28.10.2020 09:02

Market Outlook: Sentiment is still weighed down by COVID-19 and US election uncertainty

So far, most third quarter corporate reports have been impressive. In the United States, 86% of companies in the S&P 500 index have beaten expectations. This is the highest figure in 26 years. But stock markets have not reacted so much to these positive figures. Instead, uncertainty about COVID-19, the US election, Brexit and the economic outlook are clouding investors' view of the future. Despite a rise in coronavirus cases for several weeks, the trigger that led to lower share prices was that US infection figures surpassed their July peak. Continued deadlock in negotiations between Democrats and Republicans on new federal stimulus measures also pushed down stock market sentiment.

Rising numbers of new coronavirus infections

Reported COVID-19 cases are accelerating. The US has recorded new record numbers of daily infections, while coronavirus deaths are rising in Europe and restrictions are being tightened even further in Italy, Spain and elsewhere.
On October 26, AstraZeneca released an interim analysis of its COVID-19 vaccine trials showing positive results in older populations, but roll-out of a vaccine is not expected until early 2021. Last March it took 3-4 weeks between rapidly rising infection figures and the post-peak downturn, which occurred a number of weeks following large-scale lockdowns. The current unfavourable trend appears likely to continue. It is thus hard to believe that political leaders are finished imposing further restrictions. Although we have so far avoided lockdowns on the scale of last spring, new restrictions are starting to look quite extensive.

Biden is leading in voter surveys – but his margins are narrowing

With less than a week to go until the American presidential election, excitement is rising. Although the Democratic candidate, Joe Biden, remains well ahead of Donald Trump in voter surveys, the outcome in a handful of states will determine who wins. In these battleground states, the race actually looks a bit tighter. Given all the surprises delivered by voters in recent years, it is wisest to suspend judgment for at least the coming week.

Biden's lead over Trump remains far wider than Hillary Clinton's advantage four years ago. Voter survey aggregator FiveThirtyEight (which came closest to predicting the 2016 outcome correctly) estimates Biden's chance of winning at 87% while The Economist magazine's election model gives him a 93% chance. Betting companies are a little more cautious, setting Biden's odds of winning at about 65%.

Brexit – a long farewell

Trade negotiations between the United Kingdom and the European Union continue. British media report that Prime Minister Boris Johnson is hoping for a Trump victory, since this would make it easier for the UK to leave the EU single market without any trade deal. We have previously estimated the probability of a trade agreement at 75%. Recent developments are pushing this probability higher, but there is nevertheless a worryingly high risk that the British will end their Brexit transition period with no deal at year-end.

Our market view

Stock markets are continuing to fluctuate, with worries about the increased 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.

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. 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 given the encouraging overall economic outlook we are sticking to our recommendation of an overweight in equities and other risk assets.