Summary

COVID-19 developments have remained roughly static over the past few weeks, with the positive perhaps slightly outweighing the negative:

Positive:

• The number of global daily infections continues to edge lower.
• The number of U.S. daily infections also continues to decline, and is well off its peak.
• The economic recovery continues, with the consensus outlook for Canadian and U.S. growth increasing recently.
• Optimism about the timing of a vaccine continues to modestly increase.

Negative:

• Europe is struggling to a surprising extent with its own second virus wave.
• The opening of schools, and the approach of autumn, present new potential virus risks.
• S. fiscal stimulus has declined palpably in August.
• Mobility data is no longer reliably rising across much of the developed world.

Virus developments

It is easy to lose sight of the forest for the trees. Given this, let us begin with a look at the broader picture: which countries have suffered the most cumulative number of infections? The answer is that the U.S. continues to place first, followed by Brazil and the rapidly closing India (see next chart).

Trajectory of COVID-19 cases in different countries

Note: As of 08/24/2020. Dashed lines represent slope at which cases double every day/3days/week. Source: ECDC, Macrobond, RBC GAM

Globally, the number of new daily infections appears to be edging lower, and even the global fatality numbers are also now in slight decline (see next chart). These developments have been afoot for several weeks. They are nevertheless excellent news to the extent this is the ultimate arbiter of whether COVID-19 is on the offensive or the defensive.

Spread of COVID-19 globally, cases and deaths

Note: As of 08/24/2020. 7-day moving average of cases & deaths indexed to 100. Source: ECDC, Macrobond, RBC GAM

Emerging markets

Emerging market (EM) countries continue to suffer significantly more new infections than the developed world. This is perhaps unsurprising given the much larger population base of the former group. Within the EM space, the story remains quite mixed:

• Brazil has a high but declining number of new infections and fatalities (see next chart).

COVID-19 cases and deaths in Brazil

Note: As of 08/24/2020. Fatalities calculated as 7-day moving average of daily infections and new deaths smoothed with 7-day moving average. Source: ECDC, Macrobond, RBC GAM

• India’s earlier pause has proven false, with the country now suffering a rising trend once more (see next chart).

COVID-19 cases and deaths in India

Note: As of 08/24/2020. Fatalities calculated as 7-day moving average of daily infections and new deaths smoothed with 7-day moving average. Source: ECDC, Macrobond, RBC GAM

• Other mid-tier countries like Mexico and South Africa appear to be finally managing a falling virus count.

European trouble

Continental Europe continues to grapple with a second wave of the virus. We had expected the most affected such countries to tame the outbreak promptly – having learned from the mistakes (and belated successes) of the U.S. and operating in a less politicized policy environment. But the reality is that these countries continue to struggle.

As such, whereas we had initially assumed that Europe would begin to tamp down its infection numbers within a few weeks, it now appears that this may take at least a month or two. Spain in particular continues to struggle. The country is now recording around 8,000 new cases per day and rising (see next chart). This is nearly as bad as in early April, albeit with much more testing and so much less undercounting.

Spread of COVID-19 in Spain

Note: As of 08/24/2020. Source: ECDC, Macrobond, RBC GAM

The situation is not as dire elsewhere, but:

• France is now up to around 4,000 cases per day.
• Germany is up to 2,000.
• Italy remains shy of 1,000 per day, but is also rising.

Anecdotally, much of the increase is being blamed on more travel and nightlife.

It is some solace that – as with the U.S. – the latest wave tends to be younger, such that the fatality figures are unlikely to come close to their prior peak. The development is nevertheless far from risk-free to the extent the virus can easily leap between demographics.

Naturally, Europe is reluctant to fully shut down its economy as it did in March. However, it shouldn’t have to – only moderate adjustments should be necessary to get the transmission rate back below one and push the virus into retreat. The U.S. certainly didn’t grind to a halt in conducting this pivot. The most affected countries have made a number of changes, but to frustratingly little visible effect so far.

