The Stock Market and the Upcoming Election
“October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” - Mark Twain
With the U.S. stock market nearing all-time highs and the presidential election just 28 days away, you may be concerned about market risks. Investors certainly have a lot to be concerned about, even though the market is showing incredible resiliency. With over thirty years of investing experience and eight elections under my belt, I can say we’ve been through a lot over my career and no matter how good or bad things seem to be, every election brings anxiety and uncertainty.
If I’ve learned anything in all my years, it is that there is never a great time to invest. The economy is always too hot or too cold; the market’s too high or too low. Sometimes, it’s too flat. It’s what I call the Goldilocks story. It’s never perfect. There are rarely green lights in the investment world and, for sure, with the internet and media today, you don’t ever have to look too far to find a reason not to invest.
I’ve navigated clients through housing busts, the dot com crisis, the financial crisis, elections, wars, three major recessions, geopolitical crises, trade conflicts, runaway inflation, deflation, double digit interest rates and zero interest rates. We’ve seen a lot of challenges over the years with climate issues, the economy, social policies, fiscal policies, and geopolitical tensions. And, there’s been even more ordeals if we go back through history. However, despite all the uncertainty, calamities and upheavals, over the long-term the stock market has advanced. In fact, it hasn’t just advanced, it’s been quite remarkable, as evidence by figure 1 which goes back to 1925 (pre-WWII and pre-Great Depression). Provided by our good friends and partners at Janus Henderson, you can see in figure 1, the S&P 500 as represented by the dark gray line has had average 10.2% annually since 1925. Ten percent average annual return, despite all the numerous ups and downs, corrections and recessions.
U.S. Treasury securities are direct debt obligations issued by the U.S. government. With government bonds, the investor is a creditor of the government. Treasury bills and U.S. Government Bonds are guaranteed by the full faith and credit of the U.S. Government, are generally considered to be free of credit risk and typically carry lower yields than other securities. US Small Company Stocks represented by the Ibbotson Small Company Stock Index. US Large Company Stocks represented by the S&P 90 Index from 1926 through February 1957 and the S&P 500® Index thereafter. US Long-Term Government Bonds represented by 20-year U.S. Government Bond. Treasury Bills represented by 30-day U.S. Treasury Bill (no longer actively traded). Inflation represented by Consumer Price Index. Index performance does not reflect the expenses of managing a portfolio as an index is unmanaged and not available for direct investment. The example provided is hypothetical and used for illustration purposes only. It does not represent the returns of any particular investment.
Do You Plan On Making Investment Changes?
As they do every year, Hartford Funds did a study about the election, asking investors a number of different questions, such as ‘Do you plan on making investment changes because of the upcoming election?’ You may not be surprised to learn that 45% said yes, they will be making changes ahead of the election, with more than half (60%) saying they will move to a more conservative strategy. Now, a greater percentage (55%) of those surveyed said they are not making changes, and 40% said their changes would be towards a more aggressive investment strategy, so not everyone is fearful of the election right now. But what I do think is noteworthy is that 60% said they will most likely make changes following the election, depending, of course, upon who wins.
I’ll review what that might look like momentarily, but first, another question that was asked was, ‘To what degree do you think president’s influence stock prices?’ In 2015, Hartford asked the same question and only 23% said they felt the president has “a lot” of influence on stock prices. Today, however, nearly half (48%) said they felt the president has a lot of influence on stock prices. In other words, there’s plenty of investors who are concerned about the future of the market with an administrative change regardless of their social views and opinions. Should we, as investors, be worried about who becomes the next president? How much impact does the outcome of the election have on our financial goals and lifestyle needs?
Key Concerns Regarding This Election
I realize election season can make it difficult to maintain a long-term perspective, undermining a fundamental rule for successful investing. Given the strong emotions evoked by politics, particularly this year when there seems to be so much on the line, looking beyond politics may be more challenging than ever. Therefore, let’s address the key concerns regarding this upcoming election as it relates to the stock market.
