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Cam Hui, CFA | [email protected] Page 1
Confidential — Do not duplicate or distribute without written permission from Pennock Idea Hub
Quantitative & Strategy
FUN WITH TECHNICAL ANALYSIS ON THE 4TH OF JULY
July 6, 2020
EXECUTIVE SUMMARY
On this 4th of July U.S. Independence Day weekend, let’s try a change of pace and indulge
in some technical analysis of a different sort. The behavioural finance basis for technical
analysis is the wisdom of the crowds.
The latest PredictIt odds show that a Trump’s chance victory in November is slipping away
quickly. We reiterate our conclusions in our past publication (see What Would a Biden
Presidency Look Like?).
A Biden victory is expected to be a net mild negative for equity prices. Much depends on the degree of
control by the Democrats should Biden win the White House. The chance of a Blue Wave sweep is
possible, and it would embolden the progressives within the Democratic Party to steer policy further to
the left with bearish consequences for the suppliers of capital.
Expect the returns to capital to fall and returns to labour to rise under a Democrat-led
administration.
Here is what to watch for over the next four months:
How are the political odds evolving on betting sites like PredictIt and U.K.-based sites
like Betfair?
Can health policy bring the pandemic under control? Will there be an effective vaccine
before year-end?
Who will Biden pick as his vice president? Biden is view as dull by most voters. The
right vice presidential candidate can act to energize the Democratic base.
Can Trump either drive up Biden’s negatives or drive up his own positives?
The market has not fully discounted the prospect of a Biden win just yet. If and when it
does, it may act to de-rate equities based on the prospect of a lower 2021 earnings outlook.
We estimate that a Biden victory will mean a 6–12% fall in 2021 earnings, which translates
to a 6–12% decline in stock prices, assuming P/E multiples stay the same. Should the
market see P/E compression from the current lofty levels, downside risk could be
considerably higher.
Cam Hui, CFA [email protected]
Table of Contents
The Wisdom of the Crowds ...................... 2
A Referendum on Trump .......................... 4
Investment Implications ............................ 9
What to Watch For ................................. 13
Cam Hui, CFA | [email protected] Page 2
July 6, 2020
Quantitative & Strategy
The Wisdom of the Crowds
On this 4th of July U.S. Independence Day weekend, let’s try a change of pace and indulge in
some technical analysis of a different sort. The behavioural finance basis for technical analysis
is the wisdom of the crowds.
Francis Galton observed in 1906 a competition at a local fair where about 800 people tried to
guess the weight of an ox. To Galton’s surprise, the average of all the guesses was 1,197 lb. The
actual weight came in at 1,198 lb. Other studies have confirmed that a diverse crowd is better
at estimates than any single expert.
This adage, “the wisdom of the crowds” is really another formulation of the Efficient Market
Hypothesis, in which it is difficult for any single analyst to gain a consistent edge. Technical
analysis is one way of listening to the markets and applying its message to understand what the
market is discounting.
Exhibit 1: Mystery Chart
Source: PredictIt
The mystery chart is the price chart of the Trump contract on PredictIt, which pays off at $1 if
Trump were to win the election in November. The contract exhibited several support violations
on high volume, which are worrisome signs for Trump bulls. As always, this analysis is not
intended to be an endorsement of any candidate or political party, only to estimate the market
effects of an electoral outcome.
For completeness, here is the Biden contract, which has staged multiple upside breakouts on
strong volume, indicating conviction. That’s why our base-case scenario increasingly tilts
toward a Biden victory in November, which has important implications for equity investors.
Cam Hui, CFA | [email protected] Page 3
July 6, 2020
Quantitative & Strategy
Exhibit 2: Biden Contract to Win the Presidency
Source: PredictIt
Cam Hui, CFA | [email protected] Page 4
July 6, 2020
Quantitative & Strategy
A Referendum on Trump
A recent Pew Research poll is highly revealing about the internals of the race. Instead of the
usual “horse race” asking respondents who they would vote for, the poll probed voter attitudes
about each candidate. What is clear is that the race is becoming a referendum on Trump.
Prospective Trump voters are mainly voting for Trump, while prospective Biden voters are
voting against Trump, and not for Biden.
Exhibit 3: Biden Voters Are Voting Against Trump
Source: Pew Research Center
Even though the election is four months away, and four months is a long time in politics,
Trump’s electoral problems seem intractable compared to 2016. Here is how Trump won in
the last election. Even though he lost the popular vote to Hillary Clinton, he won enough of a
plurality in a handful of swing states to eke out a path to the White House.
