November Market Thinking
November 9, 2020
The US Election looks to have gone to Biden, even though it also looks like it is going to the courts. In some ways, what is more important is that the failure of the widely predicted ‘Blue Wave’ to appear will put some mental and physical checks on some of the more ‘progressive’ and radical programmes that some were hoping to bring in. The bottom line is that markets like stalemates as they neuter the ‘policy risk’ factor.
Short Term Uncertainties
Most of the polls were wrong (again) and this is also important, even if the reasons why are more nuanced. Firstly, they highlight the commercialisation of the polling companies, especially in the US where politics attracts so much money that is seeking influence. A poll showing your candidate with a 10 point lead is incredibly helpful in raising campaign finance, much of which gets spent on…more polling. Thus we would expect (and indeed saw) big poll leads in the weeks before an election which then narrowed closer to the day, allowing the pollsters to claim, after the result, that they were maybe only a few points out. This will be harder next time and may already have started to focus attention on the self serving nature of a lot of political ‘analysis’. Second their failure has highlighted the fact that people often tell pollsters what they think they want to hear – even if sometimes that is mischievous. A combination of shy Trump voters not admitting their ‘socially unacceptable’ viewpoint and those looking to deliberately ‘mess with’ the pollsters have sufficient anecdotal evidence to be worth taking into account. Third of course, it highlights the widespread confirmation bias in the media driving this, or any other narrative. There were polls (Rasmussen for example, as well as a lot of internal polling) that showed the race much closer, but as is now the pattern, people chose to follow the polls that confirmed their existing bias.
The Election itself being the ultimate poll, it has revealed something that we touched on in the blog Will a Jedi Return?, the US (and the west generally ) is divided, but increasingly it is on ‘class’ lines rather than ideological left versus right or traditional tribal Democrat versus Republican and very much not, as the Progressives would have it on identity politics, especially related to race or colour. Trump was reported to have done ‘surprisingly well’ amongst blacks and latinos for example, although it was only surprising if your prior assumptions were based in an identity politics framework. Indeed, it is now probably better to think of the divisions as being not even on class, but almost along ‘caste’ lines, with the coastal elites as the equivalent of the Brahmin and the Dalit or Untouchables as the ‘basket of deplorables’ in the ‘flyover country’ of the red states. This is of course a global caste system and is just another way of looking at the Globalist (Brahmin) versus the Populist (Dalit).
The narrowness of the victory and the balance in the Senate and Congress is thus actually to be welcomed, since, like the polls themselves it shows the situation to be far more nuanced than the cartoon black and white presented by either side and certainly on social media, where the AI is at least partly responsible for driving opinions to extremes and away from the centre.
Most important however, it should raise a serious question over the technique – now widely used in the UK for example – of using opinion polls to justify, if not in fact actually drive policy. The combination of scaring the population through a powerful state PR machine and then subsequent polling that in demonstrating the effectiveness of the message is claimed to deliver democratic legitimacy to the policy is an extremely dangerous development. Our byline statement says “Making sense of the narrative” and through that prism we see very clear and powerful use of PR – or to use its earlier name Propaganda – be it on Covid, or previously Brexit and, particularly , Climate Change. Push back on this is key to reversing the risks of a W shaped or even L shaped economy in the UK and Europe, where the end of the economic repression associated with Covid is likely to jump straight to a new economically repressive Climate Change driven Great Reset agenda.
Medium Term risks
Health (S)care risks falling in US. There will be few, if any, policies enacted in the US between now and year end, which means that there is a possibility that not only will the Covid virus have burned itself out and the politicised ‘case-demic’ be shown not to have turned into anything meaningful in terms of deaths, but that it will not be escalated by the ‘need’ to do something on the basis of predictions from the Health (S)care industry. A decisive Biden victory may well have led to a UK or French style mandated mask wearing and lockdown campaign for example, if only to ‘prove’ that Trump was bad. However, while we will see lots of ‘initiatives’ and task forces, this now looks unlikely, especially as the reality has always been that the majority of the policy is held at the state level. The fact that it didn’t suit the Biden campaign to admit that doesn’t mean that it isn’t the reality that they now have to deal with. Broadly though, any element of de-politicising Covid has to be positive for economies and markets.
Meanwhile as noted in a recent piece (cash lies dorm-ANT) the new administration will have time to talk to its supporters on Wall Street about exactly how it wants to treat China. Hundreds of millions in fees are on the table over ANT financial alone and the existential question of whether JP Morgan etc al can continue to make money out of China is going to be at the forefront of their mind when the donors sit down with their new President. Assuming it is Joe Biden, “The senator for MBNA” as he used to be known will undoubtedly be asked to consider the welfare of his friends and donors when considering the shape of US Foreign Policy towards China. A reasonable guess would be a reversion to the Obama regime of nice(r) to China and more aggressive to Russia and Iran.
We might however expect to hear some commentary on issues such as the $, where on balance we would expect to see it talked down and government spending, where the talk would be for more not less – although the reality beyond the rhetoric given the separation of powers might be less than hoped – or feared.
