October 30, 2020

One of the most striking financial characteristics of the pandemic experience has been the seeming disconnect between the economy and the stock market. The economy was severely damaged by the lockdown of business and sheltering in place policies put in effect earlier this year, but until this week the market has been rising with more stocks.

The unemployment rate which had fallen to 3.5% last year, the lowest level since 1969, skyrocketed with the lockdowns, reaching 14.7% in April, a level not seen since the Great Depression. Since then it’s fallen, to a still elevated 7.9 % in September, the last report before the election.
How sound are the economy and markets going into the election? What could change?

Joining us with some answers this week will be financial thought leader, Jason Trennert. Trennert is co-founder, Chairman, CEO, and Chief Investment Strategist of Strategas, He says the wide policy differences between Biden and Trump call for different portfolio strategies post-election.

WEALTHTRACK Episode #1718; Originally Broadcast on October 30, 2020

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  • Co-Founder, Chairman, CEO & Chief Investment Strategist,
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CM: This week on WEALTHTRACK Strategas Chief Investment Strategist Jason Trennert on the health of the economy and markets heading into the elections.

JT: By any normal standard, this would be a very deep recession. So it's a very difficult line to walk for public policymakers because the costs of the lockdown economically and also socially, I think are quite large.

CM: What could change is our focus this week on Consuelo Mack WEALTHTRACK.

Announcer: Funding provided by Morgan Le Fay Dreams Foundation, ClearBridge Investments, Royce Investment Partners, Matthews Asia, First Eagle Investment Management and Strategas Asset Management.

CM: Hello and welcome to this edition of WEALTHTRACK, I'm Consuelo Mack. One of the most striking financial characteristics of the pandemic experience has been the seeming disconnect between the economy and the stock market. The economy was severely damaged by the lockdown of business and sheltering in place policies put in effect earlier this year. GDP growth fell five percent in the first three months of this year, then plummeted 31.4 percent in the second quarter. Strategas Research is forecasting a sharp rebound in the third quarter and more modest gains in the final three months of the year. Unemployment, which had fallen to three and a half percent last year, the lowest level since 1969, skyrocketed with the lockdown reaching 14.7 percent in April. That's a level not seen since the Great Depression. Since then it's fallen to a still elevated 7.9 percent in September, the last report before the election. Meanwhile, the stock market, which suffered a big decline in February and March, has rebounded from its March 23rd low and has gained some momentum and broader participation from some previously lagging sectors.

CM: Well how sound are the economy and markets going into the election? What could change? Joining us is Jason Trennert, Co-Founder, Chairman and Chief Executive Officer of Strategas, a leading provider of economic, market and policy research. Strategas has been voted a top macro research provider by Institutional Investor for several years in a row. It also provides asset management in separate accounts for institutions and high-net-worth individuals. Trennert has been a WEALTHTRACK guest since our launch in 2005, and Strategas is currently a WEALTHTRACK sponsor. I asked Trennert to start our conversation with a state of the economy report. How solid is the recovery?

JT: Well, I still think it's a little fragile. The good news is that we've come back a lot from where we were in March and April, but we're still about 10 million jobs shy of where we were in February. And so I think the fiscal stimulus that people are talking about is very much in the must-have as opposed to nice-to-have, especially if we're going to continue to keep a good part of the economy locked down.

CM: So the recovery then you still think is very dependent upon the fiscal stimulus packages that we've seen?

JT: I think so. I think…

CM: Why is that?

JT: Well, because the economy is still…big parts of the economy are still locked down. I think the best stimulus would be to open up the economy fully. I'm not saying that's the right thing to do, but that would be by far the best stimulus. If you can't do that, if our public policymakers don't think that's a wise thing to do, you're going to have to have more fiscal stimulus because a big part of the economy, a big part of employment is small businesses. It's about 26 percent of total employment. About 37 million people work for companies of less than a hundred people. And those are the companies that don't have access to the capital markets. They're much more dependent upon bank loans and therefore are much more fragile.

CM: So we've seen this unprecedented fiscal stimulus so far. And we've also seen, obviously…and everybody is using the word unprecedented…that the fiscal stimulus and the monetary stimulus as well. And you described it in notes to clients that it really is income replacement, it's not investment. So how important is that difference?

JT: Well, it's important to the extent to which once the income replacement dries up, you're going to need something to replace it. So that's either going to be a job for the people that are still out of work or it's going to be another check from the government. But it's hard to have it both ways. The unemployment rate is still just shy of eight percent right now, which is quite high, obviously, and it's a lot better than where we were in April. But by any normal standard, this would be a very deep recession. So it's a very difficult line to walk for public policymakers because the costs of the lockdown economically and also socially, I think are quite large. The benefits of keeping people safe are obvious. But I think as time goes on, people are going to have to balance the costs and the benefits of the lockdowns.

