Last week was the best week for equities since July. In July, however, the gains were totally dominated by the technology sector and other Covid-19 beneficiaries. Last week, the gains were much more spread out. The tech stocks did OK but financials and industrials were also gainers. It was a healthier advance.
While last week’s attention was focused on developments in Washington, this week it will turn to earnings and a few key corporate events. The largest banks will begin reporting third quarter results tomorrow. Historically, the banks have not been good precursors to earnings season. While loan volumes tie closely to economic activity, bank earnings are much more impacted by interest rate spreads and trading activity, neither very important to other major companies. A few large companies, like Johnson & Johnson# and United Healthcare, report this week but it will be next week when earnings season starts in earnest. Given the expectation that GDP in the third quarter rose 30% or more from Q2, there should be significant sequential improvement, although results for most companies will still fall short of last year’s levels. That mirrors what is expected from GDP. During the pandemic, most corporate managements stopped issuing forward looking guidance. Less than 15% of companies still offered forecasts last quarter. Given that the economy has recovered a bit quicker than one thought in early July, when Covid-19 cases were spiking in the South, I would expect the majority of companies to match or exceed analyst expectations. In earnings season, it is the comparison of results to expectations, rather than the absolute level of earnings that counts. Therefore, the stage would appear to be set for good results.
We also have two high profile corporate events happening tomorrow. Apple will hold an event where it will introduce the Apple 12 series of smartphones, the first to have 5G capability. The phones should be available next month. Of course, they will be faster, have more storage, and better cameras as well. There will be a few other surprises tomorrow. Once again, how the announcement stacks up to expectations is what will move Apple’s stock as well as those of key suppliers.
The other event is Amazon’s Prime Day, also tomorrow. Amazon insists that Prime Day wasn’t reset to coincide with my wife’s birthday. Normally Prime Day is in the summer, but given shipping delays then, it was postponed until tomorrow. It should once again be Amazon’s biggest sales day of the year.
Of course, corporate news alone isn’t the only factor moving markets. Washington still matters only three weeks and a day before the election. If you want to know which states are the tightest, watch where Trump and Biden campaign this week and next. Polls lately seem to have been moving in Biden’s favor. But in politics, three weeks can be a millennium. There is one more debate left, assuming Covid-19 doesn’t interfere again. If it is like the last one, it won’t change many opinions but will aggravate a lot of viewers. Even if it has the decorum of the Vice-Presidential debate, I am not sure that it will change any minds. What will matter is if either slips and makes a major gaffe. Otherwise, especially with so many voting early, it will probably be less meaningful than one might expect.
This week will also mark the beginning of Senate Judiciary Committee hearings on the nomination of Amy Coney Barrett to the Supreme Court. There will be a lot of fuss about Roe v. Wade, the future of Obamacare, and what might happen should the Presidential election arrive at the doorstep of the Supreme Court. But Judge Barrett won’t discuss hypotheticals or any pending cases. After the Kavanaugh hearings, I doubt Democrats will try any personal mudslinging. Thus, there will be a lot of media shouting, but here nomination seems likely to conclude with passage, perhaps along party lines. What the hearings may do is harden views of those both on the left and right. Whether that has any impact on the Presidential election is problematic.
I have said before that the choice of President is less important to the market than future monetary policy moves. The fact that stocks rose last week as Biden’s poll number increased suggests that markets don’t appear to fear a Biden win. A Trump win, assuming Democrats retain control of the House, almost certainly means at least two years of legislative gridlock, maybe four. That excludes crisis issues and I would put the pending Covid-19 relief package in that category. Consensus suggests the next relief package is likely to be larger should Biden win. The odds of anything passing before election is small, unless both sides agree almost immediately. Between the Barrett nomination process and the need of many to be out in the field campaigning, the odds of getting anything done before November 3 are small. Most impacted will be the weaker airlines and small businesses hanging on by a shoestring.
Thus, assuming interest rates stay low, and even recognizing that 10-year and 30-year Treasury yields have been inching up by about 10 basis points each, rising earnings expectations, coincident with a solid earnings season, should drive stocks higher. I think the stock market can accept either a Trump or Biden win. What will cause a blip is a messy result that must be settled by Constitutional process either in the Courts or in Congress. If the polls are reasonably accurate (questionable after 2016), the odds of a messy election aftermath are declining. Remember, the last time Courts decided the outcome, the Supreme Court certified a Bush win in 2000 by 537 votes. A state (or states) has to be similarly close for Courts to intervene. To give you some idea, President Trump won PA in 2016 by a bit over 40,000 votes or about half a percentage point. That was close but there was no thought of a recount. Proving 40,000 votes were fraudulent is a daunting task; accusing fraud alone won’t get either side very far. Thus, the markets are probably right to assume that people, not Courts, will decide this election. It is possible that the outcome in one or two key states may not be certain on the morning of November 4, but it will be known shortly thereafter.
The remaining issues for markets therefore are valuation and the future path of Covid-19. The latter is more concerning at the moment given the recent spike in new cases. It bears watching. However, remember that spikes yield reactions. A few super spreader areas (e.g. bars) get quarantined and people naturally become more careful. Unless there are material shutdowns, the economy and markets can move forward.
Today, Hugh Jackman is 52.
James M. Meyer, CFA 610-260-2220