Blue Wave Hits Stimulus Reef

The “blue wave” stimulus trade hit a reef overnight, as another night of no progress on US stimulus talks tested the conviction of investors. The effects were most noticeable on US equity markets, which finished deeply in the red, sucked out to sea by the receding blue wave. The surge in Covid-19 cases around the world, notably in Europe, has also sapped confidence, increasing fears of a “double-dip” scenario.

Investors reducing risk ahead of US election

I would expect the rest of the week to now be characterised by much of the same. A reduction of risk as investors belatedly reduce exposure ahead of the US election on Tuesday. That should see equities remain heavy, even if US big tech earnings this week remain impressive, which I expect them to do. The US dollar should also benefit along with other haven associated currencies, and interestingly, gold rose overnight, detaching itself from the US equity sell-off. Although ranges remain very compressed on gold and silver, with a large breakout soon to happen, gold’s resilience overnight suggests that haven positioning is increasing.

As I have stated ad nauseam, the “blue wave” trade is premised on a complicated series of events going just right. Life is usually not that simple. In a nutshell, Joe Biden must win handsomely, and the Democrats must win the Senate in the same manner with no close results leading to contested election results. Those would then likely, end up in front of a conservatively lop-sided Supreme Court. I personally thought US courts were apolitical, but apparently not when it comes to interpretation. This last thank you gift from the Republicans may yet play its part.

Spread betting on the US presidential and Senate elections indicates key races are much closer than the polls suggest. That is often the case and a mitigating factor this time is that according to the US Election Project, nearly 64 million American’s have already voted. I note, however, that the state heat map shows early voting has been light to medium in many swing states, Florida and Texas excepted. Votes on the day will still play their part and explains why both US presidential candidates are campaigning hard in those states.

Although Mr Mnuchin and Ms Pelosi’s teams are edging closer to stimulus deal, markets are completely ignoring the fact that it has little to no chance of making it through the US Senate. Even if the Democrats sweep all before them next week, the incumbent US Senate and presidency remains in place until January. That time is typically used to clean out offices and hand out pardons, but, well, I don’t have to explain.

So even if big tech, starting with Microsoft today, outperforms; and a stimulus agreement emerges this week, there is a potentially big mess coming next week. Any knee-jerk equity rallies are likely to be that, temporary spikes, especially as the street has been fully positioned for it for some time. Rather than betting the house on a “blue wave,” the only thing I am sure about is that volatility will be moving higher as the week progresses. There will be no shame in heading to the side-lines for the next week or two.

China’s Industrial Profits (YTD) YoY for September fell by 2.4% this morning. That is an improvement over August’s -4.4% drop but has likely disappointed the markets somewhat. Any lull, though, is a temporary one, with China data elsewhere continuing to star globally. Far more important will be China’s official PMIs, released inconveniently, this Saturday, followed by the Caixin PMIs next Monday. Both should steady the ship although the outlook may be dimmed going forward if Europe runs out of steam on a Covid-19 second wave. The yuan should continue to outperform, boosted by inflows to Chinese bonds and equities, although it will not be immune to pre-US-election dollar strength.

Tonight’s US Durable Goods data will be the day’s highlight, with orders expected to rise by 0.50%. US data of late has also outperformed but swamped in stimulus and election noise. With the White House Chief of Staff admitting yesterday the administration was all or nothing on Covid-19 vaccines, as opposed to control after a year of trying (or not), this could be peak post-virus (or not). Exploding Covid-19 infections across the country could yet dent the American fourth-quarter comeback. Looked at in conjunction with Europe’s situation, there are severe threats to the consumption side of the global recovery. For all the talk about China, it is essential to remember when America gets Covid-19, the rest of the world gets sent to the isolation facility. In this respect, I hope I am completely wrong, but I would hold off getting bullish for oil, and energy and airline companies for a while. I will happily miss the bottom of that trade.

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