BMO Wealth Management OCTOBER 2020

Outlook for Financial Markets

“If you find yourself in a hole, stop digging.”

- Will Rogers

Strained but balanced economy than initially expected. Another factor Executive Summary underpins the rebound supporting the markets was the lack of The economic rebound is aided economic imbalances in the household In the face of high unemployment, stalled by a balanced economy and and corporate sectors heading into negotiations, various election low debt service payments. 2020. Compared with 2008, for example, possibilities, and even the possibility of debt service payments as a percent of Current economic, political higher taxes, why has the U.S. equity disposable income – both at the mortgage and COVID-19 uncertainty is market held up so well? The answer, like and total household levels – was at historic real, but should not result in the question, is multifaceted but begins highs, but today is at 40-year lows an economic “unwinding”. with a more vigorous economic rebound (Exhibit 2). Economic “unwinding” in than many anticipated. While the labor Presidential and Senate election the form of behavior changes in debt, market still has a great deal to overcome, outcomes remain uncertain, spending, and labor and capital allocation the current unemployment rate of 7.9% is but cautious optimism is – which occurred post the 2001-2002 more than a full percentage point below warranted for 2021. and in 2008-2009 downturns – is a the Fed’s expectation back in June for the more precarious and uncertain process year-end unemployment rate because of the economic restructuring (Exhibit 1). The Fed’s unemployment that takes place. Today, filling in the forecast has since been revised downward. massive economic crater that exists takes But referencing their belief of just a time and resources. But the process few short months ago shows that the for confronting an exogenous shock rebound has been much more vigorous is clear, at least in relative terms. OCTOBER 2020

Exhibit 1 » Unemployment rate and Fed’s year-end projection The first rule of being in a hole, of course, is to stop

16% digging. That’s easier said than done when an autumn COVID resurgence has slammed Europe. Germany, 14% France, Spain and several other countries are regularly 12% Fed's year-end reporting more than 10 times the number of daily COVID expectation made in 10% June of 2020 cases than prevailed in the late spring when the virus 8% looked better contained.1 The U.S. is also bracing for a 6% virus resurgence, just as the general election nears. Yet, Fed's current expectation for 4% while risk is building, so too are vaccine developments year-end 2% continuing apace. , head of “Operation 0% Warp Speed” and a former professor of immunology and head of GlaxoSmithKline’s vaccine department , recently Jun-19 Jun-20 Mar-19 Mar-20 Dec-18 Dec-19 Dec-20 Sep-18 Sep-19 Sep-20 expressed hope that a vaccine could be available by year Source: U.S. Bureau of Labor Statistics; end for high-risk populations and that the vaccine would have a favorable profile at 80% to 90% efficacy.2

Exhibit 2 » Debt service payments as a percent of disposable income Adjusting to election and stimulus uncertainty

14% Uncertainty is known to be unpalatable to financial markets. Household Mortgage 12% Yet, uncertainty has the greatest impact when the economic

10% implications are longer term in nature, or the potential

8% outcomes include scenarios whose scope seems expansive.

6% For example, the dot-com bust of 2000 - 2002 did more than

4% just erase a vast amount of wealth. It called into question

2% the foundation of productivity increases and business models

0% that were believed to be at the core of the “New Economy” – a designation that was formalized with capital letters in

06/2004 06/2005 06/2006 06/2007 06/2008 06/2009 06/2010 06/2011 06/2012 06/2013 06/2014 06/2015 06/2016 06/2017 06/2018 06/2019 06/2020 print media. The of 2008-2009 presented the potential abyss of a financial system meltdown, the Source: Federal Reserve implications of which seemed almost limitless in the moment.

1 Johns Hopkins University, https://coronavirus.jhu.edu/map.html 2 Marketwatch, https://www.marketwatch.com/story/trumps-vaccine-czar-says-the-first-vaccine-should- be-submitted-for-emergency-authorization-around-thanksgiving-2020-10-08

