10% in 4 Days… Too Optimistic?

• Explaining the 4-day 10% equity rally 
• Are the Fed considering more QE soon? and
• Could we see a split Senate in January?

The “gridlock rally” continued at great velocity today…

We’re now up 10% in just 4-days… more on this shortly when I explain why we are headed for resistance. 

Now “gridlock’ is how the market describes a likely Biden White House; combined with a Republican controlled Senate 

As explained yesterday – this is a welcomed result for the stock market.

However, it may not sit well with the new President… who is determined to bring about meaningful change. 

In short, it will be hard for Biden to advance his election agenda.

For example, things like:  

• individual and corporate tax increases; 
• further regulation across the health care, technology, finance and energy sectors;
• a $3T+ fiscal relief deal; 
• socialized medicine;
• a Green New Deal; and
• packing the Supreme Court

.. will all be very difficult to pass. 

And whilst the (Democrat) controlled House can put forward a bill – it’s the Senate who decide what new legislation is passed.

But… 

There’s one thing the market may be overlooking (although it’s very low probability) 

There are still two closely contested Georgia based senate seats.

For example, if a candidate fails to get at least 50% of the vote there’s something called a “run off”. We could see two of these in January…  

Both of Georgia’s Senate races appear destined to go to a runoff election in January.

It seems likely Democrats would need to win both of them to achieve a 50-50 tie in the Senate; if Joe Biden wins the presidency, incoming Vice President Kamala Harris would then give control of the chamber to the Democrats.

There is an outside chance of a late break for the Democrats in Alaska’s Senate race, though it is probably a long shot. Georgia is the more likely path to a Democratic Senate.

Democrats needed a net gain of three seats to topple the Republican majority, and the race for the Senate came down to 10 or so competitive races

Now the market is discounting this event.. as it’s a low probability event.

But when I look at the status of these races – they are close. 

In the first case, the Republican incumbent (Perdue) is sitting on 49.95% of the vote with just 2% of the count remaining. It might be be higher or lower by the time you read this

And in the other case, no candidate is anywhere near 50%. 

So whilst Biden is 99.9% likely to win the election (he only needs to secure PA tonight – which very likely) – the Senate race in Georgia deserves attention the next few days. 

If there are two run-off events – we may get a tied Senate where the VP (likely to be Kamala Harris) will have the deciding vote on new legislation (on the basis Biden wins the Presidency) 

And that will be a “red flag” for the market. 

The ‘Gridlock’ Rally

Admittedly I didn’t see a 4-day 10% rally coming post the election. 

If anything – I saw the opposite. 

From mine, there could be (at least) three reasons to explain the market’s reversal from the previous week: 

• options market makers unwinding index and stock short sales
• the market less fearful of a less business-friendly blue-wave; and
• the prospect of grid-lock in Washington – meaning limited (new) legislation from Congress

But here’s the thing – we need to be careful here.

Below is the price action we see so far this week (with one day to go): 

S&P 500 – Nov 05 2020 – Post Election Rally

Technically we are still trading in the same range we have seen since July. 

However we are straight back to the top of that range where we have found resistance. 

But two things to highlight

– nothing has changed with our momentum indicators; and
– our VIX has dropped to a value of 27.5

The lower VIX makes sense – as a big event is now mostly behind us. We have a likely Biden Presidency with a Republican Senate. 

Trump will no doubt challenge the outcome of certain state results (e.g. AZ and PA)… but he is unlikely to be successful. 

And the Republican controlled Senate could be at risk if there is an election run-off with 2 seats for Georgia. 

Pending what we see with these two events – market volatility could return. 

Fed Speak: More QE Coming?

Turn on any TV and all you hear is election coverage… 

As such, what you may not have heard was the Fed’s statement on monetary policy today. 

Nothing changed with rates (expected)… but it was Powell’s choice of language which deserved note. 

For example, I think there’s a strong chance more QE (bond buying) is coming. 

Yesterday I suggested the Fed will need to increase its bond buying to fund massive deficits going forward. 

From there, assets like gold and commodities will likely rally (and the dollar will trend lower)

Today Jay Powell gave us a small hint that this is something we might see…

For example, he talked to discussions with the FOMC about their options for more QE if needed. 

This piqued my interest as it’s an insight to what they are thinking. For example, is this the Fed telegraphing that something is coming next month or early next year? 

Maybe. 

As an aside, we saw more QE from the Bank of England this week… and also AU$100B in bond buying from the Reserve Bank of Australia (as they slashed rates to just 0.1%). 

But what would more QE do? 

Not much. 

For example, when Powell was asked this question – the Chairman said it will be needed to provide a lot of support for economic activity and remove duration risk (similar to what QE3 did). 

I concede it will boost asset prices (in the short-term)… but directly support economic activity? 

I don’t know about that. 

Powell also told the audience the economic tail risks have subsided – but then talked about what new things they could do if the adequate fiscal programs are not there. 

With respect to spending, he was asked about directly funding fiscal policy (which I hinted at yesterday).

Powell was quick to shoot this down (not surprisingly)

According to Powell – the Fed is not in the business of spending. They are in the business of lending. 

Powell said “… we are a liquidity provision business… whereas it’s Congress who spend”

There is a fine line between “monetary financing” and “QE“.

But Powell is a genius at skirting around this with his language.

I found the comment interesting because it’s the Fed who is the enabler of spending.

Semantics? 

You can put it all down to “modern monetary theory”

As an aside, the Fed balance sheet and the Government’s balance sheet are basically joined at the hip… as both are essentially acting as a “fiscal function” for an economy in emergency need. 

Am I wrong?

With everyone focused on the outcome of the election… the market has lost sight of a few things.

Let’s not forget – there are still close to 20M jobs that have evaporated.

We get another jobs report tomorrow – it will be interesting to see the trend with weekly claims

This recovery will be painfully slow. 

And in the absence of any fiscal relief for small business over the past 5 months (post July 31) – with the chance of even more lock-downs – expect more near-term pain. 

Yes – we got a sharp bounce in the market. 

That’s not surprising given the sell-off we got the week prior on a possible “blue-wave” election outcome 

In fact, if you told me the Republicans would add eight house seats and retain the Senate – but Trump would lose the election – I would have said “how exactly?”

The market subsequently rallied at the prospect of Congress gridlock. 

But 10% in just 4-days is perhaps a too much enthusiasm

Nothing is solved. Lock-downs are coming as COVID cases spike to record levels. And unemployment is still a serious problem. 

Don’t be surprised to see traders take profits.

Regards,
Adrian Tout