The light at the end of the tunnel

We like analogies at Hurst Hill and we’ve used plenty of them this year. Today’s cover photo is apt because it encapsulates both light at the end of the tunnel, as well as the idea of climbing out of a deep hole. While there is room for optimism, we are still a long way from returning to normality from a global economic perspective. This hole will take decades for us to climb out of and it is unlikely that the burden of doing so will fall only onto our generation. More likely our children will pay the price for the greatest financial experiment of all time.

We would like to take this opportunity to congratulate President and Vice President elects Biden and Harris. Not only is it a triumph for democracy, but a much needed win in a year that has been riddled with adversity. President Biden’s victory signals a clear vote for basic decency. Equally meaningful is the fact that one of the most influential countries on the planet has elected a female mixed-race VP. While many are concerned about the post-election aftermath, what we are currently seeing is actually fairly standard, but perhaps somewhat amplified by the rants of a sociopath. Bush/Gore re-counts took 45 days. Re-counts happened in 2016 as well. There is no doubt that Biden will be inaugurated on the 20th of January.

It is now upto this new administration to take on the huge challenge of reuniting a country in desperate need of unification; not to mention dealing with the Covid/economic crisis. Timing is everything, and the new administration are likely to notch up a huge win over the next few months – and that is being credited for resolving the Covid-crisis. That has less to do with ability and policy, and more to do with the simple reality that the world will move on from Covid in the near future anyway. It is optically and psychologically beneficial that this will happen on Biden’s watch and there is no doubt that he will take credit for it.

Back to markets now: A few weeks ago in our last market update we turned optimistic for the first time in many months. In our opinion markets were likely to have a good run as a result of the Biden victory we projected. What ensued over the last week was the biggest rally we have had since May. We urged our clients to take advantage of volatility in the high 30s (the VIX in fact touched 41 shortly before the election). This has been a consistent and successful theme for us throughout 2020. Within days of the election outcome becoming clearer volatility had collapsed to 25. Our optimism was not based entirely on the potential outcome of the US election. Today we will discuss in more detail the myriad of obstacles that we believed a few weeks ago (and still believe today) are likely to be gradually removed over the next few months. This is not to say that the overall economic recovery will be smooth, constant or predictable – we have never underestimated the scale that an epidemic of this nature would have on the planet. However, compared to how things looked in February it is infinitely more rational to be optimistic today than it was back then.

Here are the current hurdles which we believe will be gradually removed from the landscape as we head into a 2021 of recovery:

1. US elections: Not the most impactful in a year dominated by Covid, but as we predicted the first issue to be resolved. Biden’s victory is important not only for the reasons mentioned above, but because it paves the way for the next much needed stimulus package in the US. Additionally a huge amount of uncertainty has been removed from the market; that is worth gold in a year where almost nothing has been predictable.
2. Stimulus: Second in line here as it is likely to be the next thing on the list to be resolved. The US was unable to approve it’s latest package due to election logjams. We now believe the next (much needed) stimulus package is likely to arrive in December.
3. Covid: This has been the topic of 90% of our updates this year. As we talked about at length a few weeks ago we are nearing the beginning of the end. It is still our firm belief that within 2-3 months (probably sooner) the combination of multiple vaccines and rapid-testing will put the first stage (carnage) firmly behind us, and we will start focusing on the second stage (rebuilding). We won’t go into any more detail as this was discussed at length in our previous article. This is not the end, but it is now quite clearly the beginning of the end.
4. De-escalation of global trade tension: Another positive bi-product of Biden’s victory is the almost inevitable resultant de-escalation of various trade wars, most notably with China. We had increased our exposure to Asian equities significantly before the election and so far the post-election rally has been significant.
5. Brexit: It is no secret that we have been Sterling bulls for the last 6 months. In one sense Brexit was partially nullified due to the huge impact Covid had. We still believe a resolution and a last minute deal are more likely than not. But either way we are nearing the end of the multi-year Brexit saga. By Q1 next year Brexit is unlikely to have a material impact on markets anymore. By the end of 2021 Brexit is unlikely to be a major talking point at all. Incredibly Brexit may well end up outlasting Trump and Covid-19. We still believe in the gradual recovery of Sterling (and are still long at 1.20 GBPUSD) but not only because of Brexit. As we start to move out of a risk-off environment it will become as much about dollar weakness as sterling strength.

Make no mistake – the above tailwinds will be continually offset largely by the massive headwinds associated with the economic damage done over the past year. So please do not mistake our cautious optimism for something stronger. We have been more bearish than most throughout this year and it is certain that the post-Covid recovery will be a long and bumpy road. Taking stock of the aggregate factors in play, however, it is hard not to have a bullish (but somewhat limited) bias over a 6-12 month horizon. We pushed all our chips onto the table just before the election, and for now we remain 100% invested. We still believe that the upside potential over the next 1-2 years will be supressed under the huge weight of economic damage already done. This is why upside-limited/downside-protected strategies are likely to remain a big part of our portfolio’s as we head into 2021. If you would like more information on how to structure an investment portfolio that will excel in that environment, or to see specific trade ideas, please contact us at info@hursthill.co.uk