On November 5, Janus Henderson Investors hosted a panel discussion exploring the market implications of the 2020 U.S. election. Although the final vote was still unknown at the time, Democrat Joe Biden was projected to take the White House and Republicans were expected to remain in control of the Senate, even as polls prior to the election had suggested that a Democratic sweep, or “blue wave,” was likely.
With that backdrop in mind, our panel of investment professionals – Ashwin Alankar, Ph.D., Head of Global Asset Allocation; Jim Cielinski, CFA, Global Head of Fixed Income; and Matt Peron, Director of Research – joined moderator Bruce Koepfgen, Head of North America, to discuss what the result could mean for financial markets and investors.
- Although the prospect of a split government suggests there will be less fiscal spending in the coming years, other policy risks have eased. And even without a “blue” sweep, we believe policy makers will pass some form of fiscal stimulus to help revive economic growth, particularly as the COVID-19 pandemic continues.
- Since bottoming in March, U.S. equities have been climbing the proverbial “wall of worry” as the market prices in an eventual economic recovery. With the election over, investor confidence could start to return, helping boost stocks, while low-to-negative policy rates could benefit credit.
- The election is just one of many factors to consider in today’s market. COVID-19 remains a dominant force, both in terms of upside potential (should a vaccine bring an end to the pandemic) and downside risk (should a resurgence of the virus lead to prolonged economic lockdowns). Secular stagnation, which we’ve seen in many parts of the developed world, is another consideration.
Bruce Koepfgen: This year’s election was destined to be remarkable under any circumstances, but particularly so in the context of the COVID-19 crisis. Over the past year, the pandemic has led to sharp contractions in economic growth and financial markets, while driving unemployment rates in the United States to levels not seen since the depression. The pandemic also raises questions, legitimate questions, about whether we could hold a successful election.
Although the outcome is still uncertain, election day is mercifully behind us. So we will focus our attention today on the results in the context of what it means for financial markets, the economy and investors. To do so, I am joined by Ash Alankar, Janus Henderson’s Head of Global Asset Allocation, Jim Cielinski, Global Head of Fixed Income, and Matt Peron, Director of Research. We have broken the discussion into five distinct topics. First, the immediate market reaction. Secondly, policy implications for the future. Third, the long-term impact for equities. Similarly, the long-term impact for fixed income. And then a section on volatility and downside risk. It is a lot of ground to cover, so let’s jump right in. Jim, let’s start with the market’s immediate reaction. How are bond markets responding to the outcome and what does that suggest to you?
Jim Cielinski: Well, we have priced out the blue wave, Bruce, and what I mean by that, of course, there was an anticipated clean sweep by Democrats and it looks highly unlikely now that they will gain control of the Senate. And so with that, a lot of the reflationary expectations that have been driving yields higher and the yield curve steeper in recent weeks have very abruptly actually turned around. So rates have fallen from about 0.9% down to about 0.75%. So again, not dramatic and I would like to emphasize that. Those were levels that we were at say in mid-October, but I think some of the reversal is what we saw very quickly in rates markets. And that is probably expected. I think maybe a bit more of a surprise was the recovery, which kind of kicked off almost immediately in risk assets. So credit spreads, high yield, emerging market debt, you know, very quickly found a bid and you might say, “Well, if there was less of a fiscal package coming, less fiscal stimulus, that was supposed to be bullish, why is that?” And I think that is a great question. I think first of all there will be less fiscal impetus now, but also there is less risk of say tax hikes, less risk of regulation. So I think there is kind of less of everything and less severe outcomes. And for many, right, this kind of just creates an environment where they can now look past the thing that has been right in front of their face really for the last two weeks and say, “What about the policy response? What is the policy path we face going forward?” It is more easy money. It is more low interest rates and generally supportive for risk assets. So I think that is how you explain what has happened in those riskier parts of the market. So it has been very risk-on, I would say in fixed income.
Koepfgen: Matt, let’s turn the same question to you. What about the stock market?