One surprising finding, courtesy of a recent AlphaWise/Morgan Stanley poll, is that 83% of office workers have already returned to their usual workplace in France. This is more than double the U.K. figure, and must surely be higher than North America. It may be that this is simply unsustainably high at the present juncture.

U.S. improvement continues

The U.S. virus numbers continue to improve. The daily infection rate is down to around 40,000 from a high of approximately 70,000. The fatality figures are also inching lower (see next chart).

COVID-19 cases and deaths in the U.S.

Note: As of 08/24/2020. Fatalities calculated as 7-day moving average of daily infections and new deaths smoothed with 7-day moving average. Source: ECDC, Macrobond, RBC GAM

Whether that improvement can be sustained now that schools are reopening and as economic activity incrementally revives is another question. We discuss the outlook for schools shortly.

One criticism of the recent U.S. improvement is that the number of tests conducted daily has been declining. It has dropped from a peak of around 800,000 per day in late July to more like 600,000 per day now. This may theoretically exaggerate the extent to which the U.S. is actually improving. But we note that the fraction of tests that are positive has continued to edge lower over the past month, hinting that there isn’t a serious increase in undiagnosed infections (see next chart).

COVID-19 diagnostic testing in the U.S.

Note: As of 08/23/2020. Positive rate calculated as 3-day moving average of new cases/new tests. Source: Our World in Data, ECDC, Macrobond, RBC GAM

Other developed countries

South Korea is grappling with a serious second wave, at least by its own exemplary standards. This is to say, South Korea is now up to around 300 new infections per day – a small number in an absolute sense, but around half of its peak rate in March (see next chart). It has done so well taming the virus in the past that we figure it will succeed again.

Spread of COVID-19 in South Korea

Note: As of 08/24/2020. Source: ECDC, Macrobond, RBC GAM

Japan, which is grappling with its own second wave, appears to now be on the downslope (see next chart).

Spread of COVID-19 in Japan

Note: As of 08/24/2020. Source: ECDC, Macrobond, RBC GAM

The U.K. infection numbers remain low and flat to slightly rising. Conversely, Canada’s numbers remain steady and low (see next chart).

Spread of COVID-19 in Canada

Note: As of 08/24/2020. Source: ECDC, Macrobond, RBC GAM

Finally, we note that New Zealand has sadly broken its 102-day streak of no new locally spread COVID-19 cases. In turn, the country has re-imposed some restrictions. To the extent that China has been similarly unable to completely eradicate the virus despite draconian restrictions, it seems that the aspiration to completely eliminate the virus is probably unrealistic, even within individual countries, until the development of a vaccine.

Schools in focus

The new school year is already underway in parts of the world, including a significant swath of the U.S. It will shortly be underway nearly everywhere else.

While re-opening schools creates a new vector for the transmission of the virus, it is very helpful on two counts. In the short run, it allows parents to return to work. In the long run it is critical for child development.

In the U.S., there are 14.7 million families with children under 18 and two spouses who work. There are another 8.6 million single parents who work. Together, this means there are up to 23.3 million families who cannot fully engage with the workforce until schools are operating normally.

The science so far suggests that COVID-19 represents a less severe health risk for children than for other groups, and – tentatively – that schools have not been a primary source of transmission. But much depends on the intensity of the virus in a region, the number of students per classroom, and safety measures concerning mask-wearing, sanitation and airflow.

To the extent that many children were already interacting with each other via summer camps, daycare, sports teams and more casual socializing, it may well be that any surge (or at least part of any surge) in school transmissions are merely the transposition of infections that were already happening via other venues. The past four weeks have already logged a 90% increase in new infections among U.S. children. Some of this is surely linked to the start of schooling, but much would have predated the restart. 

We will shortly have data rolling in. Twenty-two countries have already re-opened their schools, with another 12 set to re-open by mid-September. A further 55 have allowed the partial restart of schooling. There will be no shortage of data in the coming days and weeks.

