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The U.S. Election: It Is What It Is

Overnight more votes were counted in Michigan and Wisconsin, 2 states Trump won in 2016. Biden is the winner and now has a likely path to the 270 votes needed in the electoral college. Arizona (called for Biden by some, but not yet official), Georgia and even Pennsylvania may go his way. However, many of the states have razor thin margins and the Trump campaign has already filed lawsuits to challenge results and force recounts. Multiple states allow automatic recounts if the margin of error is sub 1% anyway. When all is said and done, including what is likely to be multiple trips to the Supreme Court, it is starting to look like Biden is the likely President elect. Trump still has paths to win, but it is getting increasingly unlikely, though not impossible.

However, the story is very different in the House and Senate. Democrats have gained 1 seat so far and there are 5 seats remaining. We won’t know the tally for some time (weeks actually, as there will be at least one run-off in Georgia), but a Republican Senate is increasingly likely. While the House will almost certainly remain under Democratic control, it was not a good showing with Republicans gaining 5 seats so far. In short, if Biden wins the Presidency, he will confront a less united House and a Republican Senate. This potentially means smaller stimulus plans, continued division on healthcare, and a lot of focus on 2022 mid-term elections. We will have to rely on McConnell and Biden remembering their work together in the Senate over the last few decades and hoping they can find some sort of compromise.

Despite many bold predictions of a ‘Blue Sweep’ in which Democrats gained (or re-gained) all Trumpian red territory of 2016 and then some, as of this morning it looks like only Arizona, Michigan and Wisconsin flipped from red to blue. Four states remain outstanding: Georgia, North Carolina, Nevada, and Pennsylvania. Democratic hopes for Florida and Texas faded early in the night on Tuesday.

The Republican and Democratic legal teams are preparing for trench warfare. Major legal challenges are highly likely and will delay the final outcome into December or even January. The first thing is to finish counting the absentee and mail-in ballots. Georgia, Michigan, Wisconsin, and Arizona are not accepting ballots after election day, so they will finish counting soon. Then all that remains is to see if any legal disputes arise that prevent the Electoral College members from being settled in these states, which is still possible.

Nevada will accept ballots by November 10 and North Carolina by November 12 as long as they are postmarked by election day. It is likely but not certain that Democrats will keep Nevada (~75% counted) while Republicans will keep North Carolina (~100% counted).

That leaves Pennsylvania as the biggest risk of a contested result. The deadline to receive mailed ballots is Friday, November 6, but a legal dispute is already underway as to whether the original November 3 deadline should be reinstated.

We won’t know what the final court verdict on Pennsylvania will be, but it would not be surprising at all if the Supreme Court ruled that ballots received after election day cannot be accepted. The constitution grants state legislatures the sole power of choosing a state’s electors. Each state passes its own election laws. The Pennsylvania state legislature clearly stated that ballots must be returned by election day. It was a court decision that extended the deadline. The Supreme Court could easily determine that a lower court does not have the power to change the deadline. But nobody will know until the court rules. The fact that Trump appointed several of the judges doesn’t necessarily mean they vote in his favor because they serve lifetime appointments.

Assuming North Carolina and Georgia have slipped away from Biden and that Nevada remains blue, the best-case scenario for the former vice president is a 290-electoral vote victory. That’s more than George W. Bush achieved in his two successful campaigns (271 in 2000 and 286 in 2004), but fewer than Barack Obama (365 in 2008 and 332 in 2012) and Donald Trump (304 in 2016). A win, of course, is a win. But if Biden is victorious, it will be under radically curtailed circumstances from what Democrats had assumed.

At the moment, we think a Biden win with a GOP Senate seems to have the highest probability. But the US election is not over yet. Trump still has a chance of victory by winning Pennsylvania and one other state. If the vote count does not settle the outcome clearly this week, a full-fledged contested election will emerge that may not be settled until December 14.

Risk-off sentiment will prevail in the interim, given the importance of the next economic stimulus package. What we know is that Republicans will very likely keep the Senate. This means gridlock is assured, which is actually positive for US stocks in the medium to long-term.