As already stated, some think a Biden win will be negative for the stock market because of his focus on raising taxes and a bigger government agenda, while others think a Trump win will be bad for the economy due to the lack of unified leadership and disjointed Covid-19 policies. I believe both assumptions are premature, and history supports this. Historically speaking, no political party has been exclusively good or bad for markets. Fortunately, we have a system of checks and balances which prevents one sole person, even if the president, from having that much power.
So why, then, does the market tend to view administrative changes, especially Democratic presidents, as cause for concern? One reason is that Democrats tend to enact strict business policies which can weigh on corporate profitability. Since corporate profitability is the fuel that drives stock prices, it makes sense that investors would be concerned about something like tax policies.
We know Biden has promised to reverse some of Trumps tax reform and, specifically, raise the corporate tax rates. If so, it would be reasonable to expect such action would damper earnings and, thus adversely impact stock prices. However, the reality of these policies having such a dramatic impact on the stock market is far more complicated. It’s rarely as simple as pulling one lever to trigger a specific outcome. In the short-term, investors may react unfavorably to news like a tax increase but in the context of the bigger picture, there are far too many moving parts to our economy to suggest it’s that straightforward. What drives demand for stocks, and thus pushes up valuations, is far more complex.
Before we get into the specifics of Biden’s policies and the potential impact to the market, let’s talk about what we’ve seen historically. Although past performance isn’t a guarantee of future results, I think history is a good guide. Frequently, investors get nervous over upcoming elections and, specifically, they tend to worry about performance leading up to the election. Throughout the years, there’s been plenty of instances where investors seek to change their investment strategy in anticipation of or in reaction to an election, and there are plenty who opt to sit on the sidelines and wait until after the election to invest their hard-earned dollars. But does this make sense?
Will the Markets Go Down?
Do the markets always go down leading up to an election? No, not at all. In fact, I’ve seen them go up over the past 8 elections more frequently than drop. What we’ve learned based on history is stock prices tend to fall in the three-month period leading up to an election whenever the incumbent political party loses, but it has rallied when the incumbent party won. And mind you, this is irrespective of whether the president was a Republican or Democrat.
You can see that highlighted in figure 2. When the incumbent won, the S&P 500 gained on average about 6% from August-October. If we take out the best and worst period, we see the median or typical gain is about 2% - not a huge advantage by any means. Likewise, when the incumbent lost, the market fell but only by about 2% or so on average, and typically less than that. So, what do we make of this?
Well, I think it’s fair to say getting anxious over the next 28 days is probably not productive. If you look at the average advance or decline, I don’t believe it has been consequential enough historically to get too worried about. Of course, we never know what lies ahead, however, my bet lies in innovation, progress and improvement. In fact, to bet on regression, stagnation and deterioration would defy history. Should you bet against the odds? Since August, the Dow Jones has gained 6.51% through to October 5th, so it may appear that investors anticipate a Trump win, even though the polls suggest differently. However, with nearly a month to go, it’s still anyone’s guess. What we do know is regardless of what happens, someone will win. So, perhaps the question that ought to be asked is who is better for investors over the longer-term, a Democratic President or a Republican? What do you think?
Which Party Has Been Better for Investors?
If you are like most investors, you may think Republicans are better for the stock market because they tend to be focused on less government spending, lower taxes and fewer business regulations. But guess what? It’s not that clear-cut. Although you might think Democratic presidents are more challenging for the equity markets, believe it or not, the evidence suggests the contrary. Look at figure 3.
Since 1933, Democratic presidents have, on average, seen higher stock market returns than Republican presidents, going all the way back to Roosevelt. For example, the average real (adjusted for inflation) total return for the S&P 500 Index under Democratic presidents was 10.2%, versus 6.9% under Republicans.
That said, nearly all of this outperformance advantage can be explained by the boom years under President Bill Clinton and the subsequent dot com bust and global financial crisis which gave George W. Bush a big disadvantage. Consequently, if we exclude these two anomalies, the difference between the red and the blue in real returns is practically nil.