CM: You know, it's so interesting that you're kind of tempering our enthusiasm because I read research from a lot of your competitors and everybody is kind of raving about this V shaped recovery, and they're saying in GDP, in unemployment, in housing, for instance, they're looking globally at what's going on in China. The feeling seems to be that perhaps it's more self-sustaining now. You're saying you don't think it is self-sustaining again without some massive government help.

JT: Yeah, the budget deficit as a percentage of GDP this year will be about 16 percent. And just to give the average budget deficit since 1929 in the US has been three percent.

CM: Wow.

JT: We haven't run deficits this large since World War II. So it's hard to say it's self-sustaining, given just the amount of stimulus that's been dropped into the economy, both fiscal and monetary. Again, not to sound corny about it, it's remarkable what the US economy has been able to do with the stimulus that it's been given. The US is remarkably resilient. We had a high savings rate going into this. There are a lot of positives. But I also think you have to be realistic. The budget deficit last year was three trillion dollars; we thought it was going to be a trillion dollars. And so all of that largely just went to spending. Unless you can get people back to work, there's going to have to be some income that replaces that.

CM: Are there areas where you are seeing investment?

JT: The hard part is that the places where we're seeing the most investment are places that don't necessarily hire a lot of workers. Right. So technology is a perfect example where it's roughly – it's more than 25 percent of the S&P 500, of the index. It's a smaller part of the overall economy in terms of employment. And so you're seeing a lot of investment there by companies, but it still leaves you a big hole, particularly for people that might not have a college education. So that's kind of where the rubber meets the road is that you're seeing a lot of investment, certainly seeing a lot of investment, too, in health care and other sectors of the economy. But it's going to be tough for your more traditional sectors, if you will: industrials, basic materials. It'll hard for companies in those areas to put a lot of money to work in terms of capital investment, given the uncertainty surrounding the economy and our political situation.

CM: You know, one of the things that's been very heartening that we've seen is – we've seen a big surge in business formation, so creative destruction at work. But isn't that encouraging that businesses are going under, but there's also a kind of a record surge in new businesses being formed?

JT: Yes, I think that's what makes, I think, some of the political questions very, very important is are we going to continue on that road, which is much more of a supply side road where you create incentives for people to start businesses or do you make it more difficult for them to do that? I think we have to keep things in perspective. Again, the beauty of the system of free markets is that prices allow you to clear the system and you have creative destruction. We have in some ways suspended a complete clearing of the economic and financial system by all of the fiscal and monetary stimulus that we've done. So I don't want to get too optimistic about that. It's a great sign. But there's probably more pain to come for, particularly, again, in the smaller business part of the economy.

CM: How bad is the situation for small business?

JT: It seems to be quite regional, which is to say really, it's kind of a sliding scale between the extent of the lockdowns that you have on the one hand and also, on the other hand, getting a helping hand from the federal government. Where the lockdowns are most severe, certainly there's I think small businesses – let's say if you take the restaurant business. The very large, well-capitalized public companies are doing extremely well because they have take-out, they obviously have plenty of capital, they can work through this period of time. The smaller business that doesn't necessarily have the space or the infrastructure to deal with that is in a much, much more difficult situation. And again, it really is going to be hard for that smaller business and those areas really to get through this until there's a vaccine or there's a different attitude with regard to the lockdown.

CM: Right. And so the knock-off effects of that, we're not seeing it reflected in the stock market, which I'll get to in a minute. Are there comparable periods where if small business is on the ropes that it actually can kind of take down the entire economy or slow it sufficiently so that it shows up in the GDP numbers?

JT: Well, there's never been anything quite like this. I cannot think of a period where public policymakers are largely encouraging people not to engage in commerce. So that is different. I'm not sure that small businesses are probably large enough to pull the entire economy into recession, but it could keep it more slowly moving for quite some time. And it could also exacerbate some social issues in terms of income inequality and other questions that clearly have been on people's minds. So it's a serious issue.

CM: So going into the election, I know that you and your team at Strategas have definitely looked at the plans of both candidates. Is there a big difference in the plans between the two candidates as far as more fiscal stimulus, more help for workers?

JT: I think the market is anticipating that if Vice President Biden were to win, they'll get more fiscal stimulus at the margin. What I don't think is being priced in is that if there was a blue wave, for instance, if the Democrats were to take control of both the Senate and the House, along with getting the presidency, there would also be a big increase in taxes and not just on incomes above $400,000. It would be on capital gains, it would be on dividends. It would be on corporate profits, be on estates. So you're looking at very wide-ranging tax increases, which in my opinion is a difficult argument to make, given the fact that the unemployment rate is still quite high. So I'm not quite sure that scenario is priced into current stock prices.