Biden Needed the Senate

The predicted ‘Blue Sweep’ didn’t materialize. That means whoever prevails in the presidential race, Mitch McConnell is likely to remain in charge of the upper chamber and that means that the American government will be divided or “gridlocked” for the next two years. As things stand, Democrats picked up two senate seats, Arizona and Colorado, but fell short everywhere else. They may even have lost a seat in Michigan. This leaves the balance of power at ~52-48 in favor of Republicans. In this case, Biden would be the first president in 32 years to come into office without control of Congress, another dynamic that would weaken claims of a strong mandate.

The Democrats’ anti-filibuster movement and its interest in expanding the Supreme Court and the Senate, or any other process reforms to maximize a new Democratic president’s power and influence, would be placed on pause. President Biden’s agenda would be defined by his ability to win over the entire Senate Democratic caucus, from Bernie Sanders to Joe Manchin, and then as many as 10 Republicans. Ultimately, Biden would have to deal with McConnell, who would undoubtedly reprise the role he played in the Obama era when he had no incentive to help Obama rack up legislative achievements.

For markets, this is probably the best possible long-term outcome. Historically gridlock offers more upside for the S&P 500 than a single-party sweep. However, there is risk that the short-term economic stimulus will be much smaller than the market wants in the case of a Biden win with a Republican Senate. If Trump prevails, he has more leverage to force the Senate to approve a much larger economic stimulus package before the end of the year. A Trump administration will also face gridlock because of the Democratic majority in the House. In his case, the gridlock is reflationary at first (good for markets) but problematic later due to continuation and likely expansion of Trump’s trade war focus.

A Biden gridlock is deflationary at first but the best outcome for investors over the long run as it will mean that a Biden administration cannot introduce sweeping new regulations on everything from healthcare to technology companies or fracking. And it is unlikely a Republican senate will approve any tax increases. History shows that a gridlocked government tends to be positive for the economy as a whole. On top of that, a Biden administration is less likely to start a global trade war than a Trump administration. Or at least take a more considered and diplomatic approach to it. Both are positive for the global economy.

It means that a potential Biden administration will have to govern from the middle and that the progressive wing from the Democratic party will have limited influence on policy. It seems that the United States is not yet ready for a more left-leaning government, despite many predictions to the contrary.

Market Impact

Now for the bad news, a contested election will lead to market uncertainty in the short-term. Mainly because it is now unclear when to expect the much-needed next economic pandemic stimulus and how big it will be.

So far, neither the election nor Ant Group’s Initial Public Offering (IPO) derailing have had a major impact on markets. All markets were up the last couple of days, basically reclaiming last week’s sell-off. We are likely to see continued uncertainty in the coming 1-2 weeks, but do not expect any major correction. Equity markets are comfortable with a Biden Presidency and a Republican Senate, so there may be some risk if recounts point the other way, but we do not expect such a move to be material enough to warrant a change in our outlook.

Over the next 12-24 months we continue to favour equities given the ongoing economic recovery, likely progress on Covid and other healthcare measures, and of course the potential for government stimulus in the US (especially now that any tax increases are likely to be constrained by the Senate).

Ant Group’s IPO

While the US election is the biggest news globally, Ant is Asia’s leading story right now. It seems that the IPO, due to be the largest ever globally, has been put on hold by the Chinese government. Ant is already the largest non-State-Owned financial player in China and going public would put it more squarely in the private and non-government-controlled camp. This is a continuation of ongoing conflict in China between the private sector (best embodied by the outspoken and fluent in English Jack Ma) and the Communist Party (firmly controlled by Xi Jinping).

There is lots of speculation that Jack Ma’s speech over the prior weekend about regulators holding back innovation in finance was the final straw for those in power in China. The IPO, scheduled for today in Hong Kong and Shanghai, was cancelled only two days before listing and after more than three months of reviews. This suggests the decision was made top down by Xi Jinping and the Communist Party, not by the many administrators who reviewed it in prior months.

Alibaba, Ant’s parent and major shareholder, dropped 8-9% in Hong Kong and NewYork on Wednesday. It is unclear how long the “regulatory” review will take and when the IPO will come back. We think that eventually the Ant IPO will go through as it is too important to be allowed to fail for both Shanghai and Hong Kong markets.