Matt Peron: Yes, like Jim was saying, the risk-on and the credit markets also was the case in the equities markets. And in particular, the absence of the blue wave that Jim mentioned had interesting sector level implications. In particular, we saw the tech and the health care sectors quite strong yesterday as some of the feared most impactful policies were pretty much taken off the table to benefit them. And on the flipside, we saw the financials underperform because as Jim mentioned, rates were lower, which would pressure their earnings recovery. But all-in-all, it was a risk-on reaction and we will get into some of the reasons for that as Jim mentioned and we will continue to talk about those.
Koepfgen: Excellent, and Ash, as a signal for election outcomes, the option market often telegraphs a message that differs from the consensus view. In 2016, I think the polls called for pretty much a Democratic sweep of the White House. But the options markets were more bullish on a Trump win. What was the option market telling us or signaling for us in this election and are you surprised by the outcome?
Ashwin Alankar: Great question. So the option market, fortunately, maintained its good track record. It was signaling a much tighter race than reflected in the consensus polls. We use option prices to, to get a sense of this, we use option prices to measure the expected upside to expected downside to a so-called basket of stocks, which would do really well under a Trump win and a basket of stocks which would do really well under a Biden win. And what you saw a few weeks coming into the election is something really, really interesting. The option market began favoring the Trump basket a few weeks before the election. And up to the election, the Trump basket of stocks was in fact expected to outperform the Biden baskets of stocks according to option prices. And assuming that public polls are priced by the cash markets, which is really reasonable assumption giving we all believe the market’s price and public information, what the option implied information is telling us is that the option market saw Biden’s lead to be much lower than what the public consensus polls were suggesting. In other words, a few days before the election, the polls had Biden at about a 7-1/2-point favorite and the option market was telling us, “Well, that lead is much, much, much lower.” This turned out to be true. The consensus poll once again got it wrong. As Bruce mentioned, the same thing happened back in 2016. The markets were telling us it was going to be tight and it turned out to be tight.
Koepfgen: Right. Well, let’s turn from that to kind of a further exploration of the policy implications of this outcome. You know, legal challenges aside, let’s assume for a second that the White House changes hands to the Democrats, so Republicans appear to be in a position to hold control of the Senate. The House will be controlled by the Democrats, but surprisingly I think to many, they lost seats in this election. So neither party seems to return to Washington with a resounding mandate, at least not to move to the extremes of their parties. Some suggest this kind of takes the worst-case scenario off the table. You all touched on that in the first section, but I would like to explore that a little bit more. Ash, what do you think, you know, in more depth, what does that really mean for policy going forward and what can the market depend on or dismiss as a risk for the markets?
Alankar: Well, first and foremost, the policy implication of a divided government has diminished political uncertainty going forward. The checks and balances inherent to a divided government take off the table the extreme, just as Matt and Jim alluded to. Fears of extreme tax hikes, fears of a strong antitrust movement targeted at big tech, fears of an overly aggressive trade policy and attacks, these are all off the table. And with these fears off the table, so are the tail risks associated with that. A divided government should bring moderate thinking, front and center, and if this does, and if this divided government does take shape here in the U.S., we must not forget, we absolutely must not forget it will have broad and far-reaching implications across the rest of the world, just like the progressive and populist movements here in the U.S., spawn their rise globally over the past few years. And this rejection of extremism in the U.S. may signal that the days of extreme progressive and populist movements are in fact behind us and political landscapes likely will move toward center thinking. And this moderate landscape on the political front is actually very, very market friendly. Markets don’t like uncertainty and they definitely do not like tail risks. And to no surprise, academic and empirical work has shown as an example, and these are pretty startling numbers, that even surprised me. U.S. equities outperformed by nearly 500 basis points per year under a split government that otherwise with data going back to 1950. This founding architecture behind our government system, which is rooted in checks and balances is something the markets clearly embrace.
Koepfgen: Can we conclude from that, Ash, and from the most recent market moves that another way of saying that is the market likes the center?
Alankar: Yes, I think that the market likes the center. I think another way to say the same thing, markets like weak governments. Markets like governments which don’t intervene. And if you have a split government, it is very hard for large legislation, particularly extreme legislation, to pass, which allows the capital market, just like Adam Smith alluded to and Adam Smith is famous about, that invisible hand allows capital markets, allows the private sector, to allocate capital in the most efficient way possible. And so if the government is not interfering with that efficient allocation of capital, all is equal, it is very, very good for risky assets. It is very good for economic growth and that is what you are seeing today, a continuation of what you saw yesterday in the capital markets.
