22 Oct A November to Remember
by Justin Lowry, CIO, Global Beta Advisors
As the market navigates what has been historically the two most volatile months of the year in September and October, November is setting up to be a month to remember. Of course, the election is set for November 3rd, Pfizer and Moderna recently announced that it will likely be in a position to file its COVID-19 vaccine for emergency use authorization with the FDA by the end of November, and most of the country will be heading into the flu season while experiencing much colder climates, which will lead to more indoor congregations with rising COVID-19 cases in the background. As a result, investors are preparing for a bumpy November. Below is a chart displaying the call option volume for VIX futures with a November 18th expiration:
VIX Call Option Volume: November 18 Expiration
Source: Trading data from fidelity, as of 10/19/20
This begs the question: what is the consequence of the outcome for each of these events?
Let’s start with the election. Eyes will not only be on the winner of the presidency but also on what party (if any) takes control of congress. A democratic sweep of the presidency and congress would lead to a significant overhaul of current policy, which has significantly reduced corporate taxes and regulation (particularly for the financial sector). Below is a chart comparing the policies between the two candidates and the financial impacts they carry:
Biden Administration
| Proposed Policy | Potential Ramification | Sector Affected | Factor Affected |
|---|---|---|---|
| Capital Gains Tax Increase | Short term market volatility, particularly in sectors with large gains | Positive: Consumer Staples and Healthcare Negative: Information Technology, Communication Services, and Utilities | Positive: Volatility and Quality Negative: Yield, Growth, and Momentum |
| Corporate Tax Increase | Reduce number of companies that issue dividend and stock buyback programs | Positive: Information Technology and Healthcare Negative: Communication Services, Utilities, and Real Estate | Positive: Volatility and Quality Negative: Yield, Value, and Momentum |
| Larger COVID Relief Package | Increased consumer spending and Inflation catalyst | Positive: Consumer Staples, Consumer Discretion, Energy, Financials, Materials, REITs Negative: Communication Services, Utilities and Information Technology | Positive: Value and Size Negative: Growth and Volatility |
| Affordable Care Act Expansion | Increased healthcare cost structure and increased federal deficit | Positive: Information Technology Negative: Healthcare and industrials | Positive: Growth, Volatility and Quality Negative: Value and Size |
| Infrastructure and Clean Energy Spending | Increased US economic government investment; reduction in investment in current energy Infrastructure | Positive: Information Technology, Industrials, Real Estate and Materials Negative: Energy, Communication Services and Utilities | Positive: Value, Size, and Growth Negative: Volatility |
| Elimination of Chinese tariffs | Reduce trade war risk and reduce large trade deal probability | Positive: Consumer Discretionary, Industrials, and Materials Negative: Information Technology | Positive: Value and Size Negative: Growth and Volatility |
Source of policies: joebiden.com
Trump Administration
| Proposed Policy | Potential Ramification | Sector Affected | Factor Affected |
|---|---|---|---|
| Capital Gains Tax Decrease | Short term market surge | Positive:
Information Technology, Communication Services, and Utilities Negative: Consumer Staples and Healthcare | Positive: Yield, Growth, and Momentum Negative: Volatility and Quality |
| Tax Reduction Aimed at “Middle Class” | Increased consumer spending and inflation catalyst | Positive: Consumer Staples, Consumer Discretion, Energy, Financials, Materials, REITs Negative: Communication Services and Information Technology | Positive: Yield, Value, and Size Negative: Growth and Volatility |
| Modest COVID Relief Package | Sustained consumer spending | Positive: Consumer Staples, Consumer Discretion, Energy, Financials, Materials, REITs Negative: Communication Services and Information Technology | Positive: Value and Size Negative: Growth and Volatility |
| Affordable Care Act Repeal | Reduction of healthcare cost structure | Positive: Healthcare and Industrials Negative: Information Technology | Positive: Value and Size Negative: Growth, Volatility, and Quality |
| Infrastructure Spending | Increased US economic government investment; increased in investment in current energy Infrastructure | Positive: Energy, Industrials, Real Estate and Materials Negative: Information Technology, Communication Services and Utilities | Positive: Value and Size Negative: Volatility and Growth |
| Continued trade pressure on China | Increased trade war risk | Positive: Information Technology Negative: Consumer Discretionary, Industrials, and Materials | Positive: Growth and Volatility Negative: Value and Size |
Source of policies: based on current administration policies, ideas cited from pbs.org, and mentioned during white house briefings
Based on our assessment; consumer cyclicals, value, and size are likely to see significant benefits from both administrations as both administrations seek to provide more economic stimulus but at varying degrees. The Biden Administration stimulus is more likely if the democrats win the White House and Congress; however, the Trump Administration stimulus is more likely if the republicans win the White House and/or keep control of the Senate. Overall, we believe getting through the election cycle is likely going to be more important to the market than the winner himself, however, there will likely be heightened volatility along the way, particularly if the results of the election are delayed and/or in question. However, the underlying critical element is that at least some level of COVID based economic stimulus is passed under either administration.