The 2016 election was highly unusual inasmuch as both major candidates had high negative
ratings. Voters viewed both Trump and Clinton more negatively than positively. Trump waged
a masterful campaign to drive up Clinton’s negatives and to encourage defection to third-party
candidates. As the consensus was a Clinton win, there were sufficient voters who dislike her
sufficiently to cast protest votes for the likes of Jill Stein, the Green Party candidate, that Trump
was able to gain a plurality in key battleground states.
Cam Hui, CFA | [email protected] Page 5
July 6, 2020
Quantitative & Strategy
Fast forward to 2020. The polling data shows that Biden voters are voting against Trump,
instead of for Biden. Trump is entering this election with high negative support, while Biden’s
ratings are slightly positive. Here are the ways that Trump can find a path to victory.
Energize the base (not sure how much more juice there is left in that lemon)
Drive up Biden’s negatives
Change the focus from a referendum on Trump
Encourage the emergence of a third-party candidate
Another headwind is the Never Trump contingent within the Republican Party has become far
more vocal in its opposition. Reuters reported that former George W. Bush officials have
formed a Political Action Committee to raise funds to elect Biden, though the former president
is not involved in the campaign.
Hundreds of officials who worked for former Republican President George W. Bush are set to endorse
Democratic White House hopeful Joe Biden, people involved in the effort said, the latest Republican-
led group coming out to oppose the re-election of Donald Trump.
The officials, who include Cabinet secretaries and other senior people in the Bush administration, have
formed a political action committee — 43 Alumni for Biden - to support the former vice president in
his Nov. 3 race, three organizers of the group told Reuters. Bush was the country’s 43rd president.
As well, a group of Republicans at the Lincoln Project have been running anti-Trump ads in
key battleground states. If you haven’t seen them, check out their YouTube lineup of ads to
see how they are driving up Trump’s negatives.
To be sure, the Trump campaign still has a funding advantage. Despite the news that the Biden
and Democrats had better fundraising success than Trump and the Republicans for both the
months of May and June, the Trump-RNC fund reported $295 million in its account at Q2.
The Biden-DNC campaign did not report its cash for June yet, but it had about $122 million
at the end of May.
While nothing is impossible, those are indeed formidable challenges for the Trump campaign.
The Pew Research poll asked respondents what soured voters on Trump. The disapproval
ratings on Trump rose for people who are younger, have lower income and more likely to live
in areas most affected by COVID-19. He has to improve his performance in those areas,
especially among the key low-income demographic and in the COVID-19 regions.
Cam Hui, CFA | [email protected] Page 6
July 6, 2020
Quantitative & Strategy
Exhibit 4: Where Trump Is Losing Support
Source: Pew Research Center
As well, Trump’s falling poll numbers are likely to affect the Republicans down ballot too. The
consensus is the Democrats will retain control of the House, but the real battle will be the
Senate. Biden needs to control both chambers of Congress to push through his programs
should he win in November. The Pew Research poll shows that approval among Republican
supporters is tanking, which is an ominous sign for GOP Senators in November.
Cam Hui, CFA | [email protected] Page 7
July 6, 2020
Quantitative & Strategy
Exhibit 5: Republican Satisfaction Is Tanking
Source: Pew Research Center
The PredictIt odds for Senate control has been steadily rising for the Democrats. While the price action is not as definitive as the Biden contract, this contract did stage an upside breakout on strong volume.
Cam Hui, CFA | [email protected] Page 8
July 6, 2020
Quantitative & Strategy
Exhibit 6: The Democrats Are Gaining Strength in the PredictIt Senate Contract
Source: PredictIt
These results call for a base-case scenario of a Biden win, accompanied by a Blue Wave where
the Democrats take both the House and Senate in November.
Cam Hui, CFA | [email protected] Page 9
July 6, 2020
Quantitative & Strategy
Investment Implications
Here are the investment implications for equity investors. In the past, the market performs
much better if the incumbent wins, compared to if the incumbent loses the election. With Biden
starting to pull away in the polls, will the market start to follow the incumbent loss pattern in
2020?
Exhibit 7: S&P 500 Doesn’t Perform Well When the Incumbent Loses
Source: UPFINA
We reiterate our conclusions in our past publication (see What Would a Biden Presidency Look
Like?).
A Biden victory is expected to be a net mild negative for equity prices. Much depends on the degree of
control by the Democrats should Biden win the White House. The chance of a Blue Wave sweep is
possible, and it would embolden the progressives within the Democratic Party to steer policy further to
the left with bearish consequences for the suppliers of capital.
