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The Americans have managed to turn their federal election process into a financially wasteful, intellectually maddening three-ring circus. Mercifully, the current season has its finale this week and the outcome will have significant market implications.

Donald Trump’s victory in 2016 taught investors not to trust polls or election forecasts and, while Joe Biden appears poised to prevail, this time is no different. Active investors need to remain flexible, according to Morgan Stanley strategist Michael Zezas.

Mr. Zezas advises clients to prepare for a number of plausible scenarios, not just who becomes president but also the parties that wind up controlling the Senate and the House of Representatives. The potential for a delayed or legally contentious result must be considered as well.

The strategist expects fiscal stimulus legislation to be passed no matter what the result of the elections. “We’re more confident in economically supportive fiscal policy across most outcomes, in particular a Democratic sweep scenario,” he writes, “whereas investors remain somewhat concerned about the impact of higher taxes and more regulation.”

Mr. Zezas sees gridlock – a Democratic president and House with a Republican Senate - as an underrated market risk. He believes that less fiscal stimulus, or none, might be the result.

Depressingly, Morgan Stanley is not convinced we’ll know the winner of the presidential election Wednesday morning. Mr. Zezas notes that if the Democrats win Florida and North Carolina, “it could be a short night for investors.” Tighter races there, however, likely mean that investors will have to wait a few days for final vote counts from battleground states like Pennsylvania, Michigan and Wisconsin.

The Blue Wave scenario – a Democratic clean sweep of the White House, House and Senate – is the most bullish for markets because it all but guarantees a big fiscal stimulus package. Even in this event, Mr. Zezas warned that equities may drop initially as the effects of higher corporate taxes are assessed.

-- Scott Barlow, Globe and Mail market strategist

This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.

Stocks to ponder

Lithium Americas Corp. (LAC-T) Shares in this lithium project operator have risen over 200 per cent year-to-date. However, since a record high on Oct. 5, the share price has plunged 39 per cent. The recent price weakness may soon represent a buying opportunity for long-term investors, and a Joe Biden win Tuesday night could be a catalyst for further gains. Jennifer Dowty looks at the investment case. (for subscribers)

The Rundown

The most important thing for income investors to do in what promises to be a very unsettling month ahead

October was a lousy month for stocks, and investors would be wise to buckle up for a volatile November. Continued escalation in COVID-19 cases will heighten fears of a reversion to the dark economic days of last spring. That could be compounded by political concerns in the aftermath of the U.S. election. For income investors, the key is to keep your cool, whatever happens. Gordon Pape explains his recommended game strategy for those who count on dividends in their portfolios. (for subscribers)

Three things to keep in mind as America votes

Given all the disparate political scenarios that may arise out of the U.S. election, one conclusion seems clear: Investors should sit tight until the fog clears. While analysts have produced endless reports detailing the potential impacts of this policy or that policy on individual sectors, the unknown factors still far outweigh the known ones. Ian McGugan provides his advice on the eve of the American vote for putting things into perspective. (for subscribers)

Also see: How investors are gaming out U.S. election night

Have robo-advisers just been outflanked by a cheaper, better way to invest?

Digital investing is finally hitting its stride as a way to make the portfolio-building process cheap, easy and accessible to all investors, including those with accounts too small to interest anyone on the human side of managing money. Introduced this week, Toronto-Dominion Bank’s new GoalAssist investing app is the latest example. It offers a way to set financial goals and then reach them by investing money in TD’s family of exchange-traded funds at no cost. Rob Carrick tells us all about it. (for subscribers)

Tech stocks may be in for turbulence, regardless of who wins the U.S. election

Some investors are betting the technology and communications stocks that drove a massive rebound in U.S. markets this year will face a tougher slog in coming months, no matter whether Republican President Donald Trump or Democratic challenger Joe Biden wins Tuesday’s election. Betting against big technology has been a risky proposition over the last decade, as stocks like Amazon, Google and Netflix have shot higher at the expense of so-called value and cyclical stocks such as banks and energy companies. Recently, however, some fund managers say they are growing alarmed by what they see as a consensus in Washington to tighten regulations, and prospects that another large stimulus bill would bolster a rotation out of tech and into other sectors including economically sensitive value stocks. David Randall and Svea Herbst-Bayliss of Reuters report (for everyone)

Others (for subscribers)

John Heinzl’s model dividend growth portfolio as of Oct. 31, 2020

The highest yielding stocks on the TSX, plus risk data

Monday’s analyst upgrades and downgrades

Monday’s Insider Report: Directors are buying these two dividend stocks that are nearing oversold territory

Others (for everyone)

This index can help forecast the end of a market sell-off

Ask Globe Investor

Question: What is your opinion of covered-call exchange-traded funds? They have higher yields than regular ETFs but I’m wondering if there are any hidden risks.

