Even in the context of an eventful decade, 2020 is a year few will forget. After initially strong economic momentum, the first wave of the coronavirus forced much of the world into lockdowns and economic contraction, with deeply negative impacts on the financial markets. Aggressive steps by central banks and fiscal authorities fostered liquidity and a sharp market rebound, although economic recovery remains a work in progress. Beyond that, we witnessed extensive protests over racial and economic justice, and are now on the cusp of a historic election with major implications for society, the economy and markets. Not only are policy differences exceptionally wide, but practical issues tied to COVID-19 could make the voting process more difficult and potentially lengthy.
For investors, dealing with this uncertainty and turmoil is, in our view, largely about having an appropriate portfolio strategy in place that keeps long-term goals in mind, and, where feasible, can pivot to generate opportunity or insulate against volatility. As noted in the summer issue of Investment Quarterly, the centerpiece of our client discussions has been our Recovery Playbook, where we have postulated various scenarios on how the COVID-19 crisis and its economic effects could unfold. You can see our recent economic projections below, noting our base case outlook for a slow, U-shaped recovery through next year, which assumes success in containing the virus. Below, we provide some broad observations about current factors affecting the market environment, with particular focus on the election, and offer some thoughts on approaching current investment challenges.
Economic Scenarios, From Bull to Bear
Estimated Path of U.S. GDP Growth
Source: Neuberger Berman. GDP quarterly growth presented annualized. Information is as of the date indicated and subject to change without notice. Nothing herein constitutes a prediction or projection of future events or future market behavior. For illustrative and discussion purposes only. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic, market or security estimates or forecasts discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates or forecasts. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. Past performance is not indicative of future results.
The Pandemic and Economy: Works in Progress
COVID-19. The pandemic remains one of the most devastating health crises in modern history, with the U.S. death toll passing 200,000 in September. After a summer spike in many states, containment measures helped curb new cases, while early hotspots like New York moved toward more extensive reopening. A return to schools and cooler temperatures appear to have contributed to more infections recently, but death rates have been lower, and hospitalizations remain well within the system’s current capacity. Overseas, China has largely returned to normal, while Europe has been forced to reintroduce lockdowns in certain locations. Latin America and India continue to struggle with the virus.
U.S. Hospital Capacity
Number of U.S. Hospital Beds Occupied/Unoccupied (7-Day Moving Average)
Source: CDC, Neuberger Berman estimates. Data through September 25, 2020.
We have come to know more about the virus over time, including who is most at risk. Testing availability has improved, and treatment has become more effective, contributing to reduced hospital stays and lower fatality rates. Meanwhile, the race for a vaccine continues, with more than 100 vaccine candidates, a number of which have moved into Stage 3 trials. Although safety remains a concern, there is hope that there will be one or more approved vaccines by year-end or early 2021, with wide distribution sometime in the middle of next year.
The Economy. With reopening, economic growth has recovered rapidly since its nadir in March and April, and our base case is for a 30% gain in the third quarter, followed by 3% in the fourth, and 4% growth in 2021, assuming initial vaccine approval in 4Q and some additional stimulus in 2021.
After a historic surge, new unemployment claims have declined, while the unemployment rate has fallen from 14.4% in April to 7.9% in September, and payrolls have recovered about half of the jobs lost. Supported by over $3 trillion in fiscal support, savings rates have expanded rapidly, while consumer confidence has been inching back up.
In the private sector, the pandemic loosely divided businesses into three camps: those that could benefit from lockdowns, such as providers of remote technology or online commerce, those that could easily adapt (financial firms, food delivery), and those with far greater vulnerability (retailers, sit-down restaurants, hotels). It’s clear, in our view, that the longer a restrained environment continues, the more permanent damage there will be to weaker businesses. That said, low interest rates have allowed many companies to refinance and extend maturities, and although new fiscal stimulus has become a hostage of the election, there’s hope that more will be in the works as we roll toward next year.
Unemployment Claims Are Elevated, but Trending Down
Thousands, Seasonally Adjusted
Source: BofA Merrill Lynch, as of August 31, 2020.
The Election Takes Center Stage
Overshadowed for months by the pandemic, the U.S. election returned to investor focus in late summer and early fall. As I write, Joe Biden is now favored over Donald Trump. Meanwhile, the Senate, with a small Republican majority, is considered a toss-up, with several tightly contested seats in the balance. The House is generally thought to be safely in Democratic hands.
This is by no means a typical election, however, and the actual dynamics are hard to predict. For example, the COVID-19 crisis will likely move much of the voting to mail-in ballots. Given that far more Democrats favor remote voting than Republicans (see display), their degree of success in casting those ballots combined with the level of in-person turnout could have a significant impact on the outcome. Moreover, given extended deadlines in some states, it could take weeks to finish counting votes. Meanwhile, there are likely to be multiple legal fights over ballot acceptance (perhaps making the 2000 “hanging chads” controversy seem like a minor scuffle), with the electoral college vote on December 14 and Senate commencement on January 3 serving as possible outside deadlines for resolution.1
Trump Supporters More Likely to Vote in Person
Source: NBC News/Wall Street Journal poll, August 9 – 12, 2020.