A New Wave of Covid Infections

Stocks rallied in the spring and summer on hopes that the worst of the pandemic was over and that fiscal stimulus would continue to prop up employment and spending. Now, both assumptions are being challenged. The number of coronavirus cases continues to rise worldwide. In both Europe and the US, the daily tally of confirmed new cases exceeds the March peak. The only saving grace is that the number of deaths has not risen by as much as many had feared.

While governments have understandably tightened restrictions to control the latest surge in Covid cases, they are unlikely to fully revert to the extreme measures taken in March. Back then, there was considerable uncertainty over how fatal the virus was, with estimates for the mortality rate ranging from 0.5% to over 5%. The latest research suggests that the true number is near the bottom of that range, and perhaps even below it.

Progress continues to be made on a vaccine. Close to 95% of professional forecasters surveyed by The Good Judgement Project expect a vaccine to be widely available within the next 12 months.

Ironically, the severity of this second (or third) wave of the pandemic will likely lead to even more economic stimulus than the market was expecting. Every developed country in the world has already run up deficits to finance economic stimulus. There is no politician in the world that is now going to stop spending. Especially with elections coming up in all the major countries in Europe over the next 18 months.

The combination of a vaccine and further fiscal support against a backdrop of ultra-easy monetary policy should be enough to lift global equities. While the near-term picture for stocks is uncertain, investors should remain invested in global equities.

Fixed Income Markets

A democratic Blue Sweep would have led to extensive fiscal spending the next few years. This is now much less likely to happen and that is positive for fixed income markets. Biden’s original economic plan would have likely pushed up U.S. Treasury yields.

Now that spending will be curtailed by a Republican Senate it is more likely that bond yields will remain subdued for longer. Which in turn is not only positive for bond prices in the short-term but is also positive for growth stocks as the discount rate will stay low for longer.

The U.S. Dollar

As a countercyclical currency, the US dollar is poised to weaken next year. Typically, non-US stocks outperform when global growth is strengthening, and the dollar is weakening. Moreover, a generous monetary and fiscal policy setting in the U.S. has eroded the dollar’s appeal as the country’s trade deficit widens. Furthermore, U.S. broad money growth stands far above that of other major economies. Compared with other major central banks, the Fed is more guilty of financing the public- sector’s debt binge. Debt monetization creates a real risk to a stable USD.

The expanding global recovery creates an additional problem for the countercyclical dollar. China’s role is particularly important in this regard as the nation’s domestic economic activity will improve further in response to the lagged impact of a rapid climb in total social financing. Likewise, China’s healthy recovery has lifted interest rate differentials in favor of the yuan. A strong CNY improves China’s purchasing power abroad and diminishes deflationary pressures around the world. This combination should stimulate the global manufacturing sector, which benefits foreign economies more than it does the U.S.

Portfolio Impact

For all 2020 we have maintained a neutral position on both our US and non-US equity weightings. The performance of growth stocks and the additions of a technology position and a healthcare position have been tailwinds for our portfolios. We do anticipate a rebalance in the near future as the aforementioned have appreciated in advance of their value counterparts. Post-rebalance, we believe we are well-positioned to profit from the economic outlook described above. Despite any short-term market volatility we might see.

Fixed Income Portfolio

Whether Biden or Trumps eventually wins, a gridlocked Congress will likely mean that bond yields won’t rise any time soon. Yields across much of the government bond universe in USD, EUR and JPY are close to 0% and are likely to stay there. With yields low and spreads narrow on higher risk bonds, our preference is to remain core in nature with an eye on duration and credit risk, specifically investment grade, being more attractive than rate risk.

DISCLAIMER: The views expressed in this economic update are those of the author and do not necessarily reflect those of BFT.  This update contains “forward-looking statements” that relate to future events, including future economic performance and plans. These forward-looking statements can be identified by the use of such words as “believe,” “think,” “intend,” “may,” “will,” “should,” ”expect,” ”anticipate,” “estimate,” or “could,” or variations of these terms or the use of other comparable terms. There are certain risks and uncertainties that could cause actual results to differ from those predicted in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this update.