Long Term Trends
One of the most important consequences of the Covid response is that it has effectively cemented Modern Monetary Theory (MMT or the Magic Money Tree) into government policy. The billions if not trillions of dollars/Euros/pounds already issued by central banks and spent by governments represents a fundamental shift in monetary and fiscal policy that will have long term consequences for growth and inflation. As we noted in the blog (inflation is about Balance sheets) a good way to think of an economy is in terms of cash flows between the Four Sector Balance Sheets; Household, Corporate, Government and Financial; consumption is household to corporate, wages are corporate to household. Government to households is government benefit spending, households to government is taxation and so on. When one or more sectors uses the financial sector to increase its leverage/expand its balance sheet then the system is out of balance and we get too much money chasing too few goods – ie inflation. The nature of that inflation will depend on what that leverage is being used for. Traditionally it has been the household sector and mortgages causing house price inflation and associated consumer goods inflation, but the last decade it has been the financial sector itself and the government sector via the central banks. Corporates have recently joined in thanks to access to ultra cheap money. They have all bought financial products – which is why stock and bond returns have been so strong. Inflation. Now with the MMT, we see the other part of the government balance sheet expanding and the inflation is going to appear where they are spending the money.
We are already seeing increased spending on the wide range of consultants (and naturally lawyers) but this is likely to extend to blue collar workers as well, which suggests we are going to see some more general wage inflation, For example, minimum wage legislation risks a wage price spiral similar to the old style 1970s union driven equivalent, albeit more likely to end in unemployment. Here the EU experience is instructive, where the high cost of social taxes on labour leaves labour unemployed and demand unsatisfied. We are also likely to see higher medical and healthcare pricing as well as infrastructure and commodity inflation.
The bond and equity markets all saw a sharp rise in risk premium around mid month as uncertainty rose ahead of the US elections. As we noted on the blog, a Biden Presidency actually has higher uncertainty than a second Trump one, almost by definition, since we know very little of what actual policies might be. However, with a shrunken majority in the House and having likely failed to take the Senate, the (over) predicted Blue Wave has failed to materialise, suggesting more policy paralysis, which, paradoxically for markets, is usually a good thing. A post election rally is thus a measure of appreciation for ‘none of the above’.
The MSCI World posted a negative return of 3.07% in October, as risk premia jumped running into the US Election. Our Global Equity Model Portfolio was pretty much in line with this at -3.01%. Year to date, the MSCI World’ now has negative return of 1.42%. By contrast, our Core Global Equity Model Portfolio still shows a positive return of over +4.92%, and importantly with just over half the volatility. At the factor level, against the overall drop in October, the best performing factor was Size, which showed dropped by -1.45%, while the two bottom performing components were Value and Minimum Volatility, which both posted a drop of -3.53%.
The Global Bond Model Portfolio posted a loss over the month of -1.12% and under-performed the Bloomberg Barclays Global-Aggregate Index, which posted a little gain of +0.1%. The main driver to this was the medium size (but reducing) position in the US Long Bond ETF, which returned a drop of -3.41%. while the best performing bond ETF was Global Aggregate, which gained 0.1% and is also the benchmark. Year to date, the bond portfolio has returned +9.23% versus +5.82% for the benchmark, still a significant outperformance when looking at the bigger picture.
The Global Balanced 70:30 Model Portfolio was rebalanced at the beginning of the October. Consistent with the underlying Bond and Equity portfolios, the balanced portfolio posted a loss over the month of -2.41%, meaning it slightly under-performed the benchmark (70% MSCI World Total Return Index + 30% Bloomberg Barclays Global-Aggregate Total Return Index), which indicated a loss of -2.11%. This was down almost entirely to the fact that the benchmark for bonds was positive for the month while our bond component was dragged down by its exposure to US long bonds. However, year to date, the portfolio performance is well ahead at +6.43% versus the benchmark’s +1.94%, and importantly with around half the volatility.
The Global Thematic Growth Model Portfolio held up remarkably well against a weak equity backdrop in October and actually posted a gain over the month of 0.62% making a healthy outperformance of the MSCI World Index, which posted a loss of -3.06%. Perhaps more important for absolute return focused investors this means that year to date the portfolio has returned a significant outperformance of over 25%, with a positive return of +23.90% versus the MSCI world loss at -1.42%. Moreover, it has achieved this with ‘normal’ volatility of around 14% compared to the abnormal levels of over 30% YTD for Global Equities. The top Contributing theme was Global Clean Energy, which gained +5.79%, while the bottom performer was Digital Security, which posted a drop of -4.36%. Compared to the benchmark, the individual thematic ETFs performed generally better, as only 2 themes, namely Digitalization and Digital Security dropped more than the benchmark. Moreover, the portfolio put less weight on average to the laggard themes, which gave us positive return and outperformance over the volatile market in October, thanks to effect of dynamic asset allocation.