If there ever was a poster child for the definition of “disruption,” the year 2020 would certainly be it. In these first seven months we have dealt with one shock after another – the global healthcare crisis, rising political, social, and civil unrest, incredible market volatility and the largest economic intervention the modern world has ever seen.
Certainly, life as we once knew it has inexorably changed and humankind is struggling to adapt to our post-COVID world. While we cannot control the events around us, we can focus on trying to understand what areas are impacted by existential threats and where the burgeoning opportunities lie in this New World we live in.
Our New World is increasingly binary between the haves and the have-nots – not only on an individual level, but also on a country, sector, and industry level as well. The virus has done nothing but to accelerate and accentuate this trend. From an economic and market perspective, our base case remains a “W”-shaped recovery, characterized by strong economic rebounds interspersed with short-duration setbacks, with certain segments of the economy proving more resilient and durable than others.
Figure 1: New Economy Sectors vs. Old: The Strong Get Stronger
Source: Cornerstone Macro
While many headlines these days seem dire and can even be downright depressing, we believe it is important to keep following the data and look at the underlying drivers of economic recovery. It is clear that certain industries will take years to get back to “normal,” if ever, but it is also clear that there is significant strength building in important segments of our economy – specifically the ones that amplify and accelerate growth such as manufacturing, housing and small business sentiment.
Figure 2: Underlying Improvements in Key Multipliers
Source: Cornerstone Macro
During all this turmoil and tragedy, we have been amazed by so many examples of incredible human spirit and perseverance. Promising signs of a vaccine, businesses innovating and pivoting their strategies and simple acts of people being kind to each other have all been encouraging to see. 2020 will pass, and COVID-19 will eventually pass too. What will life, industry, and healthcare look like on the other side? As necessity has always been the mother of invention, we choose to embrace this disruption and are continuing to expand our client portfolio exposures to Innovation.
Figure 3: More Than Just a Style: Innovation is a Strategic Allocation Across Our Client Equity Holdings
Source: ARK Invest
While some may try and access Innovation by simply investing into the technology sector, we think of it in terms of how technology can act as a catalyst across multiple industries and sectors, and how that ultimately improves quality of life. For example, we recently built exposures to molecular diagnostics, gene therapy and genome sequencing into our clients’ portfolios, adding to our existing exposures of smart power, artificial intelligence (AI), robotics and automation. Also, for several of our Qualified Purchaser clients, we recently sourced and allocated significant capital to a private Growth Equity fund with a mandate to invest in FinTech, Retail Disruptors, Healthcare Technology and Enterprise Solutions. Two of the Fund’s early investments in global online dating platforms and sustainable plant-based foods are proving both extremely profitable and very timely.
Figure 4: Platforms for Growth in a post-COVID World
Source: ARK Invest
These days everyone could use some good news, and the forecasts for these platforms for growth are truly something to get excited about. International Data Corporation predicts that spending on AI and robotics is expected to grow at a 28% compound annual rate and spending on the Internet of Things (IoT) is expected to grow at double digit rates though 2022, surpassing $1T dollars. Thoughtful capital expenditures and R&D ultimately lead to productivity growth, which leads to profitability and market growth. As society continues to muddle through persistently low interest rates, meager inflation and growth expectations, we continue to believe that investing in Innovation is the best way to help our clients navigate this New World.
Figure 5: Projections for Total Equity Market Capitalization By Disruptor
Source: ARK Invest
While we painstakingly work our way through the COVID-19 crisis, investor attention is increasingly turning towards the November election. Since 1928, no Incumbent President has ever been re-elected when there has either been a recession or a 20% market decline during the election year. If history is any guide, President Trump faces an uphill battle given that the US has already experienced both in 2020.
Figure 6: Election Year Bear Markets and Recessions Historically Do Not Favor the Incumbent
Source: Ned Davis Research
Regardless on which side of the political aisle one sits, significant market implications remain from one of the three likely electoral outcomes: 1) a Democratic sweep, 2) a Biden win and split Congress, or 3) Status Quo. We view the chances of the fourth possible outcome, a GOP sweep, as extremely unlikely. We have detailed some of the possible ramifications of the first three scenarios, and their estimated chances of occurring, below.
A Democratic sweep (45% chance) is broadly seen as negative for the markets, would likely result in increased corporate taxes of $1.5T over the next 10 years, impacting S&P earnings by 4-13%. Higher personal, business and investment taxes would lower potential GDP while the healthcare, tech and financial sectors would be at risk for targeted taxes and increased regulation.
A Biden win and split Congress (20% chance) would probably be viewed as neutral or even a net positive for financial markets. The current tax regime would likely remain intact, and lower trade risks combined with higher federal spending would be supportive of GDP in the near term. One downside would be the expectation for substantially higher regulatory costs.
A status quo outcome (30% chance) would also likely be neutral for the financial markets as pro-growth tax rates would remain the same, federal spending stays consistent and regulatory costs remain low. On the flip side, trade risks and general uncertainty would likely be higher during a second Trump term.
Figure 7: Current Odds Give Slight Edge to a Market-Friendly Outcome, 55% to 45%
Source: Cornerstone Macro
Gauging downside risk to the markets in the case of a Trump loss and corresponding Democratic sweep is exceedingly difficult to estimate. Since 1928, there have been five instances when the Incumbent Republican has lost, and each time the market has experienced a reasonable correction and corresponding rally during that election year. While the electoral outcome remains highly uncertain, it is clear that volatility is substantially higher when the incumbent party loses.
Figure 8: Election Year Volatility
Source: Ned Davis Research
As with the path of the virus, time will tell when election clarity will finally start to arrive. We suspect the markets will likely start to price in the election results as we move through the third quarter of this most unusual year. We are encouraged by the strength of the economic rebound so far and remain hopeful for a continued recovery and better days ahead.
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