It should be noted that some trouble has already ensued. Ten countries, including Australia and South Korea, have already shut some schools in response to the virus, though in many cases this was part of a broader pivot in social distancing as opposed to schools proving specifically problematic. Of these, five have since reopened. Perhaps the most useful lesson is that school administrators must be nimble.

In the U.S, most major school systems are starting the year online. However, school-related outbreaks have already been identified in Florida, Georgia and Mississippi, and some universities are now having second thoughts and joining their peers with virtual schooling.

There is no one-size-fits-all prescription for how to handle schooling. The right solution depends on the intensity of the virus in the area, the measures taken by the school system and for that matter the comfort level of each family.

To the extent we are all on watch for a second (or third) virus wave, schools represent an obvious new risk alongside what could be seasonal considerations as the summer turns to fall.

The three-day workweek

In our ongoing effort to identify past parallels to the COVID-19 pandemic so as to better anticipate the path forward, a curious new one recently came to light.

It involved not a virus but rather an acute fuel shortage in the U.K. between January and March of 1974. The 1973—1974 oil embargo was ongoing, limiting the supply of oil. British coal miners were also on strike at a time when coal provided 70% of the country’s electricity.

There simply wasn’t enough electricity to go around, and instead of imposing rolling blackouts, the government mandated a three-day rather than a five-day week. Industrial and most commercial activity was limited to three consecutive days per week. Other measures included extinguishing half of all street lights, stopping television broadcasts at 10:30 p.m. and turning down the heat in public and commercial buildings.

While the root cause is quite different, there are considerable parallels between that multi-month artificial disruption to economic activity and the one today. Key among the questions, how badly was economic activity affected, and how quickly did it respond?

Overall, the economic impact was surprisingly mild. Production fell briefly by around 10% – less than the 40% decline that simple math would have suggested from the elimination of two out of five working days. Workers and companies operated more efficiently and intensively during their allotted work periods. Unemployment spiked by a million workers, but only briefly. Household earnings fell by nearly 5% in January of the year, but consumer spending was only curtailed by 1.5% in the first quarter of 1974.

Similarly, the rebound proved quite fast once the electricity restrictions expired. While this might seem an obvious result, it actually isn’t as companies or households could easily have become risk averse or lacked the funds to engage in their usual outlays.

So far, it appears the COVID-19 pandemic is playing out similarly. The upfront economic decline – of around 10% to 20% – was notably less than initially feared. If you had heard that, without warning, almost no one would be able to go to work for a multi-month period, it would have been reasonable to imagine an economic decline of 50% or worse. Similarly, as with the three-day workweek, the economic rebound has proven surprisingly smooth and robust so far. Let us hope it continues much as it did in 1974.

Vaccine timing

As summer progresses toward fall, we are nearing the earliest period when a vaccine might theoretically be approved for widespread use. The timing of a vaccine is key, as it determines when economic activity and life more generally can fully return to normal.

Optimists focus on the following factors:

• There are literally hundreds of vaccines under development, and countless more therapeutic drugs.
• Many smart people have been set to the task, and given unprecedented financial resources in the effort.
• It is not just the U.S. or even the developed world that is in hot pursuit of a vaccine, but also some EM countries including Russia and – most prominently – China.
• Russia claims to have a viable vaccine (though this remains to be established).
• A number of vaccines are already in stage 3 trials – years ahead of the usual schedule.
• The science of vaccine development continues to advance, including new techniques such as RNA vaccines.
• COVID-19 does not appear to be mutating as much as initially feared.
• People who were previously infected appear to have maintained their immunity for the most part so far.

