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Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s soundbites, we speak with Todd Mattina, senior vice-president and chief economist at Mackenzie Investments. Todd has been considering the short- and long-term impacts of the U.S. election on financial markets. I started by asking why the market’s reaction to recent violence was so muted.

Todd Mattina (TM): In periods of past violence and civil unrest in America, stock markets have looked past the social and political upheavals in the near term. If you look back in the 1960s, the S&P 500 actually finished higher in those years, despite some pretty intense civil right protests and riots, and even political assassinations.

So, markets can sometimes look disconnected from the current developments. But markets are generally forward-looking mechanisms, pricing in what they expect to happen to fundamentals. So, I believe the markets are looking through the near-term uncertainty and focusing instead on how the Democrats’ policy agenda over the next two years will impact market fundamentals.

Why this election has been so unlike previous ones.

TM: The political cycle and its impact on markets looks a little different this year than we’ve seen historically. We generally see markets always looking forward to what the impact of policies will be of the party that’s expected to win. And this year the expected winner didn’t really shape up until January 5th, following the runoff elections in Georgia. Now we see that we have a Democratic sweep of both houses of Congress, and of course Joe Biden in the White House. And that has really abruptly changed the outlook for the policy agenda over the next two years.

What signposts he sees in the near future.

TM: The election has really set the stage for three key themes to drive financial markets in 2021. First, a vaccine-driven economic rebound. Second, absolute abundant central bank liquidity with policy interest rates still around zero. And, finally, a much more aggressive fiscal stimulus, particularly in the U.S. I think the big question is what’s next? And there’s really a number of things to keep an eye on. The Fed policy response, with a number of regional presidents talking about the timing of tapering which seems odd, given the extent of the downturn. Any signs of more prolonged lag in the distribution of vaccines that could delay that vaccine-driven rebound. And finally, and most importantly, overheating from excessive fiscal stimulus and abundant central bank liquidity that could drive up inflation and interest rates.

Where he sees opportunities.

TM: Investors have already reacted strongly to the Democratic sweep, and they did this by focusing on the so-called reflation trade. That has been generally positive for the U.S. stock market overall and global equities. But we’ve seen a significant rotation in leadership from the more tech and growth-sensitive names to more industrial, financial, and energy-type stocks. It has also been bearish for sovereign bonds, and particularly U.S. treasuries which have been pushing toward about 1.1%, breaking out of a much lower sub-1% range for most of 2020. It is also very bearish for expected inflation rates, based on pricing and inflation rate bonds. We’ve seen that a proxy for expected inflation in 2021 is pushing well north of 2.5%, which would be one of the highest expected inflation rates that we’ve seen in the last decade. And that’s really on the back of the substantial fiscal stimulus and monetary easing that we’re seeing in the U.S. and other major economies. So, in looking ahead, it’ll be surprises I guess in growth and inflation, relativities, expectations that are going to drive asset prices over the next year. But we expect stocks to continue outperforming sovereign long-term bonds, we’re bullish and overweight in emerging market stocks, and we’re also overweight in the euro.

And, finally, what the long-term prospects could be, in the event of ongoing violence.

TM: If the unrest continues, based on the historical experience, we’re likely to go through a period of near-term volatility, but markets are likely to look past that short-term volatility and focus on longer-term fundamentals. For asset prices what matters most for determining fair value, is what is happening to long-term expected growth, corporate cash flows, and starting yields, starting valuations. So, the implications I think for long-term oriented investors is to stay invested, rebalance your long-term target asset mix periodically, and keep your eye on long-term financial goals.

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Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Once again, our thanks again to Todd Mattina, senior vice-president and chief economist at Mackenzie Investments. Join us every Wednesday at InvestmentExecutive.com, where you can sign up for our AM newsletter and never miss another episode of Soundbites.

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