In other words, history says neither political party is exclusively good or bad for the markets. What do you make of that? If you are a naysayer, you will say “This time it’s different!” I’ve certainly heard that objection numerous times over the years, too. But, again, it hasn’t generally proven to be true. I think what we need to recognize is that instead of who wins, what matters more is the what will the next four years look like. There’s a multitude of policies presidents enact over their term, and we’ve got to consider their total net sum impact. For example, President Trump’s tax cuts were a positive or the markets, but his foreign policy and trade tariffs have had the opposite effect. Thus, the sum of these policies often balances themselves out. And this totally discounts the power of innovation, consumer influence and other factors relevant to the economy.
And that leads to the question: What impact would Biden’s main policies have on equity markets?
What about Biden's policies? I believe there are four main policies we need to consider based on Biden’s campaign pledge. The first is taxes and the largest risk facing our stock market is the potential for U.S. corporate tax rates to increase. In 2017 Trump lowered the corporate tax rate from a whopping 35% down to 21%, which resulted in a major boost to corporate earnings. You can see in figure 4, the corporate tax rates dropped substantially in 2018 as a result of the Tax Cut and Jobs Act, bringing our corporate tax rates for the first time in over 20 years lower than the global tax rates.
Biden, on the other, has said he plans to at least partially reverse this policy in early 2021. Undoubtedly, such action could have significant consequences for stocks. Of course, that’s assuming he’s able to get legislation passed, which I’ll address in a moment.
Biden has also proposed raising minimum wages, and, obviously, that could also impact corporate profits. Between rising taxes and higher operating costs, it’s reasonable to conclude the U.S. stock market may lose steam under Biden’s policies. Again, that is assuming he could get these passed through legislation. Mind you, too, this also totally discounts any other policies he may institute that could be favorable for the economy, such as job growth, improvement with Covid-19, resolution of the civil unrests, etc.
Another point to consider is that even if the market reacts unfavorably to Biden’s policies, it doesn’t mean money will just disappear. It means assets will shift. Money goes where it’s treated best. If there is a Biden win, I believe we may begin to see an appeal of international or non-U.S. stocks. This is because there is a high probability Biden will restore economic cooperation with Europe and Asia and ease up on tariffs. After a decade of the U.S. equity market outperforming, we might see a policy shift that benefits foreign economies. If so, money will follow, as it has in the past.
At the sector level, communication services, healthcare, technology and consumer staples like food, beverage and household goods would probably see their earnings impacted the hardest under Biden’s plan. However, not all sectors would be impacted equally. For example, energy, real estate, and utilities would likely not be materially affected at all. Figure 5 highlights forecasts under Biden’s tax plan which projects that those industries to have benefited the most from the tax cuts would likely be the most vulnerable.
The other policy change Biden has proposed is in healthcare. The pandemic has disproportionately affected lower-income families and has exposed the inequality in access to healthcare. Consequently, Biden is expected to double down on drug pricing controls and create a public health insurance option to compete with private companies. Trump has also pledged to take action against drug pricing and, in fact, instituted an executive order last month. Such action could be negative for pharmaceutical companies as well as health insurers. However, with Covid-19 the top economic issue, I’m not sure how far either administration will get in this health care battle. We will surely be relying more on big pharma to help fight the coronavirus.
Now let’s turn to the issue around technology and antitrust rules because there is a concern that the Democrats would usher in new rules and potentially break up the five large tech companies, or at least make their growth more challenging. Most people don’t know this but there is an immense concentration in the U.S. equity market in the big five companies - Microsoft, Amazon, Apple, Google, and Facebook. These five companies account for roughly 20% of the total U.S. market value. Talk about too big to fail! So, it should be no surprise that we have seen a big push, specifically from the Democrats, against these tech giants.