The other major event that is expected in November is the potential emergency use authorization of a COVID-19 vaccine. As it stands now, Pfizer and Moderna are the two most likely companies to at least file for the authorization to the FDA by the end of November. At this point, the market expectation is for approval of at least a limited supply of safe and effective vaccines by the end of November. Given that a COVID-19 vaccine is viewed by the market as the true end to the COVID-19 pandemic, any disruptions or delays from the FDA will certainly spike fears of a protracted period of the pandemic, resulting in further economic despair. For that reason, it is our opinion that vaccine news carries more downside risk than upside potential. We believe the VIX options volume that we charted above reflects that concern as traders begin to hedge their positions for downside potential.
Finally, it is important to acknowledge that much of the country will be heading into the flu season as the climate drops into winter temperatures. Many medical experts are concerned about the comorbid effect of individuals getting the flu and COVID-19. According to the CDC, approximately 40% of patients that have died from COVID-19 had symptoms of pneumonia and influenza. Compounding the issue of a potential deadlier effect with the introduction of influenza is the issue of falling temperatures, forcing more gatherings to occur indoor. Many restaurants are currently relying on outdoor seating to stretch their capacity limits. While we know that is something that will come to an end during the winter temperatures, the question is, exactly when? Goldman Sachs recently came out with a study to determine when demand for outdoor dining meaningfully declines. Below is a chart of their findings:
Effect of Temperature on Seasonally Adjusted Restaurant Bookings
Cold Weather During the Pandemic Had had a Non-Linear Negative Effect on Dining in Excess of Normal Seasonal Patterns
Note: Controls for time and city fixed effects. Solid bars indicate statistical significance at the lowest 0.05 level. Estimated over September-October 2020
Source: Department of Commerce, OpenTable, Goldman Sachs Global Investment Research
As you can see, demand begins to meaningfully become impacted at around 45 degrees Fahrenheit. Below is graph of the continental U.S. displaying the 30-year average low temperature for each state/region in November:
Average November Temperatures (1981 – 2010)
As you can see, states as far south as Georgia begin to see low temperatures hover around and below that 45-degree threshold during the month of November, which means many restaurant/entertainment venues across the U.S. will lose their ability to host guests outdoors by some point in November. Therefore, if the comorbidity of COVID-19 and influenza is more lethal than anticipated, we may see these venues face further restrictions while dealing with less venue flexibility, resulting in further economic drag and volatility in the market.
What does all of this mean for investors? It would seem that the next few months are going to be difficult, however, there may be opportunities that present themselves through that adversity. Additionally, it’s important for investors to rebalance their portfolios to ensure that they are not overexposed and to create a plan to add some downside protection. Global Beta contends that valuations are always important, and in times of corrections, they tend to become even more glaring.