Pessimistic arguments include:

• Therapeutic drugs can reduce the mortality rate. But to the extent that people must be sufficiently sick as to be hospitalized before they can benefit from the drugs, this hardly allows a return to normal life.
• There are not really hundreds of unique vaccines under development. Many are quite similar, and so will succeed or fail in lock-step with one another.
• Vaccine development is inherently slow. Much of the process involves immunizing thousands of people with the test substance and waiting to see if they become infected or suffer adverse effects over a lengthy period of time. No amount of scientific genius can shorten this waiting game.
• There is a risk that countries or companies will not be willing to share their vaccine with others, or will delay distribution internationally until their domestic populations have been fully treated.
• There is no vaccine for malaria, AIDS or the common cold. As such, vaccine is not assured for COVID-19, particularly since the coronavirus is known to be difficult to crack.
• Historically, it has taken a decade or longer to develop past vaccines. A one-year timeline could easily be unrealistic.
• Some vaccines are hard to manufacture, particularly at scale.
• The duration of immunity from a vaccine (or from contracting the disease) is uncertain – a new inoculation could be needed quarterly or semi-annually, challenging practicality.
• Vaccines are not usually 100% effective – as such, a vaccine doesn’t mean that everyone can immediately return to normal.
• Not everyone will be willing or able to take the vaccine, further impeding the quest for herd immunity.

Where do we land, given all of this back and forth? We continue to take our main cues from betting markets, which assign a 48% chance that the U.S. will secure tens of millions of doses of a vaccine by the end of the first quarter of 2021. This probability has been rising in recent months. Should that fail, the market believes there is an 88% chance that a vaccine will be developed and distributed by the end of the third quarter of 2021. Only a tiny fraction of bettors believe a vaccine will have to wait until 2022.

In approximate alignment with this view, vaccine expert Bill Gates reiterated in early August that he expects the U.S. to largely be past the pandemic by the end of next year.

While developed countries without homegrown vaccine solutions could lag slightly in resolving COVID-19 on their own shores, this is unlikely to be a major delay. We strongly expect cooperative efforts to manufacture the vaccine as widely as possible and some prospective manufacturers seem to think they can produce billions of doses. There is a risk, however, that poorer countries will struggle to get their allotment in a timely fashion.

There were recently rumblings that the White House might push through the AstraZeneca vaccine via an “emergency use authorization” before the U.S. election, but this has since been denied with the first quarter of 2021 identified as the main target. There is still a chance of this, however. On the positive side, there is a strong probability that the vaccine proves effective, based on the results so far. But on the negative side, any misstep could not just damage human health but seriously reduce uptake of any future vaccine.

What if the vaccines don’t work?

It seems likely that at least one of the many vaccines under development will work. But what if a vaccine proves elusive or is much less effective than hoped?

First, there are so many different strategies available in the pursuit of a vaccine that efforts would likely continue for years to come. Failure wouldn’t be declared any time soon.

In the meantime, a decision would have to be made between trying to eradicate the virus and achieving herd immunity naturally (via infection). Eradication always sounds like the most attractive strategy, though it does come at an economic cost as we detailed in an earlier research note. However, one must now question whether it is even possible given the recent misfires by both New Zealand and China.

Any push toward herd immunity would have to occur gradually so as not to overwhelm the healthcare system. It would be a process spanning several years. Throughout this, economic and social activity would have to remain limited to prevent the virus transmission rate from revving back up to its natural multiple of two to three.

Ominously, the work of achieving herd immunity via natural means might never be quite done. The constant arrival of newly born babies means that there would always be a population of uninfected. Indeed, in an extreme worst-case scenario, the recurrence of The Plague and Black Death over the decades and centuries illustrates how these diseases can experience not just seasonal waves but long-term ebb and flow as the fraction of the population with immunity declines with time. London suffered repeated outbreaks of the Black Death roughly once a decade for more than 300 years, wiping out around 20% of the population each time!

Economic recovery

The economic recovery is now well underway. This is no longer just visible in the real-time data, but also in the traditional monthly figures. The following chart shows the peak-to-trough decline and subsequent partial revival of U.S. employment, retail sales, food services and industrial production.

U.S. COVID-19 recovery

Note: As of July 2020. Trough since Feb 2020. Source: Macrobond, RBC GAM

Looking forward, we continue to assume an ever-decelerating rebound. This is to say, the rate of economic growth is likely to remain faster than normal, but not nearly as stupendous as it was in May and June.

