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Potential risks the presidential election will bring the economy

Miles Lewis - Royce Investment Partners Portfolio Manager joins Yahoo Finance’s On The Move panel to discuss how the presidential election will impact markets.

Video Transcript

ADAM SHAPRIO: But as we look at markets right now, the Dow is up over 370 points, up over 4%. And to help us break down how markets are reacting not only to the debate, but what's going on with the negotiations for stimulus-- remember, the House voting on a $2.2-trillion smaller proposal from the Democrats-- to help us break this down is Miles Lewis. He's Royce Investments' partners portfolio manager. Good to have you here, and we appreciate you joining us from Fairfield, Connecticut.

I want to start with something that you pointed out-- that incomes during this most recent pandemic-motivated recession-- despite, as you said, the worst recession in a very long time, that consumer incomes went up during this recession. Break that down for us. Because we know that the very wealthy did well with their stock holdings. But in regards to income, was part of this the stimulus that people were getting from the federal government, the $600 and the $1,200 check?

MILES LEWIS: Yeah, that's exactly what it was. Historically, incomes go down during a recession. But the federal government has stepped in in a big way to preserve what is effectively 70% of the US economy, and that's the consumer.

And so there's a lot of debate about how long that will last. And that's one of the reasons that the current focus on the new stimulus package is so important to markets. But either way the consumer, is in relatively healthy shape, all things considered, given the size of this contraction, the speed of this contraction.

Another important metric would be to look at the personal savings rate, which just skyrocketed during the recession. It's come back down a little bit as consumers have drawn on some of those savings to fund their daily needs, but they're still in a very healthy position. So I think that's something that is an important difference in this recession versus prior recessions and could bode well as we start to come out of it, which is just simply that the consumer is in relatively good shape, all things considered.

- Well, Miles, you were saying that the market is really focused on whether this is going to continue. It ended already, right? People are not getting these checks anymore. And we are starting to see, on a corporate level-- not just on a consumer level, but on a corporate level-- some of the effects of this as we start to see more and more layoffs. So the market, while maybe focused on that stimulus, hasn't necessarily-- I mean, yes, we had a pullback. But is it really pricing in the idea that maybe stimulus won't happen, or are investors assuming that it's going to get done?

MILES LEWIS: I think that's it's a little bit hard to tell because there's so many moving pieces in the market. But I think that what we'll ultimately see is if the markets behave poorly enough, then Washington DC will get its act together and get things done. So that's historically what's happened. Obviously, the election plays a big role in that.

So we're not politicians. I'm a stock picker and focused on businesses, so I don't have an edge on whether or not a stimulus is going to get done. But I think it's probably more likely to get done than not. And hopefully, that provides a much-needed bridge for the economy and the consumer until we get a vaccine and things can start to get back to something we call normal.

- Miles, I want to get back to the election risks that has been factored in here. Not to make too much of the market moves during the debate yesterday, but it did seem like investors, when you're looking at where futures were trading, did sour on this debate towards the end when the president started talking about having his supporters go to the polls and watch very closely with concerns about voter fraud.

And I'm just wondering-- we keep hearing our guests over and over saying, yes, the election risk has been priced in. But what exactly has been priced in? I mean, this scenario of a drawn-out election, a contested election-- the president's refusing to commit to accepting the results. I mean, is all of that factored in right now when you look at where the market is trading?

MILES LEWIS: It's probably not, and we probably have some more volatility ahead. But there's the old saying that markets love to climb a wall of worry. And personally, as an investor, I like uncertainty because that creates a lot of opportunity for long-term-oriented investors like us at Royce. So we'll see how this all shakes out. But if it creates volatility, and therefore opportunity to buy good businesses at discounted prices, then we welcome that volatility.

ADAM SHAPRIO: The Russell 2000 is up. I'm looking at a monitor right now. It's up about 1.25%. You actually think that there's some constructive future for small-cap stocks over the next few years. What it's telling you that small caps might be something investors should consider?

MILES LEWIS: Well, the biggest thing, frankly, is just how much small caps have lagged large caps. And historically, when they've lagged as significantly as they have-- and they have for a decade-plus now-- then the returns on a forward-looking basis are very attractive. So that's one thing.

The second thing would just be that I think we're going to see a recovery that shows the economy is fairly resilient. And that's, of course, predicated on getting a vaccine at some point in mid-2021 and it being widely available. Not a scientist or a doctor, so I have no edge on that. I'm relying on all the same expert opinions that everybody else is.

But assuming that's the case, then we think small caps are going to do very, very well, particularly the more cyclical and economically sensitive small-cap companies out there. Because that earnings volatility, which in the past has been discounted and not favored by the market, could be rewarded as we come out of a recession. And you get positive operating leverage on the way back up, and that portends higher earnings and better earnings growth. And so we think it's actually a pretty good backdrop for small caps on a forward-looking basis over the next couple of years.

ADAM SHAPRIO: All right. We want to say thank you to Miles Lewis, Royce Investment Partners. You're a portfolio manage there. We appreciate your insight.