be a positive outcome in the longer term. Companies like Renishaw and Schneider that are adopting and applying new technologies have been identified by some as examples of how to be positioned in Europe.

Emerging Markets. While North Asia and the rest of emerging markets were not completely immune to the global stock rout that ended last week, they had a mild cold compared to the rest of the world. Flows into emerging markets have turned positive in recent weeks as investors look to capture yield at attractive valuations. North Asia and India equity markets in particular have seen strong inflows from foreign investors, with an emphasis on technology names. In fixed income markets, there is renewed demand for higher-yielding local currency bonds in Brazil, South Africa and Mexico as investors expect the USD to enter a period of sustained weakness.

China’s ruling Communist Party held its Fifth Plenum of the 19th Central Committee where it outlined the country’s next Five-Year Plan (2021-2025) and long-term objectives by 2035. What stood out among the long list of objectives was the plan’s focus on fostering domestic demand and reducing reliance on exports. To achieve this goal, China will redouble efforts to digitize its economy and boost investments in key areas of the economy, including healthcare, education and finance. Environmental protection is another key part of the plan, with targets for peak carbon emissions by 2030 and carbon neutrality by 2060 — achieved, in part, by investments in green technology. Chinese equities reacted positively, with technology names, in particular, closing the week up strongly.
RockCreek Update
The RockCreek team continues to work seamlessly and efficiently remotely, with some team members coming into the office. While remote, our team has been staying connected with morning coffee sessions, town halls, guided meditations and more. On Thursday, the RockCreek Book Club gathered virtually to discuss Calling Bullshit: The Art of Skepticism in a Data-Driven World. Written by two science professors at the University of Washington, Carl T. Bergstrom and Jevin West, the book offers tools to critically identify and dismantle misinformation. Stay tuned for next month’s pick!

Last week, Afsaneh Beschloss joined Tom Keene, Jonathan Ferro and Lisa Abramowicz on Bloomberg Surveillance to discuss renewable energy growth and the impact of the pandemic and the elections on the economy. Watch here. She also participated in a panel at the Toronto Global Forum alongside Benjamin E. Diokno, Stanley M. Bergman, and Guy Cormier to discuss trade policy, sustainable investing, and how to create a resilient economy. Watch here.

Hollis Park Partners’ founder and CIO, Troy Dixon, joined RockCreek to share his thoughts on how Covid-19 has impacted the CMBS space and possible investment opportunities in structured credit. Watch here.

At RockCreek, November 3 is a holiday for the 2020 Election given the uncertainties created by the pandemic so team members can vote and participate as volunteers. Plans have been made for team members with market-related positions to have time to vote.

Team RockCreek

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