Investing during and after an election
Investing during and after an election
US presidential elections can be tough on the nerves; however, the 2020 election appears to be the toughest in modern history. Politics can bring out strong emotions and biases, especially as we are amidst the most impactful pandemic in over 100 years. Unemployment is just under 8%, the federal deficit as a percentage of GDP is the largest since World War II, the US death toll from COVID-19 is over 200,000, and President Trump was sidelined by the virus just four weeks ahead of the election — yet markets are near their pre-pandemic peaks.
Understandably, many clients have been asking “What should I be doing ahead of the election?” “Should I be preparing for a Trump win or a Democratic sweep?”
In short, you should not be making any drastic changes to portfolios. It is important to stay the course of your short, medium, and long-term financial goals.
As noted in the 2016 election, it is near impossible to predict the outcome. According to 2016 polls, the likelihood of Hillary Clinton beating Donald Trump was over 70% a few weeks prior to the election. In addition to the inability to predict the election outcome, it is also unlikely that we can predict how the markets will react. When the news broke that Donald Trump won the election, equity markets dramatically sold-off overnight only to rebound, significantly, during his first term.
Here are some reasons why you should remain disciplined and invested in your goals and plans.
Investors worry too much about which party wins the election
There’s nothing wrong with wanting your candidate to win, but investors can run into trouble when they place too much importance on election results. Historically speaking, the outcome of US presidential elections have made essentially no difference when it comes to long-term investment returns.
What should matter more to investors is staying invested. Although past results are not indicative of future returns, according to Capital Group, “A $1,000 investment in the S&P 500 made when Franklin D. Roosevelt took office in 1933, would have been worth over $14 million on December 31, 2019. During this period there have been exactly seven Democratic and seven Republican presidents. Making investing decisions to avoid a certain party or candidate in office could have severely detracted from an investor’s long-term returns.”
Volatility in September and October is perfectly normal, but could still be worrying.
September and October typically tend to be the most volatile months of the year. We have seen a market sell-off of -3.02%, -4.64%, and -6.47% in the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite Index respectively during September 2020.
On average, the standard deviation of the Dow’s October daily gyrations has been 38% higher than it is for the remaining 11 months.
There are a few common misconceptions regarding why October might be a more volatile month than others:
- Uncertainty created by midterm and presidential elections, which occur in early November; however, Octobers are actually slightly more volatile in non-election years than during years of midterm and presidential elections.
- Many mutual funds fiscal year ends on 10/31. Perhaps the volatility is due to year-end transactions undertaken by those mutual funds whose fiscal years end on Halloween? This does not seem to be the culprit, as even before the 1970s and 1980s, when mutual funds became big players in the stock market, October was the most volatile month.
- Most companies report third quarter earnings in October. Could that be the reason for increased volatility in October? If this was the culprit, then investors would also expect there to be comparable jumps in volatility for January, April, and July when the other three quarters’ earnings are announced; however, that is not the case, as you can see from the accompanying chart.
- Might the broader economy follow a seasonal cycle in which, during October, the future is particularly uncertain? This is perhaps the most theoretically sound explanation, since there is a strong historical correlation between stock-market volatility and the Economic Policy Uncertainty index (EPU) that was introduced in 2016. It is difficult to say on that reasoning though, as the EPU is a relatively new index and volatility in October dates back to the Dow Jones Industrial Average’s inception in 1896.
Until and unless a more plausible explanation for October’s volatility is discovered, the odds are high that it is a random fluke of the data and investors should not make any knee jerk reactions to seasonal volatility.
Focus on fundamentals.
Investors should expect short-term stock market volatility as the election heats up; however, long-term, economic fundamentals are more likely to be important drivers for stocks rather than who wins the White House. Regardless of the election outcome, focusing on the fundamentals can help you weather the potential market response. Follow your financial plan (or create one). Save, invest, diversify, and rebalance to help accomplish your long-term goals…and ignore the noise.
The economic landscape may have changed, but have your goals?
One of the best ways to stay objective is to have and stick to a financial plan. This kind of “long-term roadmap” should include what you are saving for, how much you need to put away, and how long it will take to reach your goals. It can also provide much-needed perspective when market volatility and political uncertainty are elevated.
Election results could take a while.
