US equity markets are close enough to historic highs. Are things really that good?


Equity markets appear to have convinced themselves that a Biden Presidency with a Democratic House and a Republican Senate is a ‘goldilocks’ scenario. Certainly, encouraging news on the vaccine front has been important in the recent equity ebullience pushing negative news on a second wave of increasing magnitude into the background. But that second wave is reality that will have economic effects.

The ‘glass half-full’ thinking goes that there will be some fiscal stimulus but without the ‘tax nasties’, particularly higher corporate taxes. Further that any re-regulation will be relatively light and not overly crimp the tech sector.

However, political gridlock while maybe preventing an excess of bad policy can also mean the delay of innovative reform and restrain the polity from enacting a policy or regulatory framework in response to ever changing circumstances.

Of course in the background remains the tremendous faith in the Fed’s monetary accommodation and attendant flush liquidity even when the Fed’s armoury is exhausted and further monetary stimulus does potentially more harm than good.

On the ‘glass half-empty’ front the following are potentially underappreciated:

  • First, arguments over the form of any fiscal stimulus package between the Biden administration and a Republican Senate mean further delays in the delivery of that stimulus and raises the prospect of a relatively impotent package in the end. Much of what has been priced by the equity market embodies a strong recovery. That is what has driven the rotation we’ve seen from tech to broader cyclicals. The recovery may occur and there are grounds for optimism, not the least with the vaccine news. But the second wave is real and the vaccine roll-out uncertain so despite that I’m having trouble accepting risk markets at historic highs?
  • A second element to ponder is the re-regulation agenda. In particular, anti-trust  measures and the impact on the tech sector. Tech companies don’t enjoy a lot of support on either side of politics. The ‘oligopolistic privilege’ enjoyed by the tech sector is therefore still likely to come under increasing scrutiny.

The Senate may be a brake on some of the more onerous bits of the Democratic re-regulatory agenda but the momentum for re-regulation is there. Any re-regulation of the economy can diminish its flexibility and hamper the US economy’s capacity to respond to changing circumstances. This also includes regulation at the State government level.

The underlying flexibility of the US economy has long been to its advantage as evidenced by the pace at which it bounces back from setbacks compared with say its European counterparts where regulatory constraints are more pervasive. Democrats have, for example, been quiet about winding-back President Trump’s protectionist agenda.

Of course, there will be sectoral opportunities in equity markets that can be successfully exploited by good active equity managers. In totality, however, the market faces meaningful hurdles: macro stimulus – monetary and maybe even fiscal –  is diminishing in potency. As well, the pandemic ‘second wave’ is gathering speed and the policy agenda is at best uncertain and at worse difficult for markets.

By Stephen Miller, investment strategy adviser

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