The two presidential candidates have very different views of how the country should move forward, and that’s reflected in the policy priorities after the election. President Trump largely represents the status quo. He would like to make permanent the elements of his tax reform that sunset after 2025, maintain low corporate tax rates and continue the task of reducing regulation across industries. Former Vice President Joe Biden favors a rollback of many of the 2017 tax changes (See “Estate Planning and the Election” ), a renewed focus on climate change and reengagement with multilateral organizations. On health care, the president continues to seek cheaper alternatives to the Affordable Care Act, while Biden wants to restore ACA viability with the introduction of a new “public option,” among many initiatives. Despite their obvious differences, the two actually share common ground on the need for drug pricing limitations, infrastructure spending and an aversion to cutting traditional entitlements. Although executive branch control creates enormous opportunities to drive policy, how many priorities actually gain traction depends largely on the overall mix of the government come next year.
Policy Implications of Potential Election Outcomes
Source: Neuberger Berman. As of September 30, 2020.
Divided government should, in theory, encourage compromise. Once the election is over, Republicans and Democrats may be able to come together on certain priorities, such as additional fiscal stimulus to offset damage from the coronavirus.
Even if we see a sweep by one party, however, that doesn’t mean that all of its proposals will go into effect. First, it takes time to push through important legislation. It may be that stimulus is the priority, while tax increases are deferred until they can have a less dampening effect on the economy. There are also structural impediments to radical change. Although diminished, the Senate filibuster rule still requires 60 votes to allow consideration of most non-budgetary items. And while there’s talk of eliminating the filibuster, some senators appear reluctant to remove this key protection against abrupt partisan change. Beyond this specific issue, officeholders from swing states will likely feel pressure to stake out moderate positions, dampening more extreme impulses within both parties.
Impacts on the Markets
Although COVID-19, monetary and fiscal stimulus, and reopening have been key drivers of the market this year, the election has recently contributed to price volatility. What could be the effect of various election scenarios? A status quo result (Republican president and Senate, Democratic House) is generally seen as the most positive of likely outcomes for the equity market, because it could maintain the current low-tax regime and trend toward deregulation. However, a Biden presidency combined with Republican Senate might prove relatively benign: Although re-regulation will be a key priority, prospects for tax increases may be limited, while there would be potential for reduced trade tensions and less vitriol in public discourse. In contrast, a “blue wave” could introduce an array of long-term changes, including tighter regulation of the technology sector (historically a beneficiary of Democratic presidencies) and financial companies, as well as an expansion of government health care. Priorities would likely focus on stimulus, while tax increases, even if introduced in 2021, would probably not start to crimp pocketbooks or corporate earnings until 2022. Even then, compromises to draw in moderate Democrats and even some Republicans could reduce the extent of tax hikes.
Using Your Playbook
Despite the strong rebound from March lows, the current environment remains highly uncertain. Elevated volatility will likely continue through the election season, particularly if early results are inconclusive, and vote-counting and legal wrangling extend much past November 3. Depending on the outcome, there could be further uncertainty, as investors assess the nature of legislative measures and how they could prove impactful for companies and individuals.
That said, our Asset Allocation Committee believes the outlook over the next 12 months is constructive. Once the election is out of the way and policy trends become more certain, businesses can plan more effectively. And although COVID-19 remains a major destructive force, trends toward better management and treatment of the disease, potentially culminating in a vaccine, could provide for a much improved economy next year, even if long-term structure issues such as budget deficits and debt, renewed inflation and climate impacts remain concerns.
How can investors work through current volatility? Is there a bridge to greater certainty as we progress into 2021? Returning to our Recovery Playbook, we believe it’s important to assess portfolios in light of current dynamics. Our major themes (shown below) look to provide both attractive performance opportunities and potential diversification, and all are intended to function within a traditional asset allocation, created based on individual risk tolerance and long-term priorities.
We believe maintaining an investment framework of strategic holdings, complemented where appropriate with tactical tilts to capitalize on shorter-term dynamics, can help transcend periodic turbulence. Importantly, it’s an opportune time to keep in close contact with wealth and/or portfolio managers, to ensure that you are maintaining an appropriate portfolio and taking any investment and/or planning steps that may be useful in current circumstances. Events can alter the nature of the obstacles we face, but proactive, careful planning and analysis can help you move past them and stay on the proper course.
‘Playbook’ Investment Themes
For illustrative purposes only. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Investing entails risks, including possible loss of principal.