DISCLOSURES: Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.  There are risks associated with these types of investments and include but are not limited to the following:  Typically no secondary market exists for the security listed above.  Potential difficulty discerning between routine interest payments and principal repayment.  Redemption price of a REIT may be worth more or less than the original price paid.  Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.  Involves risks such as refinancing in the real estate industry, interest rates, vailability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.  This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value. The Nasdaq Composite Index is an unmanaged group of securities representative of the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred.  Returns do not include reinvested dividends.

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Truths, No Matter Who Wins The Election

As we get to the back half of 2020 one thing we can say with complete and emphatic certainty – there’s been a lot of drama this year. I certainly don’t mean to downplay the severity of COVID-19. It is terrible. And, we continue to pay a dear price in lives affected both physically and economically.

We do have another bit of drama left to play out this year and it’s a doozy. The 2020 presidential election. To quote my daughter, “It’s a hot mess.”

I have no interest in promoting any political party in the course of my work or writings. Wealth managers should view markets and investing in an agnostic manner. We review the data at hand, and that may influence our decisions, but we have a lengthy view and understand that along the way parties change.

Be sure to put your feet in the right place, then stand firm.

Abraham Lincoln

This quote from Abraham Lincoln is a truth that gives staying power to our decisions and efforts. Sticking with truths, let me share some truths no matter who wins the election.

Markets have performed well under both parties.

The S&P 500 index delivered an average annual return of approximately 11% over the past 75 years, through both parties’ administrations. During that same period, the economy expanded by around 3%(1). Neither party can boast a superior economic or financial market performance.

We do not radically re-engineer the US economy. 

The biggest fear among investors is that a progressive candidate might make a radical change in the economy. Remember, all presidents also need control of the Congress. This checks and balances system resulted in the last two presidents getting one signature achievement before losing the House. And despite concerns about major policy changes, business investment and government spending have been remarkably consistent as a percent of GDP.(2)

The historical narrative is not always as you remember it. 

We often draw on the past to make decisions on the future, but we don’t always get the history right. Here are a few “surprises.”

  • Jimmy Carter presided over significant job growth. 
  • Under Reagan, income for those in the 50th percentile ranked by income grew by almost 20%. 
  • During Obama’s presidency, despite concerns that his policies would cause massive inflation, the US had one of the longest deflationary environments on record.  
  • Under Trump, capital expenditures have been below their historical growth rate, even in the aftermath of a large corporate tax cut.(3)

Monetary policy matters more.

For all the focus put on the executive branch I would argue the that monetary policy matters more. The adage holds true: Don’t fight the Fed. Historically, presidents have been hurt or helped by the Federal Reserve. Both Reagan and Clinton benefited from falling rates. Both George H.W. and George W. Bush were hurt by Fed tightening. Obama befitted from a benign environment. And Trump’s first two years found a tighter policy.(4)

Markets don’t care if you don’t like who’s president.

The market can do well whether you like the president or not. Some of the best returns came when the presidential rating was in the low range of between 36% and 50%.(5)

That means the market delivered some of its best returns when half or more of the country didn’t approve of the current administration. Still, it’s hard to discern any direct relationship between the president’s popularity and the health and overall performance of the economy.

This is, in fact, not the most vitriolic election. Really.

Let’s look at the media not playing it straight through a historical lens.  

Newspapers were filled “with all the invective that disappointment, ignorance of facts, and malicious falsehoods could invent to misrepresent my politics.

George Washington

Nothing can now be believed which is seen in a newspaper.  Truth itself becomes superstitious by being put into that polluted vehicle.

 Thomas Jefferson

And finally, you think the ire and nastiness today is at a new unparalleled high? Remember back when Vice President Aaron Burr and former Treasury Secretary Alexander Hamilton had a vendetta, they settled it on the cliffs of Weehawken (with dualling pistols!), ultimately resulting in Mr. Hamilton’s death. As long as it stays on Twitter, believe it or not, we’re on a higher level.

