Canadian stocks declined modestly, pressured by weakness in technology and industrial stocks. Following three consecutive weekly advances, U.S. stocks also declined last week. The news flow was dominated by headlines around the negotiations for another round of fiscal relief from Washington before the U.S. election, which is fast approaching. The 10-year Government of Canada and U.S. Treasury yields rose to the highest level in four months amid expectations that a potential Biden win would lead to a larger relief package to support the U.S. economy. Aside from the speculation about potential election outcomes and policies, U.S. economic data for the week was encouraging to the long-term outlook, showing an improvement in jobless claims and continued strength in the housing market.

Markets behaved in a somewhat orderly fashion last week, oscillating in a fairly narrow band that left equity markets slightly in the red for the week.  We’d stop short of labeling last week the "calm before the storm" because we think there are credible reasons for stocks to have a toehold. That said, we think investors would be well served to brace for a bumpier ride as we work our way to, and through, the U.S. election.

Current conditions are prompting a perception among some investors that the U.S. election represents a binary outcome for the market. November 3 may be viewed as a seminal moment in America’s political landscape, but when it comes to investing, it’s the much broader periods of time – not singular moments – that matter most.

In addition to political headlines and reasonably encouraging economic readings, last week brought a few market “anniversaries”, including the 33rd anniversary of the “Black Monday” crash. Here’s a look back at a range of notable days or periods for the market and the accompanying investment conditions that can provide some perspective on what may lay ahead for investors:

One Week: All Eyes on Congress    

• Most eyes are focused on the race for the Oval Office with one week to go until election day, but the market took its cues from the progress (or lack thereof) on negotiations for another round of fiscal relief from Washington. Stocks rose on glints of partisan compromise and softened on any news of renewed stalemates.
• The fact that the market moves were more influenced by the prospects of fiscal stimulus than the impending election signals three things:
  1. The importance of additional fiscal relief to the health of the economic recovery.
  2. This election matters, but the growth of the economy and corporate earnings will be a more powerful and lasting driver of market performance after the election frenzy subsides.
  3. The market has become somewhat more comfortable with the fiscal implications of potential election outcomes.
• 10-year rates rose last week, signaling that the market may be applying a more positive outlook to economic growth next year regardless of the election outcome¹. It appears the market is reflecting a view that a Biden win, while likely to bring higher tax rates for businesses and high-income earners, could also come with a larger fiscal aid package and/or infrastructure bill, which would offer a boost to near-term GDP.
• We maintain our view that the economic expansion in Canada and the U.S. will be sustained in the coming years, irrespective of who wins the White House. At the same time, we’re not convinced that the market will maintain its tranquility in the coming weeks.
• We expect markets to swing widely around the election, particularly if November 3rd produces a contested or inconclusive result.  Any election-driven volatility should not, in our view, be a reason to abandon your longer-term strategy.  Election anxiety may be sizable or extended, but it will pass, and markets will take their cues from the larger economic recovery.  Economic readings last week are indicative of an economy is still enduring pandemic headwinds, but remains on a path of broad improvement. 

Seven Months: The Bear Market Turns Into a Bull

• March 23 was the pandemic bear-market low, with the fastest drop in history from record highs to finding a bottom¹. Stocks fell 35% in just over a month as the health care crisis and budding economic shutdown produced the first bear market in more than a decade¹.
• The drop was severe and jarring, but discipline and perspective were rewarded as March 23 represented the inflection point in the stock market “V." Equities have returned to new highs, including a 60% rally from late March to early September, one of the most vigorous starts to a market recovery in history¹.
• While the unique nature of the recession (a self-imposed shutdown) played a key role in the sharp moves, the policy responses from the central banks and lawmakers formed the foundation that enabled the rebound to take shape. We expect these forces to remain helpful as we advance. Domestically, support from the Bank of Canada and Ottawa should remain in place for the next few years and are likely to be tuned as economic conditions warrant. In the U.S., we think the Fed will keep rates low, support credit markets and provide unprecedented liquidity for several years to come. And while not without partisan battles, we think another round of U.S. fiscal aid after the election will transpire, providing needed relief to businesses and households that can support spending amid the economic gap until the labour market heals further and an eventual vaccine can usher in more normal economic activity.