However, Biden’s general stance on tech is still relatively unclear. And, of course, the coronavirus has increased our reliance on tech and digital services so, for now, at least, it appears the anti-tech momentum has dampened. But we should not ignore the fact that the Democratic party has moved significantly to the left on this issue and will likely pressure Biden to ramp up regulatory scrutiny. Additionally. the low taxes paid by these giants is likely to be a big focus. To that end, Biden has proposed to double the global minimum tax on offshore profits from 10.5% today to 21%. This is yet another reason his win might take some steam out of our markets, at least temporarily.
Finally, there’s the issue of foreign policy. Based on polls, 66% of Americans have said they have an unfavorable view on China. Indeed, geopolitical tensions between the U.S. and China are likely to continue, especially with regard to technology and trade practices. However, under Biden, relations with Europe and other parts of Asia are expected to improve, which could inject a degree of stability into global affairs. This could, yet again, could be a boost for the global markets.
Above all else, though, remember that in order for Biden to enact these major policies changes, especially tax changes, the Democrats will likely need to secure the Senate. If they don’t, it is highly doubtful any major tax legislation will pass, which means there is the potential for gridlock if we see a divided government.
What Are the Potential Outcomes?
According to research from StratEgas, investors are giving a slightly better than fifty percent probability of a Democratic sweep in November. This is where the President, the Senate and House of Representatives are controlled by the Democrats, also called the “blue wave.” If you believe that research, keep in mind there’s still room for a nearly equal chance that won’t happen, so let’s consider all the potential outcomes here.
If the Democrats win the White House, the Senate and maintain control of the House, the so-called the “blue wave” would likely produce the greatest degree of political change, starting with the reversal of Trump’s policy agenda on taxes, immigration and regulation. We could also see the elimination of the filibuster in the Senate, which would allow legislation to pass with a simple majority vote.
But another scenario is gridlock. In this scenario, Biden wins the White House, but Republicans maintain control of the Senate. With this outcome, the Republicans would surely block major Democratic initiatives, much as they did during the second term of the Obama presidency. In this case, I think we would see Biden governing through executive orders which could result in rising tensions on both sides of the aisle. But there probably wouldn’t be any tax changes. Based on the history, the markets tend to like gridlock.
The other potential scenario is the status quo; Trump wins reelection, and Republicans keep the Senate. This scenario involves the least amount of change since it is, indeed, where we are today. The House is likely to remain in Democratic hands, regardless, so if things continue status quo, we can probably expect the current environment of political confrontation to continue; including the battle over COVID-19 relief legislation and the CARES Act.
Now there is a potential but very unlikely fourth scenario: and that is a split: Trump wins reelection, and the Democrats take the Senate. Now, honestly, I believe this scenario has a slim to none chance of happening but if it did, it certainly could set the stage for even greater hostility than we’ve seen in the past few years. So, yes, this outcome is theoretically possible, but it’s rather unlikely given the political dynamics of the key Senate races, which increasingly track the presidential vote in each state.
For instance, if Republicans lose key Senate races in Arizona, Colorado, Maine and North Carolina it’s hard to imagine Trump winning the White House. Still, in order to get the majority needed to claim control in the Senate, Democrats will need to hold onto 26 seats in states like West Virginia, North Dakota, Missouri, Montana, Indiana, and Florida which are up for re-election in addition to the winning Republican-held seats. We will know the outcome soon enough, of course. But in the unlikely event Trump wins and the Democrats gain control of the Senate, there will probably be a further push by the Democrats for impeachment.
Finally, it should be noted that Trump’s reelection raises another risk. If he wins without a majority of the popular vote as he did in 2016, that could lead to more civil unrest and further demands to abolish the Electoral College.
