The Election is Not Over as We Predicted

•    Election results will be challenged in court and uncertainty could persist through January 5th.
•    The Senate appears to stay Republican, leaving a divided government, but that is not assured.
•    Both a $4 trillion tax hike and a massive spending program now appear unlikely.
•    Equity markets remain historically expensive, but Pfizer’s vaccine news jump-started economic and market hopes today.
•    The bond market’s 39 year rally may be ending. Bonds should be sold.

 

The US Presidential election is not over as we predicted in our “Extreme Election Scenarios” letter on November 1. The current election results suggest the Senate held onto its Republican majority. A divided government was one of the best scenarios we wrote about, as it eliminates the politically radical prospects of either a Republican or Democratic sweep.

This perceived divided government outcome has eliminated the prospect of $4 trillion in new taxes and led to a healthy stock market last week. However, the prospect of a massive stimulus also collapsed as a Republican Senate will not tolerate either a huge new tax increase or massive spending program.

Pfizer announced today, November 9th, vaccine results that are 90% effective, and the company expects to deliver 50 million doses by year-end and 1.3 billion doses in 2021 of the two-dose vaccine. This announcement begins to reverse the enormous economic disruption of the COVID-19 pandemic and will accelerate the rotation from growth to value.

Maria Bartiromo queried Attorney Sidney Powell on Sunday Morning Futures as to the ownership of software company Dominion Software. Ms. Powell confirmed that Speaker of the House Nancy Pelosi’s former Chief of Staff is a senior executive there and Senator Diane Feinstein’s husband is a stockholder and executive there too.According to Ms. Powell, who has been defending retired General Michael Flynn against government prosecution, software algorithms were used to identify voting gaps between Trump and Biden. As the initial results showed Trump with a lead on Election Day, machines were stopped, and votes were created for Biden and or appeared in blocks of 138,000 without a single vote for Trump.

Powell also alleged that dead people voted and some even recently registered to vote shortly after their death; a postal worker filed an affidavit stating that they were directed to change postmark dates to before November 3rd; ballots with only Joe Biden’s name printed on them were found: 98,000 in Pennsylvania, 80,000-90,000 in Georgia, 42,000 in Arizona, 69,000-115,000 in Michigan, and 62,000 in Wisconsin. And Powell said: there are 800,000 contested votes in 10 states.

In one county in Michigan, election software switched 6000 votes from Trump to Biden. This “glitch” was corrected, but the software is in 47 other Michigan counties, according to Senator Ted Cruz also on Maria Bartiromo’s Sunday Morning Futures.

According to Rush Limbaugh, Biden underperformed both Hillary Clinton and Barack Obama in every state except the battleground states. These battleground states then saw Trump’s lead reverse. In the battleground states the down ballot races went for Republicans, but, surprisingly, did not support

We cannot hope to assess the voracity of these claims nor the likely adjudication of any legal scenario. We simply want to consider some unlikely and unanticipated scenarios to prepare for the unexpected.

Trump could win, but Biden must lose in either or both the courts and in recounts to lose the Presidential election. These unknowables could lead to market uncertainty in an overvalued stock market.

What we know with certainty is that the market is expensive. The Buffett Indicator shown – in the chart above – now registers the highest valuation since 1952. High valuations imply significant downside risk in unfavorable market conditions. The only rationale for such extreme valuations is the historically low-interest rates spawned by central bank unprecedented accommodation in recent decades. If interest rates rise too quickly, many market and economic problems will arise.

The best outcome for market stability, is a divided government where the Senate majority’s political party is different from the President’s political party. Odds suggest that Biden holds onto the presidency and that the Senate remains Republican. However, there are two senate seats in runoff elections in Georgia on January 5th which potentially could flip the Senate to a Democratic majority. This could be destabilizing.

If the Georgia Congressional Election leads to a Democratic Senate along with a Biden Presidency, the market could be in trouble as fears of a $4 trillion tax bill would lead to a reduction in future S&P 500 earnings as Biden has pledged to reverse the Trump tax cuts. This outcome could have a negative impact on the market. If Trump prevails in the courts, the market will likely experience some meaningful turbulence until that scenario plays out.

The rotation toward value stocks from growth stocks got a boost with Pfizer’s news that its vaccine candidate is 90% effective and that 50,000,000 doses should be distributed this year and 1.2 billion doses in 2021. We advise clients to keep high levels of cash and wait for this political contest to be decided before making significant investment commitments. We recommend reducing overweighted positions in large-cap technology stocks like the FAANG stocks (FB, AMZN, AAPL, NFLX and GOOGL).With the Pfizer announcement, prospects for economic recovery have improved significantly driving a sharp jump in today’s market. This news in combination with the election results has the stock market (S&P 500) up 3.18% midday (1:30 PM) November 9th. Below are intraday prices for major indexes and show a 6.03% move in small-cap stock index, but a weak 0.66% move for the NASDAQ 100.

The S&P 500 jumped to an all-time high today with a precarious gap opening. Gap openings amid euphoria and high valuations can signal major market peaks.

Last week we showed (see below) Liz Ann Sonder’s best and worse-case scenarios for immunizations against COVID-19.

With Pfizer’s announcement, the six months scenario now looks highly probable. A vaccine led recovery will lift cyclical stocks more and detract from large-cap technology which greatly benefited from the pandemic. Those businesses most severely impacted by COVID-19 such as restaurants, airlines, travel and leisure stocks should outperform. We like cyclical inflationary assets like financials, industrials, materials, energy, discretionary, equal weight indexes, small-cap, mid-cap, and value stocks.

The chart below shows the valuation disparity between global growth stocks and value stocks is at a historic extreme. This trend reversal and sector rotation should engage unequivocally with the vaccine aided economic recovery.

We recommend accumulating natural gas stocks like Antero Midstream Corporation (AM) and Antero Resources Corporation (AR). The cannabis sector had a nice post-election rally following the legalization of medical marijuana in five states. The cannabis sector is out of favor with improving fundamentals due to the significant potential of cannabinoids like CBD and THC in treating anxiety, nausea, arthritis, epilepsy, autism, and cancer.

Today’s market’s read on the Pfizer vaccine news has notably lifted interest rates which are near historic – 39 year – low yields. If inflation begins to engage in combination with a strengthening economy, valuations could see pressure in the coming years with the end of the unprecedented central bank accommodation and 39 years of declining rates. Rising rates could reverse the last 39 years of high stock and bond returns and traditional 60% stock and 40% bond portfolios could underperform in the years ahead.

We recommend a cautious investment stance even with the apparent divided government election outcome and today’s exciting vaccine news. This stock market is richly priced and tenuous. A blue wave or an adjudicated re-election of Donald Trump could shock the markets.

We welcome your questions and comments.