CM: The big story has been, ever since this pandemic struck, has been the seeming disconnect between stock market performance, which has been fantastic and what's going on in the economy. How do you explain that disconnect? And is it, in fact – is the stock market tone deaf?

JT: Well, no, I think the stock market is responding to the fact that interest rates are zero. And so interest rates are largely like the gravity of price-earnings multiples. And now that you have interest rates at zero, in some ways it's not surprising that investors are paying for growth at any price. So any company that has any sort of growth prospects, it's being bid up because there are so few other alternatives for both the retail investor, the average investor, as well as the institutional investor that needs to provide a certain amount of return. So that's what's allowed growth stocks to outperform so dramatically.

JT: The S&P 500 as an index is very different than the composition of GDP. GDP is about 68 percent consumer spending. If you look at the S&P 500, tech alone is about 25 percent of the market. And then if you add health care, you add financials, you add telecom, you're close to 60 percent of the market. So it's very different to the extent to which the index is much more capital spending or production-oriented, while the economy itself is much more consumer spending oriented.

CM: Are we seeing a broader rally, more breadth in the market of the kinds of companies that are participating?

JT: You are. And I think that is a good sign. And more of what we call the cyclical or more value-oriented companies are starting to participate. You're seeing that in areas like industrials. You're seeing it in areas like basic materials, consumer discretionary. Those parts of the market are starting to do better as people are expecting that at some point in 2021 we'll have a vaccine and we'll be able to get back to normal. Certainly that's where I would say the value is in the value oriented parts of the market. The problem, of course, is you're betting a little bit. And if you're a long term investor, it may be very much worth the bet. But we don't know quite when that vaccine will come and when we're going to be able to resume business as usual.

CM: Is the election going to make any difference, do you think, on the market rally, number one, and also the kinds of companies that will benefit going forward? And I should say Strategas has two model portfolios, one a Democratic portfolio and one a Republican portfolio. And the Democratic portfolio has been outperforming the Republican one for a couple of months. Is that right?

JT: That's right. And the portfolios right now – it's interesting because the market as a whole actually would give President Trump a slight edge. Which is to say, in the three months before an election, if the market's up, the incumbent wins most of the time. When you look at the internals of the market, the types of stocks that are outperforming are much more consistent with Vice President Biden winning. So that would be solar and green energy stocks. It would be marijuana stocks. It would be things that are much more kind of aligned with more government spending. On the Republican side, on the other hand like financials and energy, are suffering.

CM: Are these the kind of decisions that you would make as an investor where you would actually, you know, switch your portfolio, what you own into a blue or a red portfolio? Is that something that is a wise thing to do or is that just something that you can do as a professional, but for the rest of us, it's a waste of time?

JT: I don't think it's a waste of time. I think this business is driven a lot by common sense, a lot more than people might give it credit for, professionals like myself. And I tend to think, though you want to have very clear signals about what you're going to get. And so hopefully we'll get those on election night. Hopefully, we'll have a very clear vision of what the new government will look like, both the presidency and Congress. Until then, I wouldn't make too many moves. Hopefully we learn that evening, but if we don't, I would be very careful about changing things around too much. The differences between the two candidates on taxes and on regulation is very, very wide. And so you want to be very careful, it seems to me. I wouldn't be doing a lot of speculating ahead of a very clear signal of what the new government looks like,

CM: What could derail the economy? What are you most concerned about as far as the economy is concerned?

JT: I have to say this, and I don't want to offend anyone's politics, but I do think a blue wave and an increase in taxes across the board, it's very, very difficult to see that as a good development for stocks. Corporate profits are going to be down about 20 percent for the S&P 500 this year. We calculate that if all of Vice President Biden's tax increases were to be enacted, it would cut at least another 10 percent off of corporate profits off of a level that's already down 20 percent. That would be very, very difficult for employment and for the economy as a whole going into 2021. That's what concerns me. Divided government is OK, but a blue wave would be problematic for me.

CM: Let me just counter that as well, because there's this adage, "Don't fight the Fed." There's a tremendous amount of stimulus, both fiscal and monetary, in the system already. We know that no matter who wins, that stimulus is probably going to continue. It's such a huge wave. Can't that overcome what will be legislative efforts that probably are not going to take effect right away anyhow?

JT: In the past, most of those tax increases that were passed happened to be retroactive to January 1st. So people to pay them, so there's that. But I also think you need the participation of the private sector and you want the private sector to be feeling confident so that they'll invest in their own companies and hire more workers. I think it would be very difficult. You do not want to get, I don't think either side wants to get into the habit of replacing private enterprise to get economic growth. Eventually, you'll run out of other people's money and it will cause other problems which are not good for investors either, like inflation.