One new tailwind is that more parents can now return to work as their children go back to school. However, the new headwinds are arguably more powerful. The easy part of the recovery has now occurred. Further gains are likely to prove more limited given that many sectors are set to remain mere shells of their prior selves until a vaccine is developed.

The reduction in low-hanging fruit can be seen, as an example, in some of the more interesting special questions posed in Canada’s Labour Force Survey. Fully half of the people who were on “temporary” layoff have now returned to their jobs, meaning that the great majority of those who remain unemployed – 83% – will have to secure an entirely new position when they return to the workforce. Even if the economic demand were there, the matching process takes time.

Similarly, the number of Canadians working sharply fewer than normal hours has already declined by around 60%, leaving less room for this easiest manner of recovering lost labour output (see next chart).

Cumulative number of Canadians working fewer than 50% of normal hours

Note: As of July 2020. Source StatCan Labour Force Survey, RBC GAM

Economic developments

Mobility data

Perhaps unsurprisingly, the Spanish mobility data has been in moderate retreat in recent weeks as the country seeks to gain control of its latest COVID-19 outbreak. This is bad news from a short-term economic standpoint. But it is good news in that it indicates Spaniards are responding and so can feasibly tame the outbreak. Italy is also now down somewhat.

South Korean mobility data has also been falling recently, presumably in response to the country’s own mini-outbreak.

Conversely, the U.S. mobility data is starting to rise again (with Canada also rising). If anything, the true underlying international pattern has been one of convergence: the most enthusiastically open countries have closed down somewhat, whereas the more cautious countries have continued to open up.

Our U.S. real-time economic activity index has now clearly begun to rise again after nearly two months of stagnation (see next chart).

U.S. economic activity picks up after pause

Note: As of 08/15/2020. Economic Activity Index is the average of 10 high-frequency economic data series measuring the year-over-year percentage change. Source: Bank of America, Goldman Sachs, OpenTable, Macrobond, RBC GAM

Consensus outlook

The consensus GDP forecast for both the U.S. and Canada rose in August for 2020 and 2021. This is in alignment with our own adjustments over the past month. However, the trend was not universal: the U.K. and Japan suffered 2020 downgrades.

Indeed, the recent release of the Q2 2020 GDP figure for the U.K. practically necessitates the downward revision for the country all by itself given a decline of 20.4% (unannualized!) that was more severe than almost any other country.

Traditional data

U.S. jobless claims – a most helpful indicator given its weekly frequency – has unfortunately rebounded to 1.1 million new applicants in the latest week, after having fallen below 1 million for the first time since the pandemic the prior week. More importantly, continuing claims continue to inch forward, falling to 14.8 million from 16.1 million roughly the month before. As such, we believe the U.S. economic recovery is continuing. Of course, the new number remains massively higher than the 1.7 million continuing claims level that prevailed pre-pandemic.

Further evidence that the U.S. economy was growing in August came from a bevy of Markit PMI (Purchasing Managers’ Index) numbers that managed a further incremental gain.

Going forward, two U.S. storms in the Gulf of Mexico threaten to become hurricanes and make landfall. Gulf oil production has already been shuttered. These events rarely have a lasting influence on the economic figures, though they would still be unwelcome to the extent the recovery is fragile and any temporary disruption would blur the true underlying trajectory of the economy. Louisiana, Mississippi and Texas are at the greatest risk.

International data

Chinese economic data for July was mostly softer than expected, though not outright bad. For example:

• Retail sales, after having clawed their way back to a positive year-over-year figure in June, slipped back to -1% in July.
• Industrial production remains up around 5% relative to the year before, but by slightly less than in June.

These developments are surprising, but it seems unlikely that the stutter-step will persist. Further growth is likely for China.