Koepfgen: Matt, during the lead-up to the election, there was a lot of discussion about whether more fiscal stimulus was needed for an economic recovery. So I guess the question is if so, how much stimulus are we going to get now, if any?
Peron: Yeah, that was a key question, as you mentioned, Bruce, for the markets and they were pretty keyed on the discussions around stimulus now for a few weeks as well. And I see a number of questions from our audience already on that topic. So let’s dig in a little bit into what the fiscal stimulus means and what the likely path of that would be. So as Ash mentioned, without the mandate on either side and that more centrist type of policies are the path for fiscal stimulus will be significant, but probably less so than under different scenarios that we had modeled out. So we turned to sort of a more central base case type of path for stimulus and we assume that a package of around $1 trillion gets passed and that $1 trillion gets spread over some amount of time. The impact of the pandemic was quite significant earlier in the year, but as we move on, the economy has started to recover and if a fiscal package of the size we are talking about passes, again, this is probably regardless of any outcome now given that we know that the senate, which is much more important, that the GDP could surpass 2019 highs in 2021. So that would be a significant and quite a quick recovery to old pre-pandemic highs in GDP. So that would be quite constructive for the market is another reason why risk assets feel enough, that there will be enough tailwind behind them to continue the economy into expansion.
Koepfgen: And Jim, through the last few months of political chaos, you know, the Federal Reserve has played an outsized role in supporting the financial markets. Is that likely to continue do you think in the near term and how might that influence policy as well?
Cielinski: They will do all they can, Bruce. I think they will say they are willing to step in, they want to support markets. And as they do that though, they are going to be wondering what that means, because they don’t have a whole lot left in the tool kit. And as you can see on this chart, this does not just include the Fed, but the G4 central banks and what their policy rates are today, but also what the market implied rate is for the next three years. So rates are low, they are at zero, they are negative and they are going nowhere. And if you believe that volatility story, that is pretty powerful, but you can also say, you know, what is left? And you can see the phenomenal amount of balance sheet expansion. This is truly stunning. Again, G4 balance sheets at the central bank level have just exploded. And you can’t really model this. So if you are saying what does the Fed do, I think they are hoping and praying that the recovery is self-sustaining, first of all. They do have the ammunition to increase purchases. So when all you have is a hammer, every problem looks like a nail, they can do more QE and they will do more QE, they will do more direct intervention in markets. Maybe not the most effective, but it is certainly one of their most effective remaining tools. So I don’t see that coming any time soon, but to argue that they are out of ammunition for a central bank, that is always a mistake. But I think rates are going nowhere. They will do what they can to support Bruce, but they also recognize and they said this last year, they need help. And that help is the fiscal side.
Koepfgen: Right, right. I would like to take maybe a little bit more granular look at the sector impact, and I think this is relevant to all of you. So let’s take a look at what the sector impact is, and it seems overly simplistic to say that, you know, under a Democratic regime, green does better or under a conservative regime, the financial institutions do better. It must be more nuance than that. Matt, why don’t you kick that off and let’s just engage in a discussion about sector impact.
Peron: Sure. Yeah, so we did have a number of scenarios as well, depending on how strong the mandate would be. There will be some infrastructure spending, which is significant, but not enough to really get people too concerned, more so than they already are about the budget deficit. Trade policies will move back a little bit to the center, which will be constructive for markets, both U.S. and abroad. And the taxes, the tax situation will be much more benign. And that was one of the significant concerns of the market under a blue wave, which is that the tax regime would be onerous and more challenging for markets to digest. That has been taken off the table. Certainly the prospect of regulation is a modest negative for financials, lower rates, also that has already been in play. Oil and gas will continue to see some headwinds in terms of some of the policy prescriptions, but that also has been somewhat in play. In general, for the other sectors, we see most of this as a modest positive.
Koepfgen: Jim, Ash, you want to lean in on that?