To Sum It Up: What Really Matters
Wow. That’s a lot of ‘what’s ifs!’ We can speculate all day long as to the potential outcomes, but it doesn’t change the fact that we need to secure our financial future, and to that end, we all have the same basic needs. As much as we may be divided as a nation, we are united in our essential needs. We all need to secure our retirement and we need to grow our savings. It’s easy to get sidetracked and lose sight of our objectives, especially if we spend too much time focusing on the headlines. Today will be tomorrow’s past. If you look back to past elections and other historic contentious events, you will see we’ve eventually worked through them as a nation. This, too, shall pass. You may not like the policies or agree with the agenda, but I doubt this will be the first or last time you disagree with politics. I suspect that has been the case in the past with other administrations, yet, somehow, we’ve managed to persevere and still accomplish most of our goals.
Regardless of who wins, Covid-19 will likely be the priority, and over this next four years, there will surely be a lot of post-COVID cleanup work to do. That will keep all of our leaders quite busy in and of itself. We might be in stabilization mode now, but we need to move into recovery mode and that will be an important undertaking as well as a great challenge for our representatives, regardless of the campaign propaganda.
For sure, there is a lot at stake with this upcoming election, and we just may be headed for some big changes. Then again, the gridlock and/or status quo scenario is every bit as likely as the blue wave. So regardless of your opinions about Trump or the perception that a Biden win would be a bad outcome for markets, history suggest we will get through this and move forward. Even if you don’t like who ends up in office, remember, in another short four years we’ll be talking about the next candidates and new agendas.
Should Biden win, investors should realize the potential investment implications are still very unclear and if there is a Democratic sweep, there could be an appeal in the international markets. On the other hand, if Republicans retain control of the Senate, even under a Biden win, the U.S. market rally could potentially continue undeterred. With a Trump win, though, there’s still plenty of challenges ahead and no guarantee the U.S. market rally will continue unabated.
So, what’s the conclusion? I understand elections can make it difficult to maintain a long-term perspective. It’s easy to get derailed and disregard the long-term when everyone is focusing on what might happen in the near-term. Given the strong emotions evoked by politics this year, this would be a normal response. On both sides, campaign rhetoric tends to amplify negative and contentious issues. Moreover, the media’s job is to grab your attention and they do that with inflated headlines. This election may be unprecedented and moving to the sidelines with your investments might feel like a reasonable approach, especially if you’re nervous and prefer to wait and see what happens. However, I would be remiss if I didn’t remind investors that history has shown moving out of the market just before an election is often a big mistake. What matters most is not election results but maintaining your EQ – emotional intelligence.
The last chart I want to share is the historical performance of the Standard & Poor’s 500 Index specifically over the past 19 elections. Notice in 18 out of 19 presidential elections, as highlighted in figure 6, an investment made in the market at the beginning of each election year would have gained value ten years later. In 18 out of 19 elections! I would say those are pretty good odds, don’t you agree? And, remember, that’s regardless of which party won. The only negative 10-year period as highlighted here followed the election of George W. Bush which was sort of the perfect storm with two seismic events, the dot-com crash and global financial crisis.
I also want to point out that in 15 out those 19 elections, investors doubled their money ten years later. And, last but not least, look at the 1980-1989 and 1988-1997 periods because investors gained over 400% in 10 years. I think we can say with confidence election-year jitters are normal and to be expected, but they should not deter you from focusing on your financial goals. It certainly wouldn’t have deterred you from achieving those goals in the past if you stayed on track.
For most us, we’re going to live a long life. We need our money to last potentially into our nineties so we can’t afford to get overly excited about elections. After all, they are going to come every four years. I could live to see another nine elections so if I want to build and sustain my wealth I’ve got to look beyond today’s headlines and focus on the bigger picture. I recommend you do the same.
In conclusion, don’t forget, by design elections have winners and losers, but the real winners have been investors who stayed the course and avoided the temptation to try to time the market. This is a fact that has been proven again and again.
As always, I appreciate the opportunity to serve as investment steward for our numerous valued clients and, of course, for those who are not a part of the Longevity Capital Management family, I welcome you to reach out to us to schedule a complimentary consultation should you need assistance with your investment management or retirement planning.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses or sales charges. All performance referenced is historical and is no guarantee of future results.