Sources:

  1. Invesco, real GDP data, S &P
  2. Fred-global financial data
  3. Bureau of Labor and Statistics, Bureau of Economic Analysis
  4. Goldman Sachs, Bloomberg
  5. Bloomberg

DISCLAIMER: The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of BFT Financial Group. Neither BFT Financial Group nor the author makes any warranty or representation as to the accuracy, completeness or reliability of this information. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall BFT Financial Group be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither BFT or the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.

DISCLOSURES: The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

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Introducing Aleksey Mironenko to the BFT Financial Team

BFT Financial Group is thrilled to announce the expansion of our senior leadership team with the addition of Aleksey Mironenko as Global Head of Investment Solutions.

“I am excited to be part of BFT Financial and to apply my 15 years of experience gained from working with the world’s leading institutions to improving the financial outcomes of individual investors,” said Aleksey Mironenko. “I look forward to working with the team to deliver institutional-grade investment exposures to our clients.”

Aleksey was most recently Partner and Chief Distribution Officer at Premia Partners, a Hong Kong ETF provider. Prior to this, he held various leadership positions at iShares, including Head of APAC Fixed Income and Head of Asia ex-Japan Institutional Sales, as well as being a member of the APAC COO team. Before moving to Hong Kong, Aleksey was based in BlackRock’s London and Tokyo offices, helping insurers, pensions, and asset managers invest globally. He began his career as an analyst in BlackRock’s New York office, working with Asian and Middle Eastern clients. Aleksey earned a Bachelor of Science degree, magna cum laude, in Finance and General Accounting from the Leonard N. Stern School of Business at New York University.

What this means to BFT customers

The 2019 merger with Hong Kong-based The Capital Company, greatly expanded our range of wealth management capabilities. This appointment is the latest move to expand the scope of financial solutions and support for global clients.

“Part of our mission is to provide services designed to help clients define and pursue their vision of financial success. Aleksey’s vast experience in global finance and his commitment to client outcomes is another way we continue to deliver on that mission,” said Stephen Tally, CEO. 

For over 25 years, BFT Financial has established itself as a leading cross-disciplined financial advisor and asset management firm, initially focused on serving major airline employees in the Fort Worth-Dallas area. Now managing over $1.1 billion in discretionary portfolios, we provide financial advisory services across the U.S., U.K., and the Asia-Pacific region. The firm’s growth makes it positioned to help clients navigate the complexity of financial, insurance, investment, and retirement planning with a focus on tax-efficient managed investment portfolios. 

Contact us to learn more about BFT Financial and how we can help your financial goals or subscribe to our mailing list to gain insights on financial planning and updates from our advisors.

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BFT Market Update Sept 2020

The S&P fell roughly 3.5% during Thursday’s trading session.

The drop was led by growth stocks, namely “stay at home tech” (Apple, Zoom, Nvidia, Microsoft), communications (Facebook, Netflix), and consumer discretionary (Amazon) stocks. The S&P ex tech is down only ~2%. Despite this drop, the S&P is still up 5.6% since July 31
and those growth sectors are up ~8%. (Chart below)

It’s not unexpected that a small rotation away from growth (tech/communication/consumer stocks- “stay at home stocks”) may take place as these sectors have run well ahead of others during the recovery. Likewise, we’re experiencing an easing of the lockdown and the recent
jobless claims was better than expected.

All things considered, this is a healthy correction and doesn’t suggest that we’re headed for rougher waters. As much as we all enjoy a parabolic move in the stock market it usually ends worse than a choppy trend line up.

DISCLAIMER: The views expressed in this economic update are those of the author and do not necessarily reflect those of BFT. This update contains “forward-looking statements” that relate to future events, including future economic performance and plans. These forward-looking statements can be identified by the use of such words as “believe,” “think,” “intend,” “may,” “will,” “should,” ”expect,” ”anticipate,” “estimate,” or “could,” or variations of these terms or the use of other comparable terms. There are certain risks and uncertainties that could cause actual results to differ from those predicted in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this update.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value. The Nasdaq Composite Index is an unmanaged group of securities representative of the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

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Financial Updates | July 2020

As things stand today, there are many encouraging signs of a rapid economic rebound around the world, but uncertainties also abound. Federal Reserve Chairman Jerome Powell describes the prospect of U.S. economic recovery as “extraordinarily uncertain.”