Outlook for Financial Markets • October 2020 2 OCTOBER 2020

Today’s uncertainty is quite different. Yes, there are tail that corporate taxes directly affect the bottom line. Even risk scenarios where the presidential election outcome is under a Democratic White House, however, Senate control contested and potentially controversial, but even results will largely determine what does or does not get passed in which court decisions play a role should generally be as legislation. Should Democrats manage to pick up three seen as valid. As for an additional round of fiscal stimulus, Senate seats, a 50/50 split means that a single dissenting a pre-election breakthrough now seems unlikely, but the vote across party lines would be enough to bring aggressive economic imperative will ultimately result in at least targeted tax hikes to a standstill. These hypothetical scenarios just stimulus and possibly much more activity post election. That highlight the range of possible outcomes involved. may be ice cold comfort to the currently unemployed. But in It is also important to keep in mind that the market broad macroeconomic terms, the expectation of a late 2020 narrative can sometimes shift abruptly. In the run-up to stimulus + vaccine should be sufficient to ward off downward the 2016 presidential election, talk of global trade frictions economic momentum, as long as consumer confidence does dominated the discussion around President Trump’s then not turn sharply lower. Along those lines, the University of candidacy. But once the markets opened the morning after Michigan’s Consumer Confidence Survey remains off the the election, the prospect of tax cuts – both corporate and crisis lows, but has not registered much overall improvement personal – overwhelmed those trade concerns and sent in the past few months. We will be keeping a close eye equities soaring. We are not necessarily expecting such a shift on it, and other confidence figures, in the near future. in narrative after the coming election, but that experience In sum, yes there is uncertainty around major issues. highlights the sometimes fickle nature of prevailing market And the economic hole is large. Nonetheless, we are not wisdom. We do feel confident, however, that six months faced with a precarious “unwinding”, and the core tenants from now the U.S. economy will be on the mend, and even of our economy have not broken down. We are looking more so another six months after that. Such an expectation toward a brighter future – not staring into an abyss. warrants a cautiously optimistic tilt in portfolios.

Taxes, spending, and the market narrative

A change in corporate taxes directly hits the bottom line and therefore affects the profits to which equity investors have a claim. Election outcomes for both the White House and Senate remain uncertain, but it is nonetheless important to consider potential scenarios. , should he win Michael Stritch, CFA® the election, wants to increase both corporate and personal Chief Investment Officer and taxes as well as . On net, we would National Head of Investments BMO Wealth Management - U.S. view these counterbalancing effects as something less than a wash for markets should they come to pass given Yung-Yu Ma, Ph.D. Chief Investment Strategist BMO Wealth Management - U.S.

3 Outlook for Financial Markets • October 2020 Michael Stritch, CFA® Yung-Yu Ma, Ph.D. Chief Investment Officer and Chief Investment Strategist National Head of Investments BMO Wealth Management – U.S. BMO Wealth Management – U.S. As Chief Investment Strategist, As Chief Investment Officer and National Yung-Yu is responsible for performing Head of the Investment team, Michael macroeconomic analysis, valuation chairs the Personal Asset Management modeling and market analysis across asset classes to guide strategic and tactical Committee and is responsible for setting asset allocations for client portfolios. investment policy and strategy for our clients throughout the United States. He joined BMO Wealth Prior to joining BMO Wealth Management, Yung-Yu was a finance Management in 2013 as a Managing Director of Investments for professor at Lehigh University, where he taught courses in fixed income, equities and derivatives. His academic studies have our Ultra High Net Worth group, and became National Head of been cited in the Journal, in leading finance journals, Investments in 2015. In January 2018, Michael took over the role of top law journals, the Handbook of High Frequency Trading, and Chief Investment Officer. With close to two decades of experience in Oxford Handbook of Corporate Governance. During his tenure in money management, Michael has a deep background in at Lehigh, he was awarded the Staub Outstanding Teacher economic analysis, portfolio construction and risk management. Award, awarded to one faculty member by a vote of faculty Michael earned a BA in economics from Northwestern University and and students. Prior to his academic career, Yung-Yu worked an MBA with distinction in finance and decision sciences from the for a global consulting firm performing financial and market analysis for global companies with operations in Hong Kong, J.L. Kellogg Graduate School of Management at Northwestern Taiwan and Mainland China. Later, he oversaw the operations University in Evanston, Illinois. He is a member of the Beta Gamma at a Fortune 500 subsidiary in Taipei and Mainland China. Sigma International Honor Society, holds a Chartered Financial Analyst designation, and is a member of the CFA Institute, CFA Dr. Ma earned his Ph.D. in Finance at the University of Utah and his B.A. in Economics and Political Science, magna cum laude, Society of Chicago, and the Chicago Quantitative Alliance. He is also a at Williams College. graduate of the American Bankers Association – National Trust School. Yung-Yu lives in Portland, Oregon with his wife and two children. He is a basketball fan and enjoys cheering on his children’s teams.

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