The most immediate effect of a Biden win would see higher taxes. Expect a higher corporate
tax rate and the imposition of a minimum corporate tax. As well, the top rate is expected to
rise, and so will the capital gains and dividend tax rates. High income earners will also face
higher social security taxes.
The market will focus mainly on those immediate negative factors. Consensus bottom-up 2021
earnings currently stand at $163.39. Unwinding the 2017 tax cuts would reduce about $10 off
2021 earnings, and second-order effects of potential Biden proposals, such as the corporate
minimum tax, changes to the global intangibles tax and so on, could reduce 2021 earnings by
another $10. This translates to a 2021 P/E ratio of 20.5 to 22.0, which are stratospheric for
FY2 P/E multiples.
Cam Hui, CFA | [email protected] Page 10
July 6, 2020
Quantitative & Strategy
Exhibit 8: Biden Would Unwind the 2017 Corporate Tax Cuts
Source: FactSet Information Systems
From a practical perspective, the immediate effect of a Biden victory will mean a 6–12% fall in
2021 earnings, which translates to a 6–12% decline in stock prices if P/E multiples stay the
same. Should the market see P/E compression from the current lofty levels, downside risk
could be considerably higher.
To be sure, there will be long-term positive effects of the Democrats’ re-distribution policies.
We have the results of a real-time experiment of fiscal support and re-distribution policies.
When the CARES Act gave households a flat dollar amount, the spending recovery rose faster
for low-income households than high-income households. That’s because lower income
workers have a higher propensity to spend extra income, while higher income workers have a
lower propensity to spend and a higher propensity to save and invest the government’s fiscal
support.
Cam Hui, CFA | [email protected] Page 11
July 6, 2020
Quantitative & Strategy
Exhibit 9: Low Income Household Have a Higher Propensity to Spend
Source: TrackTheRecovery.org
Over time, re-distribution should lead to higher GDP growth, though that may not necessarily
be bullish for equities. Other government measures, such as higher tax rates, re-regulation and
labour friendly legislation like a higher minimum wage are likely to squeeze profit margins.
Wage growth has not kept pace with productivity gains since 1970, and much of the excess
gains have gone to the suppliers of capital. Expect the returns to capital to fall, and returns to
labour to rise under a Democrat-led administration.
Cam Hui, CFA | [email protected] Page 12
July 6, 2020
Quantitative & Strategy
Exhibit 10: Wages Have Lagged Productivity Gains
Source: Economic Policy Institute
Cam Hui, CFA | [email protected] Page 13
July 6, 2020
Quantitative & Strategy
What to Watch For
Here is what to watch for over the next four months:
How are the political odds evolving on betting sites like PredictIt and U.K.-based sites
like Betfair?
Can health policy bring the pandemic under control? Will there be an effective vaccine
before year-end?
Who will Biden pick as his vice president? Biden is view as dull by most voters. The
right vice presidential candidate can act to energize the Democratic base.
Can Trump either drive up Biden’s negatives or drive up his own positives?
The market has not fully discounted the prospect of a Biden win just yet. If and when it does,
it may act to de-rate equities based on the prospect of a lower 2021 earnings outlook. A Biden
victory will mean a 6–12% fall in 2021 earnings, which translates to a 6–12% decline in stock
prices, assuming P/E multiples stay the same. Should the market see P/E compression from
the current lofty levels, downside risk could be considerably more.
Cam Hui, CFA | [email protected] Page 14
July 6, 2020
Quantitative & Strategy
Disclaimer
I, Cam Hui, certify that the views expressed in this commentary accurately reflect my personal views about the subject company (ies). I am
confident in my investment analysis skills, and I may buy or already own shares in those companies under discussion. I prepare and edit
every report published under my name. I depend on my colleagues for constructive criticism on my research methods and conclusions but
final responsibility is my own.
I also certify that I have not and will not be receiving direct or indirect compensation from the subject company(ies) in exchange for publishing
this commentary.
This investment analysis excludes any target price, and is not a recommendation to buy or sell a stock. It is intended to provide a means for
the author to share his experience and perspective exclusively for the benefit of the clients of Pennock Idea Hub (PIH). My articles may
contain statements and projections that are forward-looking in nature, and therefore subject to numerous risks, uncertainties, and
assumptions. The author does not assume any liability whatsoever for any direct or consequential loss arising from or relating to any use of
the information contained in this note.
This information contained in this commentary has been compiled from sources believed to be reliable but no representation or warranty,
express or implied, is made by the author or any other person as to its fairness, accuracy, completeness or correctness.
This article does not constitute an offer or solicitation in any jurisdiction.
Confidential — Do not duplicate or distribute without written permission from Pennock Idea Hub