Canada’s June retail sales data has now finally been released. The story proved similar to its peers, with a big 23% jump in June relative to May. This resulted in an aggregate level of retail activity that is now slightly higher than it was pre-pandemic in February. However, as per the “decelerating recovery” narrative, Statistics Canada estimates that retail sales then advanced by just 0.7% in July – a remarkable 33-fold deceleration from one month to the next. Let us not forget that a big chunk of the consumer support comes from government cheques, so the retail numbers will likely be closely linked to the unwinding of fiscal support going forward.

Monetary policy

The Fed Minutes yielded few major changes. Despite the erosion of fiscal support in the U.S., policymakers saw little need for urgent monetary action. The discussion suggested that yield curve control efforts remain unlikely, though average inflation targeting – effectively, a renamed version of price-level targeting – remains a serious possibility. It is one of several reasons why inflation could run hotter in the future than it has over the past decade.

The Biden platform

The U.S. Democratic Party national convention was held virtually from August 17 to 20, formalizing the nomination of former vice president Joe Biden for president and his running mate Kamala Harris – a California senator and former Democratic presidential candidate.

The election is now a mere 10 weeks away, on November 3. Given the pandemic, many people will vote before that date by mail, making the effective election date even sooner.

Current polling continues to favour Biden, with a nine point lead in the polls. This is a considerable advantage, but not insurmountable. The Democratic candidate in 1988 enjoyed a 17-point lead immediately after the convention that year, only to lose the race.

Reflecting the potential for voting intentions to shift, or that the polls are outright wrong (some Trump supporters are thought to be “shy” voters and so not well captured in conventional polling), betting markets only assign a 14 percentage point lead to Biden in terms of probability of victory. This comment might seem strange – isn’t a 14-point lead larger than a nine-point lead? Yes, but probabilities are very different than polls. If we knew with certainty that Biden would maintain the nine-point lead through election day, he would have a 100% chance of victory. 

Normally, such a sizeable lead would yield an even bigger probabilistic advantage. However, bettors were burned by their incorrect prediction in 2016. They also recognize that Biden has not yet been seen much on the campaign trail since becoming the presumptive nominee months ago, and he has a history of gaffes.

In gauging the policy implications of a Biden presidency, a key question is which Joe Biden Americans will get. He has a long history as a moderate, and skewed toward the right of the Democratic Party spectrum during the nomination battle. However, his platform is among the most progressive since Lyndon Johnson in 1964. Furthermore, with the realistic pickup of the Senate, a White House-Senate-House of Representatives sweep would enable significant reforms, if not on the order of what the far-left camp of the Democratic Party envisions.

Financial markets care in particular about several policy matters, including Biden’s COVID-19 policy plans, his taxation/fiscal plans, the trade policy outlook and energy policy.

COVID-19 policy

COVID-19 policy differences will presumably be a key campaign issue to the extent the Democrats can needle the current White House on its various missteps. Biden promises more testing, a national mask requirement and more personal protective equipment. Understandably, he spends less time talking about which sectors might have to be more limited in an effort to keep COVID-19 under control, though one might reasonably imagine that Biden would be more restrictive on this front than Trump.

Taxation/fiscal policy

The Biden platform pledges to partially reverse the Trump tax cuts of 2017, and to go further in some regards. This would include the following actions:

• Restore the top personal tax rate to 39.6%.
• Apply the payroll tax to a much higher maximum level of earnings.
• Reverse half of the Trump corporate tax cut (raising the rate from 21% to 28% but not all the way to 35%).
• Institute a tax floor for corporations based on their GAAP profits.
• Double the tax rate on capital gains and dividends for high income earners.
• Tax unrealized capital gains at death.

To the extent the Trump corporate tax cuts had boosted U.S. corporate after-tax earnings by 7-8%, these changes would threaten to reverse most of that gain.

While this is a stock market negative, there is a twist from an economic standpoint. The Democrats also propose significantly more spending, including a big infrastructure plan, an expansion of health care coverage and a climate plan. Collectively, these would add more than $4 trillion in spending over the next decade, dwarfing the revenue taken out of the economy by higher taxes.

