To say that the political landscape has been volatile of late would be a gross understatement. Over the course of a few weeks since the first presidential debate, we have witnessed an unprecedented intra-party attempt to remove Joe Biden as the Democratic Presidential candidate due to potential incompetency, followed by an attempted assassination of Donald Trump that resulted in the tragic loss of a bystander’s life. Volatile and tragic times indeed.
Ironically, that volatility has led to clearer direction around potential election outcomes by thrusting the odds firmly in the direction of Republicans. A lot can still happen over the next several months, but since the lows of 43% posted in April, the odds of a Trump win have soared to over 70% according to current betting markets.
This Republican Presidential support is spilling over into the Congressional elections as well, where the odds of a Republican sweep have risen to around 50% – over double any other potential outcome.
Depending on one’s political affiliation, extreme elation or extreme fear may be sweeping over some investors at this moment, and these emotions often spill over into the economy and markets. Many clients over the years, on both sides of the political spectrum, have said they wanted “out of the market” when their preferred candidate did not win. This action has almost invariably proven to be the wrong one. Since 1984, the market has averaged a 16.4% return one year after the Presidential election, with only one down year – and that was 2000 at the height of the tech bubble collapse.
Why such misdirected fear? Investors tend to over-emphasize the impact that politics have on the broader economy and stock market. Political volatility does not necessarily equal market volatility.
It’s not that economic policy is unimportant, but those impacts tend to be marginal and long-tailed. Policy effects are more often felt in specific sectors or asset classes, rather than through the economy as a whole, so let’s take a look at what a possible Republican sweep would mean along three main policy mechanisms: trade, fiscal, and regulatory policy.
Trade Policy: One of the major planks of Trump’s prior administration and his current platform is the use of trade tariffs. Trump has suggested a possible 10% baseline tariff on all imports and a 60% tariff on Chinese imports specifically. Biden also does not object to tariffs and has kept most of the Trump-enacted tariffs in place during his administration. Tariffs are a slight drag to GDP growth depending on how other countries retaliate, and can have an inflationary impact to the extent those tariffs are passed through to the consumer. This inflationary impact may keep interest rates higher from the Fed – all of which tends to be strong support for the US Dollar. In fact, the reaction of the USD to differing administrations is in stark contrast when looking back through the past two elections as seen in the figure below.
Fiscal Policy: the most obvious impact of a Republican sweep would be the likely extension (potentially permanent) of the 2017 TCJA tax cuts that are set to expire in 2025. While lower taxes are a boon for investors and can provide an economic lift, neither party seems overly concerned with the expense side of ballooning deficits. Risks remain that interest rates stay higher to compensate for the increased risk of US debt sustainability. While probably a topic for another letter, either party will soon have to deal with the economic reality of rapidly rising interest costs on US debt. Right now, both parties seem to be kicking the can down the road on debt and deficits.
Regulatory Policy: A Trump administration would bring a mixed bag of regulatory actions, but would generally be more favorable toward traditional energy companies and financials. It would also create a potential headwind for alternative energy providers as emissions regulations would likely be rolled back. Regarding big tech companies, acquisitions would likely come under less scrutiny, spurring increased mergers and acquisition activity. On the flip side, Trump’s Vice Presidential pick, J.D. Vance, has been a vocal supporter of Biden’s DOJ anti-trust suits against big tech.
Navigating the trade, fiscal, and regulatory impacts can be challenging and will certainly create winners and losers. But it can be easy to lose the forest for the trees – what really drives markets are the basic economic fundamentals of interest rates, corporate earnings, employment, and consumer spending. It’s natural for fears take the place of those basic fundamentals, particularly in the tumultuous political environment we’re experiencing today. It is imperative we not let those emotions drive us towards irrational investment decisions. Discipline, sticking to a plan, and focusing on the fundamentals will prevail over political fear.
Investment Commentary: The Politics of Fear
By Jonathan McAdams, CFA®
To say that the political landscape has been volatile of late would be a gross understatement. Over the course of a few weeks since the first presidential debate, we have witnessed an unprecedented intra-party attempt to remove Joe Biden as the Democratic Presidential candidate due to potential incompetency, followed by an attempted assassination of Donald Trump that resulted in the tragic loss of a bystander’s life. Volatile and tragic times indeed.
Ironically, that volatility has led to clearer direction around potential election outcomes by thrusting the odds firmly in the direction of Republicans. A lot can still happen over the next several months, but since the lows of 43% posted in April, the odds of a Trump win have soared to over 70% according to current betting markets.
Depending on one’s political affiliation, extreme elation or extreme fear may be sweeping over some investors at this moment, and these emotions often spill over into the economy and markets. Many clients over the years, on both sides of the political spectrum, have said they wanted “out of the market” when their preferred candidate did not win. This action has almost invariably proven to be the wrong one. Since 1984, the market has averaged a 16.4% return one year after the Presidential election, with only one down year – and that was 2000 at the height of the tech bubble collapse.
Why such misdirected fear? Investors tend to over-emphasize the impact that politics have on the broader economy and stock market. Political volatility does not necessarily equal market volatility.
It’s not that economic policy is unimportant, but those impacts tend to be marginal and long-tailed. Policy effects are more often felt in specific sectors or asset classes, rather than through the economy as a whole, so let’s take a look at what a possible Republican sweep would mean along three main policy mechanisms: trade, fiscal, and regulatory policy.
Trade Policy: One of the major planks of Trump’s prior administration and his current platform is the use of trade tariffs. Trump has suggested a possible 10% baseline tariff on all imports and a 60% tariff on Chinese imports specifically. Biden also does not object to tariffs and has kept most of the Trump-enacted tariffs in place during his administration. Tariffs are a slight drag to GDP growth depending on how other countries retaliate, and can have an inflationary impact to the extent those tariffs are passed through to the consumer. This inflationary impact may keep interest rates higher from the Fed – all of which tends to be strong support for the US Dollar. In fact, the reaction of the USD to differing administrations is in stark contrast when looking back through the past two elections as seen in the figure below.
Fiscal Policy: the most obvious impact of a Republican sweep would be the likely extension (potentially permanent) of the 2017 TCJA tax cuts that are set to expire in 2025. While lower taxes are a boon for investors and can provide an economic lift, neither party seems overly concerned with the expense side of ballooning deficits. Risks remain that interest rates stay higher to compensate for the increased risk of US debt sustainability. While probably a topic for another letter, either party will soon have to deal with the economic reality of rapidly rising interest costs on US debt. Right now, both parties seem to be kicking the can down the road on debt and deficits.
Regulatory Policy: A Trump administration would bring a mixed bag of regulatory actions, but would generally be more favorable toward traditional energy companies and financials. It would also create a potential headwind for alternative energy providers as emissions regulations would likely be rolled back. Regarding big tech companies, acquisitions would likely come under less scrutiny, spurring increased mergers and acquisition activity. On the flip side, Trump’s Vice Presidential pick, J.D. Vance, has been a vocal supporter of Biden’s DOJ anti-trust suits against big tech.
Navigating the trade, fiscal, and regulatory impacts can be challenging and will certainly create winners and losers. But it can be easy to lose the forest for the trees – what really drives markets are the basic economic fundamentals of interest rates, corporate earnings, employment, and consumer spending. It’s natural for fears take the place of those basic fundamentals, particularly in the tumultuous political environment we’re experiencing today. It is imperative we not let those emotions drive us towards irrational investment decisions. Discipline, sticking to a plan, and focusing on the fundamentals will prevail over political fear.
Shannon DermodyTEST