Four Years: Politics Pivots to Policy

• The four-year anniversary of the last U.S. presidential election is approaching. November 8th, 2016 shifted the market’s focus from a unique and heated campaign toward the potential policy landscape under a newly-elected President Trump.
• Markets swung widely in the week leading up to the election, became even more volatile in the overnight markets as the election results came in, and found a boost the day following election, rising more than 1% on November 9, 2016¹.
• Our view – supported by historical experience – is that markets are not partisan in the long-run, but hate uncertainty in the short-run.  Elections bring uncertainty, but as that uncertainty fades, stocks reconnect to fundamentals which are influenced – but not solely determined – by Washington policies.
• The S&P 500 saw a healthy rally following the election, rising more than 20% in 2017 with historically-low volatility (the market never experienced even a 3% pullback during that year) as the prospects of coming tax reform spurred equity-market optimism¹.
• Concerns that a Biden administration will reverse some of that tax policy are not misplaced, in our view, but it should not be overlooked that 1) markets have thrived in much higher corporate tax regimes than he is proposing and 2) the markets are finding some comfort in the potential for a larger Democratic fiscal package to offset the near-term economic and corporate profit impact of a rise to a 28% corporate tax rate¹. 
• While it can be difficult in the throes of the election, it’s important to avoid evaluating investment conditions through politically-colored lenses. The stock market has risen 62% since the last election, which included the pandemic bear market¹. The market rose 58% from 2009 through 2012, the first four years of the Obama administration, which also included a portion of the global financial crisis and Great Recession¹. This is not an endorsement or an indictment of any party, but instead a reminder that markets have done well under a myriad of different political conditions.
• Since WWII, the average stock market return in the four years between presidential elections is 37%¹. There were only three four-year terms in which the market was negative for the period. 

33 years: Black Monday Sets the Bar for Volatility

• Last week brought the 33rd anniversary of what is known as “Black Monday”. On October 19, 1987, the Dow fell 23% (508 points at the time), the largest single-day decline for the stock market. For perspective, the second-largest decline on record happened earlier this year when the Dow fell 13% (2,997 points) on March 16th¹. 
• A good reminder of why it’s important not to panic or abandon your strategy when daily declines reach extremes, the Dow had its eighth-best day on record two days after Black Monday (rising 10% on 10/21) and its fourth-best day in history earlier this year, rising more than 11% on March 24¹. 
• Conditions in 1987 were sufficiently different than they are today with the market selloff driven more by prevailing market factors and structure at the time. There was no associated recession (one of the few bear markets in history that was not accompanied by a recession) and stocks returned to pre-Black Monday levels two years later. 
• While economic conditions, policy settings and market structure are different today, the anniversary of Black Monday highlights that:
  • Market volatility is normal. Daily declines of 20% are certainly not normal, nor do we think swings, like we saw in March of this year, will be frequent or regular¹. But extreme short-term market moves don’t necessarily signal a more protracted period of market declines ahead.  In fact, historically the most significant daily declines tend to occur near the latter stages of selloffs and are often followed by similarly large up days; and 
  • Bear markets are followed by bull markets.  Black Monday was followed by the longest bull market in history, spanning from 1987 to 2000.  The ‘08/’09 financial crisis gave way to the second-longest bull market for the S&P 500 that ran from 2009 to 2020 (the TSX bull market was interrupted by a 20% bear market drop in 2014-2016)¹. We don’t think another decade-long bull market is an inevitability from here, but this year’s market rebound demonstrates the value of a disciplined strategy and a long-term approach to investing. 

Craig Fehr, CFA
Investment Strategist

^{Sources: 1. Morningstar Direct}

^{Source: Factset, 10/23/2020 *4-day performance ending on Thursday. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.}

The third-quarter earnings season is in full swing, with almost 20% of the TSX and 40% of the S&P 500 companies reporting earnings throughout the week. Important economic data being released in Canada include the Bank of Canada rate decision on Wednesday and August GDP growth on Friday.