The biggest threat to markets is a contested election. Since more Americans are likely to vote by mail due to COVID-19 concerns, it will take more time to count mail-in ballots. “That means we are unlikely to know who won on election night—and possibly for days and even weeks afterwards,” says Mike. “It’s something for investors to keep in mind, while being careful not to overreact.” The longer the uncertainty continues, the increased risk for market volatility—but having a sound financial plan can help you avoid the temptation to make big changes to your portfolio or investment strategy amidst any uncertainty.
Election outcome scenarios.
November’s US Presidential election is set to be one of high stakes, strong viewpoints, and an unprecedented mass mail-in voting process due to social distancing measures. Many expect polls to narrow over the coming weeks, which is likely to bring uncertainty to markets up to Election Day, and possibly beyond, in the case of a contested election.
There are three possible outcomes of the election and possible implications of each scenario below:
- Scenario 1 (Lower taxes, limited fiscal stimulus) - President Trump wins a second term and Congress remains split between a Democratic House and a Republican Senate.
- Scenario 2 (Higher taxes, stricter regulation, increased fiscal stimulus) - The Democrats sweep the White House and Congress.
- Scenario 3 (Less likely to pass tax changes, increased fiscal stimulus) - Former Vice President Joe Biden wins the presidency, but the Republicans hold the Senate.
Economy and taxes
Regardless of which candidate wins the election, the economy will likely still be recovering from a COVID-19 induced recession and would hardly be at full throttle. Fiscal stimulus (federal taxes and spending) is likely to be key to economic growth. While there has been disagreement over the latest fiscal stimulus package, we do believe that, regardless of the election outcome, additional stimulus is coming at some point this year.
Biden has proposed a combination of increased fiscal stimulus plans and a redistribution of the tax burden from middle income taxpayers to corporations, high-income taxpayers, and investors. Biden has proposed increasing the top corporate tax rate from 21% to 28% and for individuals from 37% to 39.6%, while treating capital gains and dividends, now taxed at a top rate of 20%, as ordinary income.
Under a Democratic sweep, inflation would likely increase and assets, such as gold and industrials, would likely outperform. There would likely be a sell-off in markets, although we do not believe a large one, if there is a Democratic sweep
With President Trump, you would likely see lower taxes on corporations, individuals, and capital gains, but less stimulus, although still some, and a more confrontational approach to US/China relations, which has unsettled markets in the past.
Interest rates
Regardless of the election, interest rates are likely to stay low for years to come. Fed Chair Jerome Powell said he aims to keep rates near zero until at least 2023. This easy monetary policy is definitely a positive for the stock market, and if we have learned one thing throughout the decade plus of quantitative easing, it is, “don’t fight the Fed.”
Low interest rates should spur economic growth with major corporations and provide a strong housing market as people leave big cities for the suburbs.
Trump Trade 2.0
The main characteristics of the first Trump Trade are likely to persist in version 2.0, although this would likely be toned down a bit. The expected pro-growth policy mix of tax cuts, fiscal stimulus targeted to infrastructure, and deregulation we believe would be net positive for growth and equities. Financials and energy could benefit both because they are key barometers of economic growth and the uncertainty of potential regulatory changes under a Biden win would be eliminated. This policy mix could also benefit large-cap tech stocks, although some would still be under antitrust risk.
The Biden Trade
There seems to be widespread concern that a Democratic sweep would be negative for US equity markets. We acknowledge the risk, but we think a Democratic sweep will have a net neutral effect on equities, though there will likely be winners and losers. Just about all companies will face the prospect of higher corporate taxes. It is important to keep in mind, however, that tax reform could be phased in over time and higher fiscal stimulus could net out the effect of tax increases. At a sector level, industrials, materials, and segments of tech and utilities could be modest beneficiaries from transportation, green, and tech infrastructure spending.
However, under a Democratic sweep, there is a risk of a sell-off as investors take profits due to the potential raising of the capital gains tax and reduced corporate profits due to increased taxes.
Conclusion
One thing is for certain, there seems to be more unpredictability in this election than we have ever seen. Volatility will likely increase, as equity markets do not favor uncertainty and the biggest risk to markets is not who wins the election, but if there will be a contested election.
By design, elections have clear winners and losers; however, the real winners were investors who avoided the temptation to base their decisions around election results and stayed invested for the long-term.
Sources: WSJ, UBS, BNY Mellon, Schwab, Fidelity