As such, one might argue that this policy mix is corporation- and stock market-negative, but conceivably GDP-positive.

Trade policy

Biden’s lengthy voting record shows support for the original NAFTA, for the long-ago U.S. push to normalize trade with China, and for the Trans-Pacific Partnership. As such, he appears to be in line with the pre-Trump era of pro-trade U.S. politicians. Furthermore, Biden has pledged to re-engage with international institutions that the current president has neglected or rejected. It is reasonable to think that non-China tariffs would go away.

However, it is not realistic to think that relations with China will return to normal. The Democratic Party has long had an anti-globalization wing, and its voice is being heard more loudly than usual. Furthermore, even if a Biden administration did not feel that China was gaining an unfair trade advantage over the U.S., complaints about Chinese human rights and environmental practices are likely to intensify.

Arguably a Biden administration could be more effective in challenging China on trade and other matters to the extent the Biden platform proposes to work with allies to put up a common front when dealing with the country.

Energy policy

The Biden platform proposes to block new oil and gas permits on federal property, but not to stop the process of hydraulic fracturing altogether.

However, plans for a carbon tax paired with a pledge for zero emissions by 2050 and zero emissions from power generation by 2035 provide considerable challenges to the energy sector.

Other items

Other prominent items on the Biden agenda include:

• a national $15 minimum wage
• universal preschool
• free college for middle income families and below
• student loan forgiveness
• higher retirement payments for seniors.

Many of these things will likely remain aspirational, but not necessarily all.

Economic implications

From a short-term perspective (<1 year), a Biden administration would likely impose more COVID-19 restrictions (negative) but also deliver more fiscal stimulus (positive). This is perhaps a slight net economic negative.

Over the medium term (1-2 years), the stricter handling of COVID-19 would likely result in fewer subsequent infections and so permit greater economic activity later, as would ongoing fiscal stimulus. But higher taxes would be a stock market negative.

Over the long run (3 years+), more immigrant-friendly policies and better trade relations would likely permit somewhat faster growth, though some of this would be offset by a less friendly tax regime.

Sweep/split

One last issue merits discussion. It matters whether one party wins in a sweep or if the two parties share control of the White House, Senate and House of Representatives.

Without contradicting the discussion above, the economy would likely be stronger in a sweep scenario – regardless of the winning party – than in a split scenario. This is mainly because fiscal stimulus becomes more likely when the other party isn’t capable of vetoing legislation. Conversely, the risk of government shutdowns, of falling off fiscal cliffs and the like, go down.

Gold bug

The price of gold recently exceeded $2000 per ounce for the first time ever. It has since retreated somewhat, but remains in rarefied air.

Why has it rallied by roughly 30% since the turn of the year? There are several answers:

• Initially, risk aversion drove investors into the perceived safety of gold, though most of the risk aversion has since faded from financial markets.
• Expectations of higher inflation are not unreasonable given enormous public debt loads, large central bank balance sheets, a possible shift toward average inflation targeting and the onshoring of supply chains.
• Ultra-low interest rates mean two things. First, gold investors are not forgoing much of a coupon in the bond market. Second, given how low yields are and a skepticism that the U.S. Federal Reserve will resort to negative interest rates, gold could well represent a better hedge against any bout of future financial market trouble than the bond market.
• S. dollar weakness usually sends commodity prices higher since they are priced in dollars whereas they are demanded globally. But the recent dollar weakness has a second implication: with the world’s reserve currency arguably in structural decline and no obvious substitute in the traditional currency world (neither the euro nor the renminbi seem ready to take over that mantle), gold has become a plausible substitute in the eyes of some.

To the extent that several of these trends seem likely to remain in place for the foreseeable future, gold may continue to perform. However, let us not lose sight of the fact that, as a real asset, an investor should expect to achieve an inflation-adjusted return on gold over the long run of 0%!

-With contributions from Vivien Lee and Kiki Oyerinde