This probably best characterizes the broad economic environment facing most investors. To be clear, we are still bullish on risk assets, but also think that a short-term set back in markets is very well possible.

Will The Bulls Continue?

Although the U.S. stock market has so far shrugged off the renewed viral spikes in Florida, Arizona and Texas, the increasing number of COVID-19 infections will remain a key risk to equities. At present, the market seems to be assuming that the viral spikes will likely be contained within these states, while the broad economic reopening in the U.S. will stay on track.

Over the past quarter we saw a combination of large-scale monetary and fiscal easing stabilize financial markets. The optimism of relaxing lockdown measures continued to spur the stock market recovery through April, May and June. The question on most investors’ minds is whether this new bull market will continue.

The next few months could be a precarious time as we see renewed virus outbreaks. Depending on how governments choose to steer through the next wave there is a high chance that stock markets will be volatile over summer and we may see again a short-term correction. However, we remain positive on equities versus bonds on a 12-month period.

Global equities have rallied strongly from their March 23rd lows. However, the fixed income environment in the past quarter paints a different picture. Bond yields have barely recovered from March. The US 10-year Treasury note is currently yielding 0.58%, down from 1.92% at the beginning of January and the 30-year bond yield offers only 1.24%. On the commodity side, we have seen oil and industrial metal prices mirror the bond yield picture whereas gold rallied with equities. The divergence in the markets have left investors perplexed.

Despite the second quarter rally, the world equity market is still down since the start of the year. More importantly is to realize that the market rebound has been driven mostly by large technology stocks. A number of large banks, industrial and energy stocks are still down 35% or more from their February levels.

We navigate the choppy waters by considering the main trends at play. In general, bond and industrial commodity markets tend to reflect the outlook of the real economy whereas stocks reflect the outlook for corporate earnings.

A Second Wave is Gaining Momentum

Countries all around the globe are on the path of relaxing lockdown measures. Governments are gradually permitting larger group gatherings and the opening of restaurants, bars and non-essential shops. This opening of the economy takes place against the backdrop of limited success in virus containment.

Although some countries have accomplished lower case and death rates, others still face increasing infection rates. These countries, however, continue down the path of relaxing measures, fearing the prospect of being left behind in the economic recovery.

Predicting the effect of a second wave on markets is difficult plagued by unknown factors. The public appetite for lockdown measures is clearly fading with a growing number of people choosing to flout or protest remaining lockdown measures in place. It is also unlikely that governments will impose the same lockdown measures as seen in the first wave, choosing instead to prioritize the economy by following the “Swedish model” which markets will favor.

Also, developments in technology have given governments the ability to create tracing systems which are better equipped to contain small breakout clusters. Furthermore, treatment options have improved since the onset of the first wave with medical professionals learning more about the virus.
Concerning equity markets, if a more deadly second wave occurs, we would expect to see some severe short-term weakness in the equity market as many sectors would reel from a second punch.

Geopolitical Risk

Another risk factor is the increasing animosity between China and the rest of the world. The implementation of a new National Security Law in Hong Kong triggered a reaction from countries like the U.S. and the U.K., while clashes at the China-India border created tensions with India, which prompted India to basically block many popular Chinese Apps.

Hong Kong is at risk of losing several legal and trade agreements with western countries. However, we feel Hong Kong as a financial center is not at risk in the short-term, as its capital market is too important to both China and the western world. Hong Kong also has more than enough monetary reserves to maintain the HKD-peg to the US dollar.

The positive news is that the increased tensions have spurred China to provide large economic stimulus packages to its domestic economy and start new infrastructure spending programs. This will be positive for Asian economies and indirectly for the world.

Equity Markets

Although equity markets will face an uncertain period, there are plenty of positive drivers which will likely keep the bull market pushing on higher. As economic data continues to improve equity markets should pull higher.
Although we may see a slowdown in growth during the second peak it is likely governments will not halt economic activity altogether in the same way. Typically recoveries from external market shocks tend to be more rapid than those created by internal problems. The pandemic would qualify as an exogenous (external) shock and, therefore, equity markets should see a more rapid recovery than for example after the 2008 global financial crisis.

