US 2020 Election Investment Pulse: The Only Certainty is Uncertainty


US 2020 Election Investment Pulse: The Only Certainty is Uncertainty

November 2, 2020

Host: Hello and welcome to Talking Markets: exclusive and unique insights from Franklin Templeton.

Today, we launch a special series of daily podcasts over the next two weeks, all related to the US elections. In this episode, we look at how current uncertainty surrounding the election and other factors is affecting equity markets, and why so much short-term uncertainty may provide longer-term opportunity.

Stephen Dover, Head of Equities at Franklin Templeton and Gene Todd, Director of Business Development at Fiduciary Trust Company International, join Katie Klingensmith for this conversation.

Transcript

Katie Klingensmith: Welcome everybody. Gene, just to start us out, what are some of those sources of uncertainty that you're really thinking about with your clients right now?

Gene Todd: Yeah. Thanks Katie. Yeah, there's tremendous uncertainty out there, and we think the only certainty is uncertainty at the moment. I mean, we're eight months into life with COVID, and we think that we're entering an inflection point. We've had this steep recovery. We've had this V in terms of equity indexes and in terms of GDP, but the snap-back, economically, has slowed down a little bit. And so, what we're focused on, and what we think investors are worried about is that the economy has only regained about 52% of the 22.1 million jobs that have been lost. And there's so many layoffs out there looming. So that's a concern that people are nervous about. COVID - we've been talking about COVID for eight months now, and we thought that maybe we were behind it. We're not behind it. We've got cases increasing. We have hospitalizations increasing, and so people are very concerned about that, and are we going to be able to get that under control. Stimulus—we thought we'd have a Phase Four deal done, and we weren't that far off. We were about $300 billion off of having a deal for Stimulus Four done. So I don't know, is it going to happen in the next 30 days? Is it going to happen in the next three months? We need to get stimulus. And then finally, election. Maybe we'll have some clarity tomorrow night, okay? Maybe we'll have a Biden victory. Maybe we'll have a “blue wave.” Maybe we'll have a split-government. Maybe we'll have a contested election. So all of those things are weighing very heavily on investor's minds right now.

Katie Klingensmith: There's so much to think about. Well, I want to probe just one piece of that before we bring Stephen in. You mentioned jobs, obviously there's been some recovery in the employment situation in the US, but I think for many people who are still without work, it's not nearly enough. I know consumption is another part of this puzzle. What do you think are the big drivers there for seeing a more robust recovery?

Gene Todd: So we've had some good news on the job front. We lost 22.1 million jobs in March and April, and we've regained a little bit more than half of those back. So we've got an unemployment rate of 7.9%. It's been going in the right direction, but we have so much further to go. And so you've got states like Nevada, like California, like Illinois, like New York, like Massachusetts, those states are much higher than the national average. And so until we start to see those States get better on the job front, then the economy being able to further expand is in jeopardy

Katie Klingensmith: And certainly, underscores the focus on stimulus right now with at least some regions and urban areas in the United States suffering so much.

Stephen, this is I think, a puzzle for a lot of us. And we've been talking about this since the recovery after the big sell-off in March, that we really have a big difference, at least in some people's minds, between what's going on in the real economy and what's going on in US and global equity markets. How do you think about this?

Stephen Dover: Well, I think that everyone should always keep in mind that the market does not represent the economy and it really knowing and predicting what is going to happen in the economy is not a very good predictor of what will happen in the market. Probably just an example of that is the economy with the biggest growth, of course, over the last 20 or 30 years has been the Chinese market. But if you knew that if you were a perfect economic forecast and therefore invested in the Chinese equity market, you would have been behind many of the other markets in the world, including the US market. The makeup of the market is really the companies that are in the market, which are market cap weighted for the most part. And right now, what's happening in the United States, is there are a few companies, we all know those are the tech companies that have actually had their profits accelerate and their revenues accelerate, and have been well-prepared for this COVID economy. And they're doing very well. They're profitable and their prices are quite high, but that doesn't necessarily represent what's going on in the economy as a whole. So I think we have to separate those two. I completely agree with Gene that over the longer period of time, we have to have an economic recovery.

