Covid and Gridlock

The stock market has had to digest multiple significant events recently. The Covid virus is in the midst of a dramatic resurgence with a highly potent third wave, adding incremental risk to the pace of the continuing global economic rebound. A new administration with a very different agenda has been elected to the White House. Additionally, highly effective vaccines will soon be available to generate the light at the end of the pandemic tunnel for which we have all been waiting. Each of these events had many traders and investors scrambling to quickly reposition their portfolios, creating heightened market volatility.

In a tightly fought and divisive race, Joe Biden and Kamala Harris have regained the White House for the Democratic Party. They ran on an economic platform which advocated higher taxes, greater government spending, additional regulations, increased healthcare outlays and significant investments in emerging technologies and a cleaner environment. However, with the Senate likely to remain in Republican control, any changes are bound to be only incremental to the current status quo. Investors have decided that gridlock is good, taxes will not be raised and interest rates will likely be lower for even longer without the large fiscal stimulus a “blue wave” victory would have enabled.

Historical precedents look favorable for stocks. Going back almost a century, the market’s average return has been higher under Democratic presidents than it has been under Republicans. The outperformance was even greater for the Democrats when the Republicans controlled the Senate. Regardless of party, the market has also risen more in a president’s first term than in the second. Finally, stock performance has been better when leadership changed from one political party to the other. While all of these factors sound very promising for the next four years, presidents probably have had very little to do with the performance of the stock market. In reality, the complexity of the economy and markets is far too great to extrapolate much from these simplistic data points, nonetheless they are interesting.

The U.S. economy grew at a record pace in the third quarter, increasing 7.4% over the prior quarter and at a 33.1% annual rate. This robust growth recovered about two-thirds of the ground lost earlier in the pandemic and leaves the economy 3.5% smaller than at the end of last year, prior to the global health crisis. Recent data suggests improvement continued into the fourth quarter, though at a slower pace than the summer’s resurgence due to headwinds from increasing Covid cases. GDP’s return to its pre-pandemic level will likely occur next year with the path of the recovery hinging on getting the pandemic under control.

The most important gauge of the recovery continues to be the labor market. Having soared to a post-World War II high of 14.7% in April, the jobless rate is now back down to 6.7% a mere seven months later. The labor market added a significant number of jobs every month since the trough and has now recovered 12.3 million of the 22 million jobs lost in March and April, when many businesses were forced to shut down in the initial phase of the pandemic. While the unemployment rate remains twice as high as pre-Covid, excellent progress has been made so far and momentum remains in the right direction.

Getting the virus under control is imperative for the economy to return to normal, and the news on that front is very mixed. Following the initial outbreak in the spring and a second wave of cases during the summer, the current third wave of the virus has only gotten worse, with daily records being set for new cases and hospitalizations across both the U.S. and Europe. Where and when these numbers will peak is unknown. However, the market is already looking beyond that following Pfizer and Moderna’s release of preliminary data about their vaccines, both of which appear to be greater than 90% effective. Additionally, President-elect Biden has made pandemic containment a much higher priority at the Federal level than the outgoing administration.

The news of such a potent weapon against the virus completely flipped the near-term script for the stock market. Investors quickly rotated from stay-at-home stocks to re-opening plays, from digital economy to old economy, from Growth to Value. Value stocks, a representation of the old economy, had been horrible laggards this year across the board and underperformed Growth stocks by an astounding 35 percentage points through Election Day. In the two days following the Pfizer vaccine announcement, Value stocks outperformed their Growth brethren by 9 percentage points. What a difference 48 hours made! However, the positive long-term fundamental outlook for Growth stocks remains largely unchanged.

Even with the vaccine and new president, our strategy remains the same, to primarily hold high-quality established and emerging Growth stocks. We are investors with a long-term perspective and do not try to compete with traders chasing the latest fashion. The companies in our portfolio should have years of strong growth in revenues and earnings ahead of them and their stock prices will continue to benefit from that. However, the Biden administration will push forward with the government’s efforts to limit the power of the technology industry, focusing on areas such as antitrust, privacy and misinformation. Tech companies and their investors are well aware of this. As the situation evolves, we will take appropriate action as necessary to safeguard our portfolios.

Holger Berndt, CFA
Director of Research
hberndt@rssic.com