by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning.  Equity markets continue to rally and lead off our coverage this morning.  The winter surge in COVID-19 continues to gather pace and comes next in today’s commentary.  Central banks are batting third—the FOMC meeting concludes today, and the BOE made policy adjustments.  Brexit news follows.  Brazil news wraps up the report.  Being Thursday, the Weekly Energy Update is available.  Here are the details:

 The election and equities:  Since the media is transfixed on the vote, we will leave that item to them.  It does appear VP Biden is likely going to win the White House, but we may not know for sure for a few days.  Since yesterday’s opening, we have seen equity indices rally.  Here is what we think is behind it all:

• Assuming Biden wins, he has been granted a weak mandate and faces a hostile Senate. That means the more leftist elements of the Democratic platform are unlikely to pass.  It also constrains his cabinet selections.  Senator Warren (D-MA) won’t get any position that requires Senate approval, for example.  We may see more senators given cabinet appointments, as there is a history of giving former senators an easier path to confirmation.
• Tax hikes are probably not happening. The ACA is in deep danger.  Ending it without a replacement would induce chaos into the healthcare system.
• Although we do expect a fiscal package (Majority Leader McConnell suggests there should be one), it almost certainly won’t be as large as the House bill. This means that if the economy stumbles (and it looks like Q4 and Q1 will be weak) the Fed will have to do more on the monetary policy side.  Since monetary policy mostly works through the financial system by lowering the discount rate and lifting asset prices, it bodes well for financial assets.
• An element of the rally in equities is that there was an elevated level of fear going into the election. We have noted on several occasions that cash levels were rising.  In late October, we saw a rise in the VIX.

This above chart shows the VIX since Labor Day.  By late October, it hit a reading of 40; in looking at daily closes in this index since 1990, a reading of 40+ occurs around 2.6% of the time.  The high VIX and elevated cash all suggest investors were bracing for serious market risk from the election[1].  Although we are not out of the woods quite yet, so far, civil order has been maintained.  As these hedges unwind, it is giving a lift to financial assets, especially equities.  However, the rise in equities is far from universal; cyclical stocks have not participated in the same degree as they are more dependent on fiscal action, which is now less likely.  Health care stocks have lifted on the idea that a single-payer system is less likely.  We will have more to say about the ramifications of this election in the coming months.  But, in the meantime, the outcome of a divided government is friendly to long-duration assets, stocks, and long-duration bonds.

COVID-19:  The number of reported cases is 48,215,732 with 1,227,096 deaths.  In the U.S., there are 9,488,875 confirmed cases with 233,734 deaths.  Yesterday, the infection rates rose above 100,000 for the first time.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high frequency data on various factors.  The Axios weekly state map shows the onset of winter; infection rates are mostly rising in the north and west, steady to falling in the south.

Virology: 

• Perhaps the most disturbing news we came across today originates in Denmark. It appears that COVID-19 has circulated in minks and has mutated into a new form that has infected at least 12 people in Denmark.  The country is the world’s largest producer of farmed minks, accounting for nearly 28% of the world’s mink output.  In order to quell the spread of this new strain, Denmark has ordered the culling of its massive mink herd.  It is still too early to tell exactly how this mutation has changed the virus, although primary indications are that it changes the “spikes” on the coronavirus and may undermine current vaccine efforts.  This explains the aggressive actions taken by Denmark.
• As infections and hospitalizations rise, we are seeing supplies of PPE tighten again.
• With surging infections, Europe is going through various stages of lockdown. Italy announced that it will close six regions and restrict travel in and out of these affected areas.  The U.K. Parliament approved a four-week national lockdown.
• We will close with some good news; AstraZeneca (AZN, USD 55.04) expects to announce the results of its Phase 3 trials before the year’s end.

Central Banks:  We report on two central banks this morning:

• The Bank of England sort of surprised the market by announcing its QE program will expand by GBP 150 billion, which was GBP 50 billion more than anticipated. However, there is a bit less here than meets the eye.  Central bank gilt purchases were extended for all of 2021 instead of the first half, meaning the overall monthly purchases will turn out to be about the same.  Essentially, QE was extended.  The GBP has rallied on the news; since QE is generally bearish for exchange rates, the fact the currency has rallied suggests this news was not bearish enough to offset the other bullish factors (e.g., expectations that Biden will win).
• The FOMC meeting concludes today. We know the markets expect too much new from this meeting.  The only area of interest will be the press conference, where we expect Chair Powell to plea for additional fiscal stimulus.

Brexit:  Although talks continue, the two sides remain stuck and deadlines are approaching.  Essentially, the problem is this—the U.K. wants out of the EU’s regulatory framework.  The EU won’t accept this and allow the U.K. open access to its market.  Westminster is dangling fishing rights for regulatory freedom.  If it wins on this point, it would be a shocker, although some areas in the EU would be severely harmed by losing access to fishing areas.  Another area where the U.K. has leverage is financial markets; its regulators are warning it won’t follow EU rules on dual listed securities if the EU doesn’t give London market access.  The transition period ends on 12/31 and it may not be possible for the EU to approve a deal at this late date.

Brazil:  Flávio Bolsonaro, the son of Brazil’s president, has been charged with corruption, specifically, embezzlement, money laundering, and criminal association.  He has been under investigation for two years.  According to reports, he was engaged in a familiar scheme in Brazil, where a state politician adds staff at the expense of the state, then demands kickbacks from workers.  The allegations have been denied, but at a minimum, it is a distraction and embarrassment for the administration.  At worst, it could create a political crisis.

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[1] Anecdotally, our conversations with financial advisors and their clients would tend to confirm this idea.