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The Brave Report: Market Commentary for November 2020

Click here for .pdf version of this report: https://www.braveboatcapital.com/wp-content/uploads/2020/11/The-Brave-Report-November-2020.pdf

I delayed writing this report this month as I wanted to get a more clear picture of the outcome of the election.  With the election being called in Biden’s favor over the weekend we can now start to digest what this means for the country, the economy and the markets.  We saw a lot of volatility coming into the election as many unknowns hung over the economy.  We now have some of those answers, but I would still stress the need for patience. What campaign promises will become actual policy initiatives, and which were just campaign rhetoric?  Until we get a full understanding of the new administration’s priorities and which of those are actually realistic with a presumptive split congress it is still difficult to project the short-term impact of a Biden presidency.

Market Overview

During the month of October, all three major indices continued to lose ground.  The S&P 500 lost 2.8%, the DOW Industrials lost 3.9% and the NASDAQ was down just shy of 2%.  While these losses represented a continuation of the weakness we saw in September, these performance numbers do not tell the whole story. Earlier in the month, both the S&P and the NASDAQ were up over 5%, only to lose ground rapidly the last week of the month to finish negative. We often see this kind of volatility heading into an election and with the current division in the country this year was no different.  Throw on top of this a rapid spike in Coronavirus cases and we had the perfect recipe to push investors to the sidelines.

We saw similar volatility on the fixed income side with the yield on the 10-year bouncing between the high 0.60s and mid 0.80s. I expect to see continued volatility as the market digests Biden’s policy agenda and we try to project out the economic impacts of a continued surge in Coronavirus cases across the country.  I expect any spikes in rates to be bought, capping their upward momentum. Once the dust settles from the election I wouldn’t be surprised to see rates settle back near 0.7%, where it has been trading from the last few months.

Over the past few months, we have seen a lot of prognostication about what the various election outcomes would mean for the economy and the markets. We have seen arguments on both sides for almost all scenarios. While some legal challenges from the Trump side still need to play, Joe Biden will be the new president.  Some questions still remain as to the final balance in the senate.  Most expect the Republicans to maintain control but the potential for two runoff votes for the final two senate seats in Georgia could still hand control back to Democrats. While this is unlikely, it is still a possibility.

As I discussed last month, the prospect of one party controlling the Executive branch and one controlling at least one house of Congress can create the best opportunities for positive stock market performance in the short-run as the more radical policies of either party cannot become a reality.  The sides are forced to work together to get anything done, thus eliminating the possibility of a tail-end policy.  In this case, if the Republicans can maintain control of the senate then some of the more radical far-left proposals would be dead on arrival. Increases in capital gains rates, rollbacks of Trump’s corporate tax cuts and aggressive spending on climate change and healthcare would be muted.  Now, I am not making the argument that some of these changes would be wrong, I am just saying that the markets prefer incremental change and when any major policy shifts are muted the markets react more positively.

Alternatively, this scenario could also hinder a large scale COVID stimulus bill from getting passed which will have a negative short-term impact on the economy, especially with the potential for more pandemic restrictions being imposed. While I expect a bill to get passed, had there been a blue wave then the bill would have been much larger.

Looking out a little longer term, it is difficult to assess what the real economic impact will be from a Biden presidency.  Throughout his campaign, he was not very specific about his economic plan, so it gives us very little to work with in terms of long-term projections. In his acceptance speech over the weekend he spoke of cooperation and working together with republicans. This is a similar sentiment as to what most other president elects have spoken about but when actual governing begins the levels of cooperation tend to fall short.  It is clear that a lot needs to be done once he takes office, ranging from controlling the pandemic and implementing stimulus to widescale infrastructure improvements. Until we get a full understanding of his agenda priorities, I will withhold making any major projections about his longer-term impact on the economy.

Outside of the election, the COVID situation is still front and center.  Cases continue to rise across the country and we have started to see more restrictions that could hinder the economic recovery. However, there has also been some bright news.  We have started to get results from some of the late-stage vaccine trials and so far, the results have been positive.  It now looks like one or more vaccines will be ready for emergency use approval within the next few weeks.  While this is amazing news for the country and will help dispel some of the long-term fear around the pandemic and give most people hope for the future, I would again stress patience.  The vaccine will take months, if not years to fully roll out and it will do nothing to alleviate the current spike in cases that we are seeing.  I expect that many places will have to increase restrictions over the next few weeks or months which could negatively impact the markets and force the need for a stimulus package sooner rather than later. However, the progress on the health front should create a light at the end of the tunnel that we will eventually get this pandemic under control.  The big question that remains is what economic damage will be done before the vaccine can be rolled out to enough vulnerable people to allow us to return to normal life?

Strategy Commentary

I continued to maintain my overall equity allocation throughout the month.  There is often a spike in volatility heading into an election and with everything going on with this election that volatility was exaggerated.  However, I was comfortable with the overall equity allocation and decided not to make any changes.  Once the dust settles from the election, I will probably do some rebalancing as there are definitely some sectors that will be worth adding to under the new administration

Domestically, I continue to maintain my overweight to technology.  With the prospect for increased capital gains rates being muted and the assumption that the Republicans maintain control of the senate I think we could see continued strength in technology.  We may see a slight rotation away from some of the more stay-at-home tech names if we continue to see progress on the virus front but the quality tech names will be able to continue to capitalize in the shifts in consumer behavior. Once we get a more clear picture of Biden’s policy priorities I will reassess adding to some other sectors that could benefit from his agenda.

Internationally, I continue to be staying away from Europe as their Covid cases have surged and their ability to form a unified policy response remains low.  With the prospects of a vaccine soon, this could change but even with a vaccine we are far from seeing society return to normal.  Alternatively, I will continue to look to add to my China exposure.  Their Covid response combined with the alleviation of some of the Trump era trade war rhetoric could create a great opportunity for outperformance.

I continue to prefer larger a cash position to a full fixed income allocation.  Rates are near the high end of their trading zone since the start of the pandemic but I expect to see rates to stay relatively low until the economy is back to normal.