Katie Klingensmith: Absolutely. Maybe you could put this into context a little bit for me, Stephen. I know that you work with the equity teams of many different styles in all of the regions of the world. And I know that there's been very different dynamics across the different equity markets. Do you feel like even with this big recovery in equity markets, that with all the uncertainty with the US elections and other sources of uncertainty, it makes sense for people to stay invested?

Stephen Dover: It certainly makes sense for people to stay invested. I think today, Monday, before the election is one of the great examples. I strongly recommend that people don't make big investment decisions over the course of this next week, despite whatever happens as the election results come in. It really pays to make long-term decisions. All evidence indicates that short-term decisions are not very fruitful for almost all investors, including professional investors. And at this point, stocks looked like, still a very good opportunity over the long period of time.

Katie Klingensmith: Now Gene, I want to bring this back into the economic context. I mean, you mentioned a lot of the different sources of uncertainty or the challenges, but you also mentioned stimulus and we're more thinking about the landscape going forward. What do you think we do know right now? Like what would you expect would be likely regardless of what happens on Tuesday or regardless of the outcome that we learn about over the next couple of weeks?

Gene Todd: Well, one thing that we know is that earning season, which is about halfway complete, it's pretty strong. We're more than halfway through in terms of companies reporting and 85% of the S&P [500 Index] has exceeded their earnings forecast. So, earnings are coming in very strong. The other thing that we know it may take a couple months to pan out, but we'll figure out this election, we'll have some certainty. We will know who the president is. We will know who represents and controls the Senate. The House isn't in question, but we will have economic certainty. We will have certainty around the election. We do know the Fed is going to be loose for a long time, so we're going to have a low interest rate environment for years to come certainly into 2023, maybe 2024 rates are going to stay low, and we will get stimulus. Again, I don't know if it's going to happen in the next 30 days, but it will happen. There's a lot of people out there suffering, and so stimulus is on the way. So those are some things that we know are going to happen. They'll happen relatively soon, and that's going to create an environment that's absolutely fantastic for equities.

Katie Klingensmith: So, you also would advise people at this moment, even with the uncertainty that we've identified to not back away from taking investment risk in their portfolio?

Gene Todd: I would. I would encourage people not to do anything rash because of the political environment but it's important to stay diversified. They always say there's no free lunch. They're wrong. Free lunch is diversification. Be diversified, not only in the United States, but there's a whole big world out there. We talk about how the US market cap represents 60% of the world's market cap. The way we see that is 40% of the world's opportunity is outside of the US so people should have an allocation to Europe and Australia and the Far East, and certainly don't forget emerging markets.

Katie Klingensmith: Absolutely. Well, and Stephen, I know that you obviously are managing equity teams, but also have thought quite a bit about individuals and their investment choices. And I've heard you talk about this, this tension sometimes between managing uncertainty versus managing risk. How do you think about that in today's environment?

Stephen Dover: Well, I think it's an important distinction. There are things we have no possibility of knowing that's uncertainty, and we have things that there's a probability of knowing, and as portfolio managers, we manage risk, which there's a probability we can manage around risk. So even the election outcome, the likelihood of the path of the economy, those are risks that we can take care of in our portfolios. Uncertainty is really the unknown and that unfortunately has been the path of the virus at this point. And so in your portfolio, when you have uncertainty, you want to be careful for that uncertain behavior.

If I may also just comment on stimulus, I think the markets are a little bit short-lived. Equity markets, particularly, but all markets—the real valuation is in the income streams they're going to have over a very long period of time. And that's why the markets recovered, was because even though this has been a very bad year in general, for earnings for a lot of companies and for the economy prediction is that over time all those companies are going to recover and they're looking at those future earnings and that's especially important in a low interest rate environment, but stimulus, by its very nature is very short term. And so while that's important in the short term for earnings and for the equity markets, we really have to be long-term investors and look at how companies or other investments are going to operate over a very long period of time and that's risk. And that's something that portfolio managers can help with and can manage.

Katie Klingensmith: Absolutely. Hey, I want to pick up on one source of uncertainty that a lot of people are talking about and you are both emphasizing that we need to be longer-term in the way that we approach investment decisions, but in the short term, how worried are you Stephen about a contested election?

