2020.11.23 – Will Mnuchin And Covid Derail The Cyclical Bull?

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EXECUTIVE SUMMARY

We hope that we haven’t offended the market gods. Just after our bullish call for a cyclical recovery (see Everything You Need to Know About the “Great Rotation” But Were Afraid to Ask), a number of contrary data points have appeared to cast doubt on the reflation thesis.

The markets were jolted by the news on Thursday that Secretary Treasury Mnuchin has declined to extend CARES Act emergency lending facilities established with the Federal Reserve. In addition, Treasury has asked the Fed to return any unused funds. This is a potentially contractionary fiscal development and a possible preview of the spending tugof- war between a Biden White House and a Republican-controlled Senate.

As well, the ongoing risk posed by a second wave of COVID-19 in Europe, and a third wave in the U.S., may derail the cyclical bull? The resurgence of the virus is quite clear in the U.S., as evidenced by rising policy stringency. In Europe, things have become so bad that even the Swedish have abandoned the Swedish model and announced shutdowns.

Should equity investors be worried?

Whether you are bullish or cautious will depend on your time horizon and pain threshold. Bear in mind that the intermediate- and long-term bull case for equities can only be invalidated if the vaccine recovery story falls apart. The question is whether the market will correct, and how far.

We honestly don’t know. The market can weaken at any time, but corrections should be viewed as buying opportunities. We are watching the value and small-cap indices which recently exhibited upside gaps. These gaps are potential bullish runaway gaps. Pullbacks that fill the gaps would be tripwires of a correction.

Until then, we are inclined to give the bull case the benefit of the doubt.

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