Cielinski: I was going to say in the credit markets, you have seen I think some similar responses. Maybe a few other things to point out though is that the dollar is weaker and with lower trade friction, I think emerging markets are looking more attractive. And so emerging market currencies, emerging market bonds have been a sector that have kind of stood out in the last two days as doing well. I think maybe a slower and steadier growth pattern, I think high yield likes that as well. So high-yield bonds, for example, in the credit markets have been doing quite well over the last 48 hours. And I think that will continue, by the way. Go ahead, Ash.
Alankar: Just one thing which I wanted to just emphasize, which I think is important regarding the fiscal stimulus, less fiscal stimulus may not actually be a bad thing. Fiscal stimulus is not the panacea that many think it is. In fact, fiscal stimulus has a terrible historical track records in terms of leading to organic long-term GDP growth. Academic work shows that just over a few quarters, the fiscal multiplier, which measures how much of the dollar a government is spending, improves GDP. That multiplier falls well under one indicating a dollar of government spending results in less than a dollar improvement to GDP. And this is particularly true of wealth transfers, directly sending out money, directly writing checks to individuals and companies, which is the form that today’s fiscal stimulus really has taken. So at best, fiscal stimulus conforms to what people call Ricardian equivalence, and at worst, it is much, much lower. So such debt overhang is going to burn in the economy in the long run, it is going to be an issue we have to deal with, just like Japan has been dealing with it for the last 30 years So don’t be too … people shouldn’t be too worried and too down in my opinion that we may not get this $2 trillion fiscal stimulus plan, and it is probably going to be closer just like Matt articulated closer to a trillion dollars.
Koepfgen: Right. With that, let’s turn a little bit to the long-term impact on equities. Matt, you know, historically how impactful have these presidential elections been to the performance of the U.S. stock market?
Peron: Yeah, so thanks, Bruce. Picking up on the theme we were talking about earlier, which is the importance of the presidential election is less impactful than the overall posture of the government, a clear mandate on one side or the other has been actually more disruptive to markets. The President is generally weak in the U.S. by design and so to a certain extent, this has had very little impact on markets. Almost under any presidential regime, markets generally perform the same way regardless. And it is more a function of what is going on in the underlying economy. So again, this really supports our theme that under any circumstance, even if there is some change, that the markets probably won’t be, probably won’t see a disruption under those scenarios. And importantly, look at the following 12 months, which is to say it is very typical for markets to rally in the longer term and that is something we will come back to and pick up in a few minutes.
Koepfgen: Well, this year the market indices have managed to hit new highs and certainly post-election they have shown some desire to continue to climb. Do you think that in the context of everything we know today that they have room for more to run?
Peron: Yeah, well markets have been climbing the wall of worry that we always talk about. But yet markets have continued to sniff out the recovery and follow the path higher, climbing the wall of both election concerns and virus concerns. And so the people have been skeptical of this rally, that is fairly typical off the bottom of a recession. So as people start to embrace this recovery is for real, the election is behind us, the policy uncertainty has been hopefully resolved. I think the markets can work higher over the long term and we will come to some of the reasons why. One thing that is interesting, we looked at fund flows before and after elections. And while elections don’t necessarily impact markets as much as people think, certainly we see that in fund flows. Prior to an election, there typically are flows out of equity markets and then after the election, there seems to be an all clear and fund flows resume and return back to equity markets. And certainly we have seen some reason why that might be the case this time. So Bruce, to your question, there is still a lot of dry powder that can come back into the markets. We have seen 500 billion come out of equity markets in the past 18 months or so. So some of that could return now that one, there is a path on the economy we hope in the coming months that is healing and back to expansionary, as well as obviously the resolution of the election.
Koepfgen: So let’s change gears just a little bit. Although this is obviously a very American election, it has implications for the rest of the world. In your view, how might the European markets, emerging markets, other regions be impacted by not just our election, but what appears to be the nature of this specific election?
Peron: Yeah, I think Jim really hit on that earlier, which is to say I think there will be some relief that some of the trade policies will be much more centrist and much more conducive to global growth. And certainly we have seen that in the market actions. So I think there will be, as markets expand globally, we are seeing that in Asia, return to expansion, there will be a much more lift, much more equal participation in markets across the globe as the recovery now unfolds.