CM: Let's talk about the sectors that you are overweighting now: tech, health care, telecom, industrials, materials. Walk us through why you're overweighting those sectors.

JT: Right. Well, so for technology, telecom and health care, it's really the growth trade that we were saying before. The idea is that in an absence of economic growth or slow growth, you want to continue to be overweight sectors that are going to provide you with better than expected earnings growth. We've started to dip our toe in a little bit with industrials and basic materials, just to the extent to which we do understand at a certain point, Lord willing, in 2021, there'll be a vaccine. You're going to start to have a more normal recovery than the one you've seen so far. So we've started to dabble in those sectors. But the real focus, generally speaking, is on the growthier parts of the market, like tech, telecom and health care.

CM: And why do you think that's going to contain? A lot of people consider those sectors, especially tech and telecom, to be pretty pricey,

JT: They're very pricey. It's again, Consuelo, it's really a sliding scale between how much you think the economy can pick up, what the policies are going to be to allow that to happen and whether interest rates increase as a result. If interest rates rise because the economy is getting stronger, in my opinion, that's very good for the value-oriented or the cyclically oriented stocks. If interest rates stay low because you have slower growth like the way we had after the last financial crisis, it seems to me growth stocks could even get more expensive than they are now.

CM: Let's talk about the growth versus value proposition, the US versus international proposition. Where do you think those trends are going to go?

JT: In many ways, those are largely the same trades, which is not that perfect overlap, but US, as a rule, is generally much more driven by growth stocks than most of the international indices, which are made up mainly or more of cyclically oriented stocks like financials, like energy, like basic materials. And so in many ways, it's the same trade. And for that reason, I would also have a bias towards the US over international in the same way I have a bias for growth over value. Until I get a really strong sense that the recovery in the economy is on very sound footing and will be really self-sustainable I think I'm going to continue to have a bias towards the growth-oriented sectors.

CM: And one investment for a long-term diversified portfolio. Jason, what do you think, given the uncertainty that we are surrounded with going into an election, what would you recommend that we all own some of that will survive whomever wins?

JT: Well, here again, this isn't that cheap, but I do think it will benefit in either scenario. And it's an ETFs called PAVE, which is an infrastructure ETF. It seems to me, given the level of unemployment that we have in this country, whether it's President Trump or President-elect Biden, it seems to me infrastructure spending is going to be a very big part of the program. You're going to get more fiscal stimulus and infrastructure is something, also, you get some productivity out of it. You get an investment, if you will, as opposed to just a transfer payment.

CM: And Jason, what are you most optimistic about? Again, regardless of who wins the election, what is it that you are looking at that is heartening to you as far as how we're getting through this pandemic?

JT: I really do think that the health care response of this country is been phenomenal. I think that given from where we started, where we are now, certainly there are more cases, but the morbidity of those cases is down dramatically. We're getting it looks like we're going to get a vaccine in time that would no one would ever think possible in the past. And it's kind of remarkable how Americans have really, frankly, put up with a very difficult situation. And so, you know, in that way, there's a lot to be optimistic about because this will end and we will have a vaccine at some point and things will get more back to normal. So in that regard, I think Americans can feel should feel good about themselves that we've been able to handle this. And this is a body blow, but we're coming back.

CM: We will leave it on that. Jason Trennert thank you so much for joining us from Strategas.

JT: Thank you.

CM: At the close of every WEALTHTRACK, we try to give you one suggestion to help you build and protect your wealth over the long term. This week's action point is: Own gold as a long-term portfolio diversifier. Strategas strategist Ryan Grabinski recently analyzed how the price of gold moved relative to seven major asset classes: large cap, small cap, international and emerging market stocks, aggregate and high yield bonds, oil and the dollar over the last year and the last 10 years. Despite higher positive correlations with all but one over the last year, in other words, moving in the same direction, gold had much lower correlations with all of them over the past 10 years, and it positively shown with its negative correlation to the dollar moving in the opposite direction in both periods. Strategas' take away – gold is a good long term portfolio diversifier in general, and particularly against the dollar. As Grabinski put it, if the dollar weakens materially over the coming years, gold should continue to do well.

CM: Next week in part two of our interview with we will identify the powerful macro forces shaping the investment climate. In this week's Extra feature, Trennert shares what he has learned from managing Strategas during the pandemic. For those of you connecting with us on Facebook, Twitter and our YouTube channel, we thank you and we really appreciate your presence with us today. Thanks for watching. Have a lovely weekend and make the week ahead a healthy, profitable and productive one.

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