'The market isn't really tied to one or the other': Strategist on how the election will impact the market

Tobias Levkovich, Citi Chief U.S. Equity Strategist, joined The Final Round to discuss his outlook for the market amid uncertainty due to COVID-19 and how the upcoming election may impact the market.

Video Transcript

MYLES UDLAND: Back to The Final Round here on Yahoo Finance, Myles Udland with you in New York. All right, let's turn our attention now to the markets, everything that's gone on in September. Of course, earnings season coming up, then we have the election. For more on all of that, we are joined now by Tobias Levkovich. He is the Chief US Equity Strategist over at Citi. So Tobias, let's start with maybe how we finished the third quarter and kind of the conversations that you were having as we wrapped up September, a month that was pretty choppy for the markets and maybe took some investors by surprise after that robust August that we saw.

TOBIAS LEVKOVICH: So actually, we were a little concerned by how strong August was. One of our primary metrics for measuring sentiment, our Panic/Euphoria model, hit a level we hadn't seen since 2001, in terms of generating a 100% probability of markets being down subsequently. Again, that's not a number you, kind of, trifle with when you say 100%. And we thought investors had got a bit over their skis, that there were still a bunch of uncertain issues, including second wave of the pandemic, the elections, et cetera, that need to, kind of, be addressed. And so September's pullback wasn't that [AUDIO OUT].

We did a survey, published just over maybe 10 days ago, and it showed, for instance, that institutional investors are looking at industrials and materials as out performers for 2021 and kind of giving up on the technology area, which is their favorite area, for 2020 was going to be more of a neutral kind of situation. So there seemed to be a little bit more of a cyclical bias, if you want to call it, kind of entering into the game here and even like financials for next year, which was a big change.

MYLES UDLAND: And so, you know, kind of jumping off of that, your note that I think was out on Friday, looking at earnings season and looking at a number of areas in the market where expectations had jumped so much-- autos, transports, software, among them-- does that kind of environment maybe set up the third quarter earnings period as a time where we do see regime change, and we do see durable, kind of, extended leadership from some of those cyclical sectors you were just mentioning?

TOBIAS LEVKOVICH: So one of the really critical issues, and what you were talking about specifically is the upward earnings revisions as a percent of total revisions, and it really spiked to levels we haven't seen. For instance, with the overall markets at about 75%, that's even higher than it was after the Trump tax cut. So it's pretty extended, everybody kind of feeling better about the future. What I found really interesting in the data was that investors are all thinking about the lapping of comparisons. So when we get to February and March of next year, some of this you want to call it COVID beneficiaries, e-commerce, Cloud, things like that, are going to see some really tough comparisons.

On the other hand, those that have been most COVID impaired-- so think leisure, hospitality, travel-- are probably going to see some of the easier comps. And there's a difference on valuation between those, you know, kind of more secular growth names. They're sitting with again extended valuation versus those that are sitting with, with more suppressed valuation, because the concerns. What happens when the thing that was growing 40%, all the sudden only grows 10%? Still really good growth, particularly off a 40% comparison the prior year, but if you lose some of the momentum, do you start peeling off some of that? They're not doing it today, if you look at the value of the markets, where they're still sticking with some of those tech names.

But you are seeing energy performing really well today. You're seeing small caps. You're seeing, you know, some of the more, again cyclically biased areas also getting a bit of a boost here. So it's kind of, we haven't given up the old winners, but there is at least a sense that maybe after the elections and people are starting to focus towards 2021, that that shift could occur.

MYLES UDLAND: And then thinking about the elections right now, we're just four weeks plus one day away from election day here in the US, how have you been thinking about that event as a catalyst for maybe some investment themes, or just as a risk to monitor for investors who, you know, obviously, everyone knows it's coming. We can all look at the VIX and see that there's some action priced in, but how have you, kind of, tried to make sense of that event?

TOBIAS LEVKOVICH: So I'm going to first off and say I'm proud to be Canadian, which usually gets the appropriate laugh, but look, investors are thinking very interestingly that yes, if Biden wins, there may be higher taxes, but it'll be offset by maybe a more stable and predictable trade policy or global alliances forming better than the more unilateral or bilateral approach taken by President Trump. And if Trump wins, then again, we don't get higher taxes. So they're kind of looking at it as, kind of, the market isn't really tied to one or the other.

Sectors can be very different. So how are you looking at anything environmentally sensitive? How are we going to be looking at health care? How are we going to be looking at infrastructure spending? Certainly it would be more of a green bent to it if the Biden team wins and takes the Senate, and we start seeing those kind of jobs programs and stimulus coming through. I think there'll probably be an infrastructure program even if President Trump won re-election, but it won't be designed that way.

So at the sector level, there are some really interesting differences. One of the ones that we don't think has as big a difference as everybody would think is energy. And that, really what ends up happening in the energy sector is currently under pressure in general, because the concerns of that more regulatory environment, more climate change focus under Biden administration, but that will also take off some of the shale projects in some of the shale supply, which will probably be positive energy prices.

And if on the other hand, President Trump wins re-election, then you probably don't have the feared regulatory, kind of, negatives or cost components associated with the energy in the streets. So that could be weirdly a winner under either scenario, and we don't think it changes that much for technology or consumer discretionary. Both sides are going to be-- particularly in technology, both sides are going to be pretty concerned about tax rates that are being paid by companies who found some really good loopholes or things around privacy issues, monopolistic power. They're sort of populists on both sides of the aisle.

MYLES UDLAND: All right, Tobias Levkovich, a Canadian, Chief US Equity Strategist over at Citi. Tobias, thanks so much for joining the show. Always great to get your thoughts.

TOBIAS LEVKOVICH: Thank you. Take care, guys.