It Might Get Interesting | ETF Trends | ETF Strategist Channel

A Pre-Election Update

  • Market volatility increased in September and might continue into the election.
  • Our equity model’s 6m forecast for the S&P 500 has improved but remains negative.
  • Our short-term risk model continues to give a Sell signal. Both models dictate defensive positioning.

Stock market volatility returned in September over concerns about the strength of economic recovery, a seasonal rise in COVID, and the upcoming presidential election. The S&P 500 dropped by 3.8% in the month, while non-US stocks outperformed by dropping only 1.8%. Zero rates and cash stimulus boosted consumer spending and the stock market in recent months, but this effect appears to be running off.

It Might Get Interesting Figure 1

We’re seeing a significant shift in our fundamental Equity Model’s results. This change is driven partly by the market decline in September which made the market slightly less overvalued, but mostly by economic improvement, primarily in the housing market. The model’s factor composition also changed. Back in July, our negative forecast for the S&P 500 was attributed mainly to a weak economy, including extremely low consumer sentiment. The Economic component of the model improved tremendously over the past two months, and is now positive on strengthening in consumer sentiment and home sales.

It Might Get Interesting Figure 2

To be sure, the economy isn’t out of the woods – it’s still in the worst recession since 1946. While several economic factors that “matter” in our model improved, the labor market – including jobless claims and new payrolls – came in weaker than expected last month (see chart below). As I’ve written before, with its enormous stimulus Congress created an “unemployed class.” Stimulus negotiations between the Democrats and the GOP just ended, although the President said that he’s open to a separate airline bailout. Without it, the airline industry indicated that it would lay off over 30,000 people.

It Might Get Interesting Figure 3

The Election Effect

Market volatility in September was attributed by many observers to the approach of the presidential election. With only a month left till November 3rd, poll averages show Joe Biden leading President Trump by around 9% and rising:

It Might Get Interesting Figure 4

Let me outline the expected effect of each candidate on the market the way I see it. Historical market performance shows that the S&P 500 rose by around 30% From Nov-2016 to Dec-2017 – first reflecting the effect of Donald Trump’s unexpected win, then his pro-growth policies, and finally the tax cut. Most of the S&P’s earnings rise in recent years occurred in 2018 due to the corporate tax cut – absent that, earnings are nearly unchanged from 2017. Joe Biden’s side indicated that they would raise taxes and would likely re-impose coronavirus-related lockdowns. Clearly, President Trump has been a positive “factor” for the stock market, and Biden would be negative.

We have an apparent contradiction between stocks trading near all-time highs and a wide poll gap in Biden’s favor. Granted, polls have inherent biases, and they were very wrong in 2016. So, one explanation is that investors are ignoring mainstream polls entirely. The latest poll by Democracy Institute which correctly predicted both the 2016 general election and Brexit, show Trump being slightly ahead.

But given the size of the gap, it’s still surprising to me that the market hasn’t reflected a higher chance of a Biden win. It could get more “interesting” as we approach November 3rd . If such a wide gap persists this month, investors might reflect the chance of a Biden win by selling stocks. If it narrows somewhat, investors might get more concerned about an undecided or “unprocessed” election. Both circumstances could cause short-term market downside leading into the election.

Original article published by Model Capital Management

About Model Capital Management LLC
Model Capital Management LLC (“MCM”) is an independent SEC-registered investment advisor, and is based in Wellesley, Massachusetts. Utilizing its fundamental, forward-looking approach to asset allocation, MCM provides asset management services that help other advisors implement its dynamic investment strategies designed to reduce significant downside risk. MCM is available to advisors on AssetMark, Envestnet, and other SMA/UMA platforms, but is not affiliated with those firms.

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