Koepfgen: So let’s turn our attention to the same question for fixed income. Corporate credit spreads have tightened this year and while rates remain globally low, you know, what are likely to be the dominant drivers to bond returns going forward?
Cielinski: Thanks, Bruce. As is always the case, the dominant drivers are number one, the path of short-term policy rates. And then secondly, you get some premium on top of that and that is inflation, I think in this market environment today, it is also about the economy, it is about I think what policy can do, how much can central banks distort markets? But with short rates locked at zero, I think you would have to get quite a surprise around inflation or growth to really push rates up significantly. And for that reason, I think you are probably likely to see kind of a range-bound market for interest rates now, particularly now that we have taken off these more severe outcomes. I think in particular though on the economy, I think Ash is absolutely right, the efficacy of fiscal is actually quite low as it impacts the economy. And one of the reasons for that is that I think a lot of people look at the level of fiscal policy and in fact, what matters a lot is the rate of change. So I am not that excited about a one trillion plus I think fiscal package. Sure it is a lot of money, but if you think about how much is rolling off from what we have done this year and many of those packages were quite temporary in nature. So what you will have without a fiscal package is actually quite a steep drop off in what I would call the credit impulse and that does create a risk. So I do think we need more fiscal help, if for no other reason to help kind of buffer the change that we are seeing as these kind of shorter-term programs roll off. I think we will get it. I see no reason for a compromise, even with a Republican Senate for some kind of fiscal package not to go through. I think everybody knows that one is needed. The terms of those will be no tax increases, by the way, so I think that is what the market is kind of focusing on. I would worry though that the rate of change, if we don’t get anything, is actually steeper than anything that we ever have witnessed on the fiscal side. So I worry that you would see some real I think harm done to the economy and that would probably lead to lower rates. So again, I think policymakers know this. They are going to err on the side of doing too much if they can, so I think we will stay true.
You asked about corporate bonds, Bruce. Like I said earlier, they have done really well post-election here. They were already doing well and I have heard over and over I think that they are disconnected from reality, right? The fundamentals don’t justify these kinds of credit spreads. But I don’t see it that way. What you had in March was the beginning of a credit crisis. You know, for me it is all three components that you need for a crisis, you had a lot of debt, you had companies losing access to capital and you had a big exogenous shock to cashflow. Those three things together are what give you a crisis. Now when central banks stepped in though, they did it with the express purpose of allowing companies to access capital. And so take away one of those three pillars, what you had was the market price in a potential crisis and then price it out. So that is not disconnected from reality, that is what is supposed to happen. But now it does get tougher. I think you are likely to see fundamentals come to the fore, as they normally do in markets. Defaults and downgrades are always lagging indicators. We are still in the midst of what the pain from the earlier in 2020 shutdowns have caused, defaults are higher, downgrades are higher, but again those are lagging indicators. Companies have termed out debt, they are now going to deliver, defaults will fall in 2021, assuming we don’t do a big double dip kind of recession. And so credit spreads to me are not going to perform the miracles they have done in the last three or four months in terms of returns, because some of that has been pulled forward. But the default environment looks actually pretty good to me, as it will continue to recede. And the search for income is, it is a steamroller. We have talked about policy rates at zero, staying there, you are talking about I think a demographic that is aging and needs to save more. The search for income, the demand for things like corporate bonds is I think going to remain extraordinarily strong, so long as you don’t get unexpected spike in defaults. And I think with what we have in front of us today, I would have argued that under several different outcomes, that default trend was likely to come down. But I don’t see anything that we have seen in the election tell me that we should change that view. Search for income, lower defaults, supportive policy, and very low real rates. When real rates are this low, companies don’t tend to default, just because they can borrow money cheaply and they don’t go out of business. So I think the outlook is actually quite good for most of these areas. Just don’t expect the extraordinary returns from either this or from bonds overall given the low starting points of yields. So you have to get used to that, but I will turn it back to you, Bruce.
