The Market Cares Less About the Election Outcome Than We Do

October 9, 2020 – Presidential elections have an important impact on many areas of our lives. In each election cycle the stakes seem higher than ever. There are social, regulatory, fiscal and judicial implications to name just a few. Some effects are short-term, many are lasting. While this election is consequential and is understandably important to us, the long-term performance of the market is not dependent on the outcome of a single election.

History reminds us that election outcomes are difficult to predict. Forecasting the financial market’s response to an election is even more challenging. Conventional wisdom leading up to the 2016 presidential election predicted (1) Hillary Clinton’s victory was a cinch, (2) she was the preferred candidate of the financial markets, and (3) if by some improbable turn of events Trump were to win, the markets would be spooked and sell-off sharply. In time, all three projections proved untrue.

Historical data show little significant difference in market performance based on the party occupying the oval office. With only a fraction of a percent difference in historical performance, Democrats have slightly outperformed Republicans. However, we know financial markets dislike uncertainty and elections can have a short-term influence on the markets. Conducting an election during a pandemic compounds the uncertainty that accompanies any imminent election. In the short term, obtaining a presidential election outcome in a timely manner will be more important than any one outcome in particular. Unless there is a decisive winner November 3^rd the results will likely be contested. Expect short-term volatility around the election and possibly the following weeks and keep in mind that these fluctuations can be expected even in a more normal environment.

Financial markets are forward-looking pricing mechanisms. We believe the markets in 2021 will not be pricing stocks based on who is in the White House, but on how the economy and corporate profits are recovering and what the outlook is for the next several quarters. We are considering the following factors, among others, and asking what the financial world will look like twelve months from now:

• Will interest rates still be low? Yes, the Federal Reserve has all but guaranteed that to be so.
• Will Congress fund another round of stimulus payments? We think so even if it is a small more targeted program.
• Will there be a safe and effective vaccine for COVID-19? Most likely, according to even conservative estimates.
• Will corporate earnings be substantially higher than current earnings? Almost certainly. The year-over-year comparisons will likely show substantial increases as most corporations recover. Even still, some industries—like hospitality and airlines—will take years to rebuild.

These are unusual circumstances but it is hard to build a case against a continued economic and market recovery.  Given the likely answers to all these questions, we believe the market environment will be positive through 2021, regardless of the election outcome.

In nearly all cases, we are managing accounts with long-term objectives. Though some may be providing for current needs, portfolios have to sustain or grow to meet objectives many years in the future. We will adhere to a thoughtful investment strategy that includes safer investments for short-term needs, while keeping a focus on long-term objectives. Your investment strategy is based on you and your personal objectives. While the market environment helps inform how we implement that strategy, it does not change the overall strategy.

We see the current U.S. stock market as fairly valued. As we reviewed last quarter, much of the gain and high valuation in 2020 has been concentrated in a handful of very large technology stocks. The rest of the market is valued at much more reasonable levels. Additionally, a recent pull back in those leadership names is helping build a base for future sustainable gains for the broader market.

Going into the global virus shutdown, international economies generally were not as strong as the U.S. economy and have not recovered as well and now especially Europe is facing of a second wave of infections. Additional stimulus should help European stocks make a comeback and for U.S. investors in foreign assets, recent weakness in the U.S. dollar also provides a tailwind for returns. We are maintaining foreign allocations primarily in Europe, while including additional diversification in emerging markets when appropriate.

With interest rates at historic lows and the Federal Reserve indicating that short-term rates will stay low, the outlook for bonds is one of lower than normal returns. If rates remain unchanged, current low interest payments will be the extent of the expected return. If rates rise, longer maturity bonds will experience price declines offset by only the modest interest payment. Bonds, or some form of low risk asset, are necessary in most portfolios. Using a very conservative approach, bonds are still useful for risk reduction—but at lower expected returns. The 10-Year Treasury bond ended the quarter at a yield of 0.68%, down from 1.92% at the start of the year. We prefer to build core portfolios of individual municipal bonds or high-quality taxable bonds, while supplementing with small allocations to specialty bond funds.

Among other asset classes, we have for some time added allocations to convertible bonds, which have characteristics of both stocks and bonds and help reduce market risk in portfolios. Real estate, which we used to treat as an asset class, we now utilize as part of a stock allocation.

Although we provide an overview of many areas of the market, our focus when managing your portfolio is on your personal goal and an individualized strategy to reach that goal. We welcome your feedback and questions.