21.10.2020 09:00

Market Outlook: COVID-19 and election uncertainty

A growing number of COVID-19 infections and the absence of a new American stimulus package have again soured the stock market mood during the past week.

The coronavirus makes a comeback

After increases in the number of new COVID-19 cases, new regional restrictions are being imposed in many countries. Although our main scenario is that widespread lockdowns will be avoided, there have been some worrisome developments. In the United Kingdom, Wales is locking down for the next two weeks. Meanwhile Belgium has closed all bars and restaurants for the next four weeks and France has imposed night-time curfews in major cities for a similar period. Right now Ireland seems to have gone the furthest, with an extensive six-week national lockdown and a five kilometre limit on non-work-related travel.

From crisis relief to squabbling – last chance for a stimulus package?

Agreeing on acute relief responses may be easy, but deciding on long-term fiscal (budget) measures may be harder. This is especially clear from the prolonged process of achieving a new American stimulus package. The Democratic speaker of the House, Nancy Pelosi, has set a deadline this week for any agreement before the November 3 elections. President Donald Trump and his negotiators have recently moved closer to the Democrats' USD 2.2 trillion proposal, but they lack support from their own Republican colleagues in the Senate, who instead wish to enact a smaller package. Neither side wants to provide their opponents with a pre-election political victory, which is why the situation remains deadlocked.

Better GDP growth forecasts

The International Monetary Fund (IMF) has revised its global GDP growth forecasts upward in the latest twice-yearly World Economic Outlook report entitled "A Long and Difficult Ascent". This upgrade was possible because the second quarter of 2020 did not turn out as badly as feared and the economic recovery was initially stronger than previously projected, but the new IMF report also notes that the recovery has lost momentum. Overall world GDP is expected to shrink by more than 4% this year. The recovery will be prolonged and highly dependent on medical developments. The IMF also emphasises that continued central bank and government stimulus packages will be needed.
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Resilient Swedish and US housing market

Swedish home prices continued to climb in September, according to Valueguard's HOX Index. Single-family houses were 11.4% more expensive than in September 2019, while tenant-owned units (mainly flats) were up 5%.
Meanwhile the mood in the US residential construction sector climbed to its highest level in 35 years, according to October's National Association of Home Builders (NAHB) Housing Market Index. This month's figures should be interpreted with some caution, given the sharp decline in activity earlier this year. Low supply and historically low mortgage interest rates are two reasons behind this autumn's market resilience.

 

Our market view

Stock markets are continuing to fluctuate, with worries about the spread of COVID-19 and the problems of achieving a new US stimulus package pulling down share prices. Uncertainty about the outcome of the US elections is probably also having an effect, but its impact on the stock market need not be so large. This time around, many analysts are pointing out that both main US presidential candidates plan to pursue an expansionary economic policy. This should help sustain growth and share prices, regardless of who wins. However, the policy mix advocated by their respective political parties diverges in a number of fields. Whereas Donald Trump and the Republicans are favoured by the market in terms of taxation policy, a victory by Joe Biden and the Democrats is likely to pave the way for larger fiscal stimulus packages.

But most observers, including us, have made the overall assessment that a Biden victory would be a bit more positive for markets – something that public opinion surveys also indicate. Although the US presidential race may trigger short-term volatility, we expect growth, stimulus packages and continued low interest rates and bond yields to be more important in determining stock market performance in the next few quarters, and these factors remain relatively encouraging.

Equity valuations are high from a historical perspective, making the market more sensitive to negative news. But there are good arguments for accepting higher valuations, especially low interest rates and yields along with major stimulus packages, which suggest continued good growth.

In the short term, this will require that corporate reports for the third quarter of 2020 at least turn out to be in line with expectations. The report season has just begun, and results from the (few) companies that have reported so far have exceeded market expectations, especially in Sweden but also in the United States and to some extent around Europe. Yet strong quarterly reports have not been fully rewarded with rising share prices, a confirmation of our view that the upturn since stock markets bottomed out last spring implies that investors are already counting on positive performance ahead, as reflected by valuations.

Yet because of better-than-expected earnings, combined with flat or slightly negative share price movements, valuations have recently fallen a bit. We do not regard today's valuation levels as alarmingly high, although they imply some limitations on potential returns.

Worrisome signals about the spread of COVID-19 and the risk of new lockdowns are probably the biggest threat at present, but we are sticking to our recommendation of an overweight in equities and other risk assets.