Stock market turbulence could last until the election, followed by a relief rally, strategists say

The stock market turbulence could be a setup for a post-election rally.

The more than 2% decline in stocks Monday came amid new worries about the coronavirus, as average daily cases hit a record high in the U.S. At the same time, the efforts between Congress and the White House to reach a stimulus deal also appeared to have hit a wall.

“It’s a bit of a double whammy. Covid’s definitely not going in the right direction in the U.S. right now. I think now there is maybe some diminishing optimism because stimulus just hasn’t come together, and the election is just around the corner,” said Tom Lee, head of research at Fundstrat Global Advisors. “I think the polling is kind of solidifying. It’s looking very much like a Biden White House and then for policy, if it’s a Biden win, there’s a chance the incumbent administration just dawdles on stimulus. That would really dampen markets into the new year.”

But Lee and other strategists said this week may be rocky for stocks, but once the election is over, the market is likely to bounce in a relief rally, if the winner is clear.

Stocks sold off out of the gate Monday, with the Dow down more than 3% at one point. The Dow fell 2.5% in afternoon trading, while the S&P 500 fell 2%. The decline was led by energy, industrial stocks and other cyclicals.

“We have a lot of things to be anxious about in the next couple of weeks. That’s why this is a pre-election market. But post-election, I think a lot of things that make people nervous turn into a tail wind,” Lee said. “Post-election stimulus is a when, not an if. Even if it’s a mixed Congress, I think there’s still some common ground. It’s just the scope that’s different. It would be a smaller package.”

Lee said Covid has become less deadly, and even if it continues to spread, it is not likely to result in the shutdowns that occurred last spring.

But comments today from Europe’s biggest software company, SAP sent a chill nonetheless. SAP said its business was being hurt by lockdowns in Europe, as the virus spread there has increased dramatically.

Lee said Covid has a big influence over the market. “It’s almost as important as the Fed right now. Covid is suppressing the economy, and it’s essentially offsetting easy money. If we didn’t have Covid, people would be going out and spending money,” said Lee. “It’s acting as a huge headwind.”

Lee said on balance, the economy continues to become more open.

“With the increase of cases in the U.S. and Europe, it’s just reminding everybody, the virus is still very much with us, and not going away any time soon, and with the weather getting colder and people moving inside, it’s likely to get worse before it gets better,” said Ed Keon, chief investment officer at QMA.

“I think it’s unlikely to be the beginning of a major sell-off,” said Keon. “I still think underlying fundamentals for companies are quite good. If you look at earnings season, it’s been pretty promising.”

Barry Knapp, managing partner at Ironsides Macroeconomics, said the market may also be reflecting concern about a possible victory by former Vice President Joseph Biden. Biden’s ability to implement his policies will be determined by whether Democrats also take a majority of seats in the Senate, now a close call.

Topping Biden’s agenda is a reversal of Republican tax cuts, which essentially would raise taxes on corporations and the wealthy. He is also expected to push a stimulus program, the size of which would be subject to whether the Senate is Democratically controlled,

“I think its is a gut check around that,” said Knapp, noting the market appears to be digesting the idea of a Democratic sweep. “For me the most important outcome of the election is: Does the corporate part of the tax cuts survive?” If not, Knapp said corporate earnings would fall and corporate spending and investment would decline.

Even so after the election, if there is a clear winner, the market should rally, strategists said.

“I think it’s likely. Elections tend to breed optimism. Then there’s the seasonality,” Knapp said. Stocks historically tend to gain between an election day and the end of the year.

If there is a protracted post-election count with no clear winner, or the election is contested that would lead to a period of choppiness for stocks.

“We’re still bullish. We still think there could be a post-election rally driven by the combination of good corporate earnings, very low interest rates and just a sense of relief that if we get this definitely behind us, there will be a reduction in risk and a rally in stocks,” said Keon.

Keon said the uncertainty could carryover even after the presidential election is decided. “We don’t know what the composition if the Senate is. If those two Georgia races end in a runoff, there’s a good chance we won’t know the composition of the Senate until those two races are decided. There’ a lot of really close races for the Senate all around the country.”