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In this episode we discuss how COVID-19 continues to drive market risk.There has been a pick-up in new Covid-19 cases across Europe - and with it, the prospect of another round of national lockdowns. This poses a major risk to markets, but it is not the only potential source of volatility. The Brexit deadline is looming, with just a few weeks to reach a Free Trade Agreement ahead of the European Council meeting. If an agreement is not forthcoming, it could lead to significant turmoil in financial and currency markets.Then there is the US election, which has been more contentious than most. Biden is still ahead in the polls, but Donald Trump has made it clear he won’t go quietly. History suggests that a disputed election may upset stockmarkets.[0.28] We’ve seen a pick up in new Covid-19 cases across Europe - and with it, the prospect of another round of national lockdowns. Is this a major risk to markets – and are there any other risks we should be thinking about?Yes, we see the risk of more lockdowns as the major risk to markets today, but we also see a number of other tail risks looming this autumnsome of these issues could include a no-deal Brexit, a disputed US election and a sell-off in technology stocks, each of which has the potential to put material downward pressure on equities (at home and abroad). [1.05] OK – let's look at some of those risks in more detail. The Brexit deadline is looming, what’s your reading of the situation?The UK has already left the EU, however, by effectively reopening-up the legislated Withdrawal Agreement, PM Boris Johnson has raised the possibility that the UK may not get even a very basic Free Trade Agreement on goods with the EU when the transition period expires at year endthe British government is changing the Withdrawal Agreement text on fears that in the event of no Free Trade Agreement, the EU could restrict trade between Great Britain and Northern Ireland and undermine the integrity of the UK the government is also concerned that the Northern Ireland Protocol (NIP) in the Withdrawal Agreement could potentially give the EU powers over UK state aid in perpetuity. The UK could make a case for reneging on some commitments made in the revised NIP in October 2019 around the government needing to play a larger role in helping the economy recover from the pandemiccertainly, article 62 of the Vienna Convention on the Law of Treaties enables parties to discharge their legal obligations when there has been a “fundamental change in circumstances” since the treaty was signed.  [2.27] And they’re arguing that the Covid-19 outbreak is just this kind of ‘change in circumstances?Exactly, and certainly this has been the biggest economic shock in modern historynevertheless, the EU is unimpressed that the UK is willing to make changes to commitments made less than a year agoBoris Johnson has given the EU a deadline of 15 October to reach a Free Trade Agreement at the European Council meetingif an agreement is not forthcoming, it could lead to volatility in financial and currency markets. [2.59] OK, let’s turn to the US. There’s a lot of noise generated by the election, but what do you see as important? Since the coronavirus crisis hit the media headlines at the start of this year, Joe Biden’s strategy has been to make the November US election an effective referendum on President Trump’s handling of the pandemicin opinion polls President Trump’s job approval rating slipped from 47% at the start of April to a low of 41% at the end of July(1)as lockdown has ended it has steadily recovered to 45% currently(2)for comparison, job approval rating data from Gallup show that in June of an election year, previous incumbents, like George H.W. Bush in 1992 on 37%, Jimmy Carter on 32% in 1980 and Gerald Ford on 45% in 1976, all lost office after one term on such low stats(3)the exception was Harry Truman, who was re-elected in 1948on just 40%(4)it is possible that the race for the keys of the White House is influenced by whether a COVID-19 vaccine is approved for distribution ahead of the electionopinion polls could narrow further and potentially lead to a wafer-thin win for either Joe Biden or Donald Trumpconsidering the partisanship between Democrats and Republicans, a tight election result would be hotly disputed, as it was when Republican George Bush was initially shown to have beaten Democrat Al Gore on 7 November 2000 by a slender margin in Floridagiven the closeness of the result, the Democrats demanded recounts, the S&P 500 fell over 8% during this period of political uncertainty until the Supreme Court ordered recounting to stop after 34 days.(5) [4.46] So mail-in voting could be the big area of contention?Yes. Lingering concerns over COVID-19 are likely to boost voting by mail. This opens a whole can of risks, ranging from allegations of fraud, lost, uncounted or rejected ballots from voters unfamiliar to verification requirementsgiven the time it will take to count voting by mail, the election result may not be known on the daythe election is on 3 November, but the deadline for all states to certify voting results is 8 Decemberultimately, unless there is a clear win for either side, the result could be disputed and that could undermine financial markets performance.  [5.28] There’s finally been some sell-off among the big tech stocks. What do you believe is happening there?The so-called FAAMG (Facebook, Apple, Amazon, Microsoft and Google) basket of technology stocks have sold off in aggregate by 16% from peak to trough so far in September(6)the biggest correction seen since the market downturn in Marchinvestors may be simply taking profits after such a strong run or getting apprehensive about increasingly demanding valuationsas the economy opens up again competitors will be able to recover at least some market share thus slowing FAAMG growth rates and reducing their relative attractivenessthe risk to equities is the size of the FAAMGs, which collectively account for around a quarter of S&P 500 market cap and around 8% of global GDP(7)a larger correction in the FAAMGs stocks could lead to a broader equity market correctionhowever, it is encouraging to see that the recent correction in the FAAMGs has had less of an impact on global equities in September than in late February and March. [6.37] What do you believe might happen if a vaccine is found and what is your outlook for markets?Even if an effective COVID-19 vaccine is found and used by the bulk of the population, related markets risks are likely to linger so we expect volatility to continuenonetheless, when viewed from a longer-term perspective, we believe the sheer scale of the unprecedented global financial stimulus and indeed hope of some medical progress against the virus leave sufficient room for some guarded optimismmoreover, the opening-up of the global economy is unleashing pent-up demandone example of where this is happening is in the important US residential sector, which reported its fastest pace of existing home sales in August for 14 years(8)confidence is returning to the US economy, as furloughed workers returns to jobs; the unemployment rate has now fallen to 8.4% currently from a peak of 14.7% back in April. This improving macro backdrop has broadened to the global economy and company earnings(9)the consensus now expects global forward Earnings Per Share growth of +15% expected over the next 12 months, a dramatic improvement from -2% just 6 months ago. As such, we see this fundamental pick-up in company earnings to support equity prices and so, we remain positive.(10)References:1-4 Real Clear Politics, data as at 24 September 20205, 8-10 Refinitiv Datastream6-7 Refinitiv Datastream, calculations by Smith & Williamson data as at 24 September 2020This episode was recorded on 30/09/2020Capital at risk. Please remember the value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance. This S&W The Pulse podcast is of a general nature and is not a substitute for professional advice. No responsibility can be accepted for the consequences of any action taken or refrained from as a result of what is said. The views expressed are not necessarily those of the presenter or of Smith & Williamson or any of its affiliates. No reproduction of this podcast may be made in whole or in part for professional or recreational purposes. No action should be taken based on this podcast and we accept no liability if we change your views on any of the subjects mentioned. Smith & Williamson Investment Management LLPAuthorised and regulated by the Financial Conduct Authority. Registered No 580531