The Prussian General Carl von Clausewitz is credited with the concept of “the fog of war.” The basic idea is that when a battle rages, relevant facts have a tendency to be distorted, with participants confused by how to interpret information. The best laid plans are suddenly lost in a fog.
Regular Market Compass readers know that we publish our thoughts weekly. Sometimes, it is a challenge to find a new angle, particularly if markets are struggling to find direction, as has been the case recently. This week, however, our predicament was compounded by the unprecedented and unfathomable events unfolding in Washington, DC. The President of the US and the First Lady have contracted Covid-19. So have three US Senators, as well as a number of top advisors to the president. More infections are likely among senior officials in the days to come. Campaign plans are in flux. Questions are being raised about Presidential succession.
Events are rapidly evolving and could easily overtake anything we write. News reports are sometimes contradictory and confusing. There is a palpable sense of a spreading fog, where facts are hard to discern with confidence. Nevertheless, we feel it is useful to do our best to step back and consider how the unfolding developments may affect financial markets.
To begin, investors dislike uncertainty. Even with announcements of a significant improvement in President Trump’s condition by Monday, market sentiment will remain guarded. Matters are compounded by distrust—we can’t put it any other way—in the White House’s inability to communicate candidly or honestly about the president’s health. For instance, on Saturday it was revealed that the president learned earlier about his Covid-19 infection than was initially reported by the White House. In addition, an upbeat Saturday medical briefing by his doctors at Walter Reed Medical Center was quickly contradicted by remarks from ‘informed sources’ – later attributed to the White House Chief of Staff – who suggested the president’s condition was more concerning than the doctors let on.
Over the past four years, investors have largely ignored White House dishonesty. And why not? Easy money, massive tax cuts and soaring corporate profits were all that mattered. But credibility, once lost, is not easily recouped as every child learns from stories like Aesop’s Fables, The Boy Who Cried Wolf. If investors become rattled about President Trump’s health and cannot believe what is said, markets could tumble.
Moreover, with three Republican Senators now in quarantine following their positive Covid-19 tests (and more likely to come), the effective Republican majority in the Senate has shrunk. Senate Majority Leader McConnell has cancelled floor votes for two weeks while the three senators quarantine, a move which could slow legislative action on fiscal stimulus, should House Speaker Pelosi and Treasury Secretary Mnuchin be able to agree on a compromise plan. As of Friday, the two sides remain far apart.
Last Friday also brought a reminder why US fiscal stimulus is pressing. Although the economy generated 661,000 new jobs in September and the unemployment rate dipped to 7.9%, the pace of job growth is slowing and the labor force participation rate declined, particularly among women.
While fiscal stimulus, alone, cannot address all of the US labor market challenges—for instance the need for childcare during school shutdowns that may be forcing many women to give up looking for work—it is nevertheless true that spending and economic growth are at risk. After all, nearly half of all workers furloughed or let go since February remain jobless. Over two million Americans have been out of work for more than six months and may soon be cut off from unemployment benefits. Permanent job losses, as opposed to temporary layoffs, are on the rise, which is likely to lead to increased household financial stress, including difficulties meeting rent, mortgage, credit card and auto payments. The economic ripple effects are broad.
On the other hand, it is possible that the president’s hospitalization, following a disastrous debate and accompanied by his (and his party’s) shrinking poll numbers might yet galvanize Republican support for popular measures such as extended unemployment benefits, direct cash payments to eligible Americans and federal transfers to state and local governments. And the Federal Reserve is surely standing by, ready to offer liquidity to capital markets, if necessary.
In short, in this time of extreme flux perhaps the only definitive statement that can be made is that political, policy and economic sources of uncertainty are on the rise.
Figuring out what will happen next and what policy decisions and economic outcomes may unfold is becoming more difficult. That explains the absence of clear sector leadership and directionless markets. Safe haven assets, such as US Treasuries or gold have failed to rally. Small capitalization and value stocks outperformed this past week, typically a sign of investor optimism. Yet market rotation has proven fickle over the course of 2020, starting only to stall. Overall, markets have struggled since their summer highs, with major indices down 5% or more since then.
It is difficult to see how markets can soon break out of nervous trading ranges. Unprecedented political risk, upcoming elections and the shifting odds regarding fiscal stimulus will keep investors guessing, probably through the November elections. A contested election would elevate and extend uncertainty for longer.
Last week, we suggested investors ‘buckle up’ for more volatile conditions ahead. In light of the most recent events, we wouldn’t be surprised if some of them preferred to pull off the road, parking until the spreading fog begins to dissipate.