Koepfgen: Sure, thank you very much. So Ash, let’s turn to volatility and downside risk. The option markets are used as a tool to manage risk and maximize opportunity. What is the option market saying about the near term and how might that differ from the consensus view that we all read about in the paper?
Alankar: Great question. What the option market first and foremost is telling us and what they are sniffing out is there is much better risk premium to be sourced in the equity markets and fixed income markets. The option market also expects many of the trends that have characterized the equity markets over really the last ten years to remain intact, it sees U.S. equities leading the pack, it sees growth equities, technology leading the pack, large cap names leading the pack. When it comes to the fixed-income markets, the option markets are telling us that the great bond bull market of the last four decades might be behind us. It is seeing much more downside risk than upside risk for treasuries. And this has tremendous implications, and I can’t emphasize this as much, tremendous implications on how w think about the role that bonds play in our portfolios going forward. We might be entering a new bond regime and if so, we need to understand what this new regime means for bonds. Will they continue to act as a great hedge to offset equity losses? What carry can we expect bonds to deliver relative to cash? What is the cost of holding bonds as a diversifier to equity risks going forward? But with this said, I personally thought 10-year yields when they were at 2% and real yields were below 50 basis points, that yields could not go much further down. And here we sit today, 10-year yield around 80 basis points, 10-year real yield nearly minus 100 basis points. So bonds could definitely surprise us going forward, but at least right now in the short run that the option market isn’t a big fan of bonds and it has seen much better risk premiums to be sourced in the end in the equity markets.
Koepfgen: And what is the option market telling us about future volatility? How can our investors protect themselves against this kind of drawdown, you know, downside risk?
Alankar: Yeah, that is a key question that I really encourage everyone on the call to pay a lot of attention to. So one, the market has sharply realized down its forward volatility expectation. Likely on the banks, it is split in the government structure resulting in lower political uncertainty, as an example. Simple example the VIX has shed about 30% over the last few days. But the level of volatility is still much higher than the low volatility that characterized the markets over the last decade. We cannot forget, hey, the pandemic is still here. We cannot forget the unprecedented amount of debt that is accumulated by governments globally in response to the pandemic. Ultimately, it has to be dealt with. These are all sources of risk, which is why volatility still is at a much higher level than we saw in 2019, 2018 and any period really post 2009. And at the same time, when you have these structural headwinds, should Biden win, we really don’t know what path he really wants to take the country on until he starts to fill his Cabinet positions. So this is another source of uncertainty that any new President Elect brings with them. So when it comes to hedging these risks, I feel it is really, really, really important to keep it simple, to keep it direct. If you get too complicated in how you are hedging the downside risk in your portfolio, it is really easy to get confused, it is really easy to get lost and it is really easy to not understand exactly what your protection is going to do and you might find yourself in the very dangerous position that the protection does not do what it is intended to do when a stress event hits. So the good news is there are several cost-effective ways to purchase very simple as an example long-dated equity put spreads to mitigate the left tail risk associated with equities. And a great way to offset, so these are cost effective, but you still have to pay a premium for insurance. Free insurance is too good to be true. And a great way to offset these costs is really taking on more alpha risk, moving more towards active investing versus passive. Thinking about adding additional tracking err to your portfolios, by allocating to hedge funds. To allocate to other sources of uncorrelated alpha. If you can find such alpha, it is a great way to help finance the cost of purchasing protection and building a very stable portfolio. So my recommendation here, if people are thinking about what are good ways to hedge equity risks? Think about first and foremost, keeping it simple and don’t get to complicated when it comes to purchasing and protecting your portfolios.
Koepfgen: Moving away from the risk mitigation question for a second. You know, with the election cycle over and the economy gradually starting to recover, can you suggest ways that investors could potentially add yield or appreciation to their portfolio?
