2020 was never going to be a dull year. As it started, investors were celebrating the signing of the long-awaited U.S.-China trade deal and markets were at record levels. But the U.S. election was everyone’s prime suspect to be the event that would control the narrative and direction for the year. Oh, how quickly things changed. While Chinese delegates were in Washington signing the trade deal, the country was already dealing with a disease outbreak that would quickly spiral out of control and destroy many lives around the world.
How quickly everything changed is a great reminder to investors of why they must always be ready to adjust their plans and positioning. As Iron Mike Tyson famously said ahead of a title fight, “everybody has a plan until they get punched in the mouth.”
Creep Higher
This was supposed to be a year the central banks sat on the sidelines, as they normally do in election years, so as not to seem political. With that backdrop, many expected interest rates to creep higher with global growth. The yield on the U.S. 10-year Treasury was supposed to approach the 2.5 per cent level. No one was expecting that by mid-March rates would be slashed to zero and bonds would rally to record high prices.
The global pandemic seems to have changed our world forever. Simple tasks such as going to a restaurant, watching a sporting event in a crowd or even shaking hands with a stranger seem foreign. We all must adjust to the new normal and be ready to adjust again with the world. ‘Buy and forget about it’ seems to be one of the casualties of the pandemic. The new normal looks much more volatile.
The VIX index, which looks at implied volatility, is well off the highs of March, but that doesn’t mean volatility is gone. There are many ways to measure volatility. One way that seems appropriate is to see how often prices move in dramatic fashion. Morgan Stanley looked at this by tracking three sigma cross-asset moves (a major price move in any asset relative to the previous day’s implied three-month volatility) and found that 2020 has already had more of these events than any year since 1998 (See Exhibit 1). Things don’t look to be calming down anytime soon.
Fears of a second wave of virus cases crept back into the equity market in June and a spike in cases in certain states has caused some of the economic reopening plan to be delayed or rolled back. Until we get a vaccine that is widely available and deployed globally, it appears the new normal will include the virus. Headlines around this will dominate investments and swing prices. But the more complex issue is still to come with the US election.
Regardless of his social beliefs, President Donald Trump has been very positive for the U.S. stock market. Entering the year, betting odds had him easily winning a second term. But as the virus has disrupted many things, it has also affected the election. Debates around how he and his administration handled (or not) the virus have dramatically altered the polls, which now show the Democrats potentially sweeping the election. This event has not been priced into the market and will become the story for the summer.
Worsening Polls
How a desperate President Trump will respond to worsening polls is becoming the biggest risk to the market. Does he lash out at his opposition even more than before or does he throw money at the problem in the form of tax cuts and stimulus packages? Does he go back to his old favorite plan of engaging in a trade war with China? Any or all of the events will be difficult to predict and model.
The first half of the year is now in the books. After a violent rebound that resulted in the strongest quarterly rally in many decades, predicting the second half of 2020 is very difficult. Safe-haven assets such as gold and large-cap tech stocks have led and appear poised to continue winning.
A rotation towards cyclicals would go a long way to broaden out the rally and place it on stronger footing. For that to occur, global growth needs to re-emerge as the story. To watch for signs of this happening, look for a weakening U.S. dollar, a higher 10-year bond yield, and a breakout in commodities.
The rebound in equities has been impressive off the March lows, but the all-clear has yet to be blown. We risk having priced in too much good news, which means disappointments will be meet with violent selling. A defensive posture for the second half may be prudent, but could also look foolish in the face of so many measures to promote higher prices. The only thing that feels certain is more uncertainty. Plan accordingly and be ready to adjust to new facts. Flexibility has never been more important.
Greg Taylor is chief investment officer at Purpose Investments.