Answer: Covered-call ETFs generate income by selling call options on a portion of their shares. Call options give the buyer the right to purchase a stock at a specified price before a certain date. (They’re known as “covered” calls because the ETF owns the stocks on which the options contracts are written.) The premium income from selling options allows the ETF to enhance the distribution paid to unitholders.

In some cases, selling call options works to the ETF’s advantage. When the underlying stocks are stable or fall in price, the option buyer has no incentive to exercise the option and the ETF simply pockets the premium. That’s why covered-call ETFs perform best, relative to plain-vanilla ETFs, in flat or falling markets.

However, in rising markets, covered-call ETFs typically underperform. When a stock rises above the “strike price” of the option, the option holder will exercise the option to buy the stock. The ETF still gets to keep the premium, but it suffers a loss on the stock, which it is forced to sell at a price below the market.

In effect, when you purchase a covered-call ETF, you’re giving up potential future gains in exchange for receiving slightly more income now. What’s more, covered-call ETFs typically have higher costs than regular ETFs, which exerts a further drag on performance.

Let’s look at an example. The BMO Covered Call Canadian Banks ETF (ZWB) yields about 6.6 per cent and charges a management expense ratio of 0.71 per cent. Year-to-date through Sept. 30 – a period when the coronavirus hammered bank stocks – ZWB posted a total return, including dividends, of negative 10.82 per cent.

Now let’s compare ZWB with the plain-vanilla BMO Equal Weight Banks Index ETF (ZEB), which yields about 4.9 per cent and has an MER of 0.61 per cent. Through Sept. 30, ZEB posted a total return, including dividends, of negative 11.5 per cent.

So, during the volatile market of 2020, the covered-call strategy generated a slightly better – or, at least, less bad – return. ZWB also slightly outperformed ZEB in 2018, which was also a bad year for bank stocks.

But in years when bank stocks did well, ZWB consistently trailed ZEB. In 2019, for instance, ZWB posted a total return of 14.27 per cent, compared with 16.03 per cent for ZEB. ZWB’s underperformance was even more dramatic in 2017 and 2016, when it lagged ZEB by 2.71 percentage points and 5.5 percentage points, respectively.

Could this be a fluke? Not likely. I compared the BMO Covered Call Dow Jones Industrial Average Hedged to CAD ETF (ZWA) with the BMO Dow Jones Industrial Average Hedged to CAD Index ETF (ZDJ). For the five years to Sept. 30, ZWA posted an annualized return of 9.62 per cent, well below ZDJ’s return of 11.88 per cent.

Remember, too, that the stock market tends to rise over time. That means there will be more periods when the covered-call strategy hurts performance than when it adds value.

Bottom line: If you’re tempted by the high yields of covered-call ETFs, remember that there is no free lunch with investing. You’ll likely pay for that fatter yield with lower overall returns.

--John Heinzl

What’s up in the days ahead

The market loves companies that have been sailing through the pandemic with strong business activity. David Berman will tell us about FirstService Corp., a relatively low-key Toronto-based company that has joined the winner’s circle.

Click here to see the Globe Investor earnings and economic news calendar.

More Globe Investor coverage

Looking for financial help? Has #COVID derailed your financial plan? Are you worried about retirement? Get some free advice from The Globe and Mail about your unique financial situation by emailing finfacelift@gmail.com to be part of our Financial Facelift series.

You can share your story under a false name and our photographers will obscure your identity in one of our trademark Financial Facelift photos. We’re especially keen to hear from the young, the struggling, the self-employed, the partially-employed, restaurant workers, freelancers, contract workers and small business owners. Hopefully our advice can help you weather these stormy times and help make sure your financial future is secure.

Compiled by Globe Investor Staff

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