Alankar: Well, it is hard. Just like Jim said, yields are low. Expected returns on bonds are low. Looking at the forward market, so what are the forward markets in fixed income on interest rates telling us about the expected return to 10-year Treasuries going forward? And this was as of about a week ago, so with rates lower today, it is going to look even lower, but the expected one-year return on a 10-year Treasury is 120 basis points per year. Expected two-year return on holding a 10-year Treasury is even less at 120 basis points per year. These are at record lows. So the days of easy carry might be behind us. Investors benefitted greatly over the last, I don’t know, 40 years, really since the 1980s when rates were close to 20% and they have just rolled down lower and lower and lower. So I do think a focus going forward has to be more on risk premium, allocating to assets where risk premiums are higher, such as equities, such as riskier credit. But this is a double-edge sword, right? This also means you are bearing more risk, so you carefully have to think about how to hedge these risks, so you are not bearing more risk in your portfolios than you are comfortable with. Tail hedging in my opinion is going to be extremely critical going forward. As carry, one could argue, was a key ingredient to successful investment over the last 30, 40 years. Going forward, I believe sourcing risk premium in a risk-aware setting, so really thinking about those tail hedges is going to be really important and is going to be the key to successful investment going forward.
Koepfgen: Okay, guys, we are coming up on time, so I think a good place to maybe wrap this up is to get each of your views one other important question. I mean given what has happened so far in 2020, pandemic, the global recession, the U.S. election, what do you see as the greatest risk in the markets that investors are overlooking? You know, what is the one thing that people are not talking about that they should be focused on?
Peron: Bruce, I will start. And the big picture is that we have started a cycle new and that expectation typically is that we have the five-year cycles or so and that earnings will continue to recover. But anything that derails that can or that interrupts that could cause a disruption in markets and could be a risk. Those are necessitated shutdowns from a resurgence in the Coronavirus would be one potential risk, I see there are some questions on that. As well as a bout of inflation, for example, which is typically very challenging for equity multiples. Those are two risks I think that certainly need to be, we need to be mindful of. But again, you know, anything that derails the recovery would certainly be problematic for equity markets.
Koepfgen: Ash or Jim?
Cielinski: I would, I know everybody is worried about inflation. I am not. I think there are a few years to go before we get the gap closed, so I wouldn’t be immediately concerned about that. I actually worry, I am talking things that are not priced in, not expected, the secular stagnation argument spreading into big parts of the U.S. economy. And we are seeing this globally, all across the western world, where a level of rates to be low enough to really encourage private credit creation and real credit demand, we haven’t found it. And I think with real rates where they are, this is a great experiment for 2021. If this cannot show itself, the recovery, to be self-sustaining, I think this kind of secular stagnation argument, which we had a few years ago of is there a rate low enough and if there isn’t, get a really sluggish growth period, returns forward and it is not just bonds that look bad, it is returns on many things that look bad and the economy itself just kind of trundles along. So I would keep that in the back of my mind for 2021. I have to worry about something, I am a bond guy.
Koepfgen: Ash, final thoughts?
Alankar: Yeah, well a risk that is on my list is in fact not a downside tail risk, but it is an upside tail risk. It is a risk I could portend to melt up. And I think one risk out here is the public, related to the pandemic, which Matt brought up, is the public may not be as adverse as many suspect in taking a coronavirus vaccine when it is made available. People want their lives to return back to normal. People want to feel safe when they are traveling. People want to feel safe when they are going out to eat. They want to feel safe to go to the movie theaters or to Broadway. So we actually may see a much greater uptake in the vaccine than a lot of people think, which could lead to a further market melt up. So you have to remember, when you are thinking about risks, you are thinking about what affects the markets. There are two forms of risk, there is bad risk, but there is good risk as well. And we have to pay attention to both. So top on my list is actually a tail risk, which is a good risk, so keep that in mind as well.
Koepfgen: Right, thanks. Well, that seems like a pretty good thought to call this to an end. Ash, Jim, Matt, thanks so much for sharing your thoughts on potential market impact in 2020 for this election and for all of those, for you on the phone and everyone listening elsewhere, thank you for joining the webcast today. We appreciate your time, we hope this discussion will help you in your conversations with your clients or in thinking about the market environment. So thank you very much and I will turn it back to Kathleen.
Our team arrives at its outlook using options market prices to infer expected tail gains (ETG) and expected tail losses (ETL) for each basket of stocks. The ratio of these two (ETG/ETL) provides signals about the risk-adjusted attractiveness of each basket. We view this ratio as a “Tail-Based Sharpe Ratio.”
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