The amount of government spending to protect people’s incomes is extraordinary. Although the CARES Act will expire by the end of July, and the 18 million Americans who are unemployed could lose the $600USD/week in extra unemployment benefits.

Both Congress and the White House agree that more fiscal support is needed, but they differ on how the next package will be structured. The Trump administration, worried about unemployment benefits being too generous, favors a “back to work” bonus. The House democrats want to simply extend the extra $600USD/week to January 2021, send another round of $1,200 cheques to each family and increase infrastructure spending.

Will ideological differences between the Republicans and Democrats lead to a blockage of the second stimulus bill? Not likely, as both parties understand that the stakes are too high. Especially now with the flare up of the virus in the southern states. Therefore, we can expect to see additional economic stimulus on top of the huge amount of fiscal spending we have already seen. This explains why the economy remains in reasonable shape despite the pandemic.

The same is happening in Europe, where it is likely that Angela Merkel will manage to get a new EU backed economic stimulus fund of 750 billion Euro approved in the short-term. Which comes on top of an earlier package of 540 billion Euro plus all the individual government spending programs.
The upcoming US elections have the potential to cause a stir in markets. If Biden ousts Trump and the democrats take control of the Senate, corporations will shudder at the prospect of Trump’s corporate tax cuts being rolled back. However, given that the current forecast is now expecting a democratic win, this risk is likely already priced into the market.

Furthermore, a Biden win would likely lead to improved relations with China which would be welcomed by global markets. Anyway, four months is still a long time in Presidential politics, and anything can still happen.

Source: Predictit via BCA Research

Source: Predictit via BCA Research

Bond Markets

Bond yields will remain depressed until inflation picks up, which we do not expect to happen any time soon. The unemployment rates have jumped so rapidly it will take likely 1-2 years to return to the levels before the pandemic and even then, it will still be another year or more before a tight labour market would lead to higher inflation.

Central banks would likely let inflation levels run up before stepping in to increase rates. Furthermore, highly indebted governments will prefer a higher inflation environment so that the real value of debt is eroded.
Bond yields could see some recovery alongside global economic growth. We will likely begin to see long term yields rising more than short-term rates. However, yields will remain low in absolute terms.

The Fed has been actively buying fixed income Exchange Traded Funds (ETFs) in the past two months to provide liquidity to the (high yield) credit market. This means the credit market does not offer particularly attractive opportunities at the moment. Given our outlook for the world we would prefer to add credit risk in emerging market debt or, for clients who can accept low liquidity, opportunities in private credit.

Investment Strategy

During the past quarter we made slight changes to our investment allocations. After the initial rebound we de-risked the portfolio slightly which we intend to hold until we see opportunities in the market which would warrant an increased appetite for risk. Specifically, we are looking forward to the presidential election in November.

There are several themes we are incorporating into our models. First, we feel that higher quality companies with stronger balance sheets and sound financial statements are better suited for a prolonged slow down should that prove to be the case. Second, we view health care innovation and biotechnology as a potential expanding segment as the pandemic crisis should lead to even more investment in healthcare and especially in health technology. And third, we believe big tech, which provided a significant boost to the market rebound, can continue to lead as the reliance on technology becomes evermore critical for business operations in a shutdown COVID environment.

With those ideas in mind, our model allocations were adjusted to reduce or eliminate small cap equity exposure, introduce large cap healthcare and technology positions and slightly underweight developed foreign large value equity. Our fixed income weightings remain unchanged overall for all allocation models and our sentiment for quality mirrors that of equities.

DISCLAIMER: The views expressed in this economic update are those of the author and do not necessarily reflect those of BFT. This update contains “forward-looking statements” that relate to future events, including future economic performance and plans. These forward-looking statements can be identified by the use of such words as “believe,” “think,” “intend,” “may,” “will,” “should,” ”expect,” ”anticipate,” “estimate,” or “could,” or variations of these terms or the use of other comparable terms. There are certain risks and uncertainties that could cause actual results to differ from those predicted in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this update.

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Emerging Markets Disclosure: Investments in emerging 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.