Stephen Dover Well, first of all, I'm not sure my personal opinion is important. And I would say that to other investors as well. Be very careful about putting your own opinion into how you invest. So what are the markets telling us? The markets are telling us that there's some probability of a contested election. I'd actually make that plural, there may or may not be a contested presidential election, but It's highly likely that there'll be some contested Senate elections, so we may not know the outcome of the Senate for a few days. And of course we don't know the outcome of the election, and this is an election where fairly big economic factors are at play and they will have an impact on the market. And so we'll be looking at that over the next few days and there's a lot of opportunity there. But I think at this point, probably one of the best indicators of what is likely to happen is the market, because those are people taking all the polls, everything else, and trying to make decisions on that, that affect their own portfolio.

Katie Klingensmith: Absolutely. So, so it really is thinking about those short-term risks to remember, to put them in a long-term or objective perspective.

Stephen Dover: That's right over the long-term it doesn't make that big a different political changes there are, but in this case, there will be difference. The market will adjust based on the outcome of the election.

Gene Todd: I mean, I agree 100% with what Steven was talking about is how people should stay, investors should stay invested in this, in this market. And I want to introduce a concept that we've been talking a lot about with clients. This is that concept of TINA—there is no alternative. So, what are you going to invest in? That's going to do better than stocks over the long-term right now. It won't be bonds given where yields are, and prices. It won't be cash, basically a bank isn't going to pay you anything for your cash. And so, we really think that there really is no alternative to equities over the long-term for investors who are looking for a return. You've got an S&P who's got a dividend yield of 1.75%. Can't get that in bonds. Can't get that in cash. And of course, you've got the upside potential as well, associated with equities.

Katie Klingensmith: I do have another question for you Gene. You're obviously working with private clients and there are any number of policy issues that really are potentially on the ballot here. I mean, I'm thinking about tax policies, fiscal issues. Are there particular topics that you are really looking out for that are contingent on the election results?

Gene Todd: Well, what we're focused on with respect to talking to clients about potential changes is it's around a “blue wave.” Don't know if that's going to happen, but that's has dominated the conversations that we've had. And if we do have a blue wave, then we think that we'll see an increase in taxes. We'll see potentially an increase in regulations. We'll see, hopefully, an uptick in infrastructure. We know that corporate taxes are going to be increased. They're going to go from 21% to 28%. That'll have an impact on corporate earnings going forward. We estimate approximately around 10%. And for individuals they'll see their tax rate go up as well, if you're considered wealthy. So a million dollars or greater, your tax rate could increase to as high as 39.6% for these higher earners. Dividends and capital gains will be treated as ordinary income. That's also at a high point of the tax rate of 39.6%. And we've been talking a lot about the estate and gift tax exemption. It's currently about $11.56 million dollars per individual. We think under a “blue wave” that will go down, potentially as low as five, maybe even $3 million.

Katie Klingensmith: So, a lot of potential implications if we do get a very convincing change in the electoral landscape, but otherwise it's harder to know how those different variables could be affected.

Gene Todd: That's right.

Katie Klingensmith: Well, I want to begin to wrap up this conversation and give a final word to Stephen Dover about what you're really looking for as we go through these next two, three weeks. What would be just your overall framework for how people should be thinking about going into tomorrow and investing especially over the next couple of weeks?

Stephen Dover: Well, I wouldn't make any big decisions investing over the next couple of weeks. A blue wave is just a different structure of the economy that will produce a lot of different opportunities that we'll be looking at it in a different way than we have over the last four years. But I would just keep listening for the opportunities that we look at in all sorts of different asset classes. To me, it's a very exciting time, not a time necessarily that we need to be particularly worried and I'm excited to see the election results as they roll out. But we have a lot of big things going on as Gene previously mentioned in Asia and Europe and all around the world and all the different asset classes.

Katie Klingensmith: I would like to thank Gene Todd, who is the head of client development at Fiduciary Trust International and Stephen Dover, the head of equities at Franklin Templeton. Thank you both.

Host: And thank you for listening to this episode of Talking Markets with Franklin Templeton. Our special series with the US elections continues tomorrow and if you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about any other major podcast provider.

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