Stocks Are In Trouble No Matter Who Wins The Election

In the short-term, the U.S. stock market looks ripe for a rally. Big important stocks and the indices as a whole came into this week after a selloff that left them sitting on strong support — places where technicians would expect a bounce. VIX is dialed up to near 40, and options data show traders are buying downside hedges and far out-of-the-money puts on the S&P 500.

It stands to reason a good chunk of that positioning reflects investor anxiety around whether or not the election goes smoothly. Let’s define smoothly as 1) certainty about a winner within a few days and, to a lesser degree, 2) that the outcome is in line with current prediction markets expecting a Biden win and Democratic Congress. Moving past this event should be negative for vol and positive for stocks. Once we know the winner, the market can go back to reflecting broader changes in the economic landscape.

The very odd problem for investors is that this landscape is improving, and it has not been conducive to higher stock prices. Instead, persistent economic recovery is chipping away at sky-high tech valuations in expensive growth stocks that thrived during quarantine. That is proving more decisive to the overall direction of the S&P 500 than strength in companies tied to economic improvement.

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The bear case for the stock market right now is incredibly simple, and incredibly compelling: tech-stock valuations will not get better than they were during quarantine, and growth stocks will continue to drag on the market. It’s going to be very tough for the next President to reverse this.

Let’s go back to the high on Sep. 2. There is only one notable news story that overlaps with that day: shares of Tesla peaking after the company said it would issue $5 billion of new shares. After a 700% one-year rally, the stock ran out of steam. That’s it. No COVID news, no election poll; nothing apart from Tesla and a slew of other high-growth tech and quarantine trades that just stopped rallying.

Since then, companies that depend on the economy have outperformed the market. This dynamic fits with the economic data, which continue to beat expectations. Last week saw the first acceleration of Citi’s economic surprise index since August. Despite rising COVID curves, consumer spending and optimism are solid and travel numbers through last month continued to steadily improve. Throughout all that, investors have been dumping tech stocks no matter how good their earnings.

The simplest explanation for why we’re down 7% from the highs and why buy-the-dip is struggling is because investors are trading high-growth tech stocks for recovery plays, and it’s hard for recovery plays that are still dealing with COVID complications to carry the S&P 500 to new highs when mega-cap tech is deflating.

Here’s the simple case for why investors should expect tech to keep deflating:

  1. Tech stocks trade with high valuations because they offer growth
  2. Investors are willing to pay more for growth when growth is scarce
  3. Quarantine created a hugely bullish asymmetry between growth in tech stocks and growth in the overall economy: tech growth actually went up while the economy’s went down.

Speaking strictly in terms of valuation, it’s hard to see how it gets any better for these companies. Quarantine created the perfect scenario for these stocks to run wild, and their addressable market share was fast-forwarded by years in some cases. If the economy continues to improve, the tech bubble should keep deflating, and for now that’s the most important thing to the market. One way to offset this could be a gigantic stimulus bill that injects more money into the economy, but whether or not that will revive the tech trade depends on where the money goes and the status of the reopening (in which quarantine is positive for tech and the market).

And this is where we get back to the candidates. Consensus is that Biden and Democrats will spend more, but if that spending goes towards hospitality and consumer services companies that are buckling under COVID quarantines, that just gives investors another reason to bet on those recovery trades.

Even if the guy who wants to spend more money wins, bulls have an uphill battle, because if the worst of the COVID crisis is behind us, tech valuations have likely peaked. While one candidate’s fiscal plan may be more growth-positive than the other, they are both still economy-positive, and we’ve seen over the last two months that rotation is not a winning recipe for the U.S. stock market as a whole.

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