As the US election quickly approaches it brings with it an unprecedented amount of uncertainty and investor concern. The uncertainty is mainly focused on who will win, what policy changes they will initiate, and at what point will we know who actually won due to COVID-19 or other potential voting delays. The widespread investor concern is focused more on potential policy changes and the fear of the unknown that all of these uncertainties inherently create. This election has caused the highest level of anxiety amongst investors than any throughout history. Many individual investors – even professionals – have warned to “sell everything” before the election, while others have advised to “buy and hold no matter what.” We would suggest that both strategies are flawed, if not dangerous.
As our team analyzes the election in terms of financial markets, we separate policy implications from investor sentiment to get the clearest picture of potential outcomes. We understand the longer-term nature of the election’s social implications as they relate to financial markets, but for sake of brevity will focus on the financial aspect.
As we unfold this analysis we see a Biden win as much less concerning than investor pessimism would suggest. We believe that investor fear that Democrats will raise taxes and repeal Republican growth policy is misguided. The US – and global – economy is much too vulnerable for any administration to raise taxes or engage in policies that would mute what little economic growth currently exists. When one considers that the Democrat’s “hands are tied” in terms of economic policy until at least mid-2021 or 2022, it should alleviate some of the anxiety of such an outcome. A Trump win concerns another large group of investors. However, in terms of policy, this outcome would likely be “business as usual.” A Republican win would not be kind to any part of the global economy that is vulnerable to the tariff war – so within these confines investor’s concerns are valid.
The House and Senate battles are another source of investor worry and we again believe that these concerns may be overblown. There is mounting investor fear that, should the Democrats take control of Congress, they will use this power unwisely. For the reasons stated above we think such an outcome would not disturb current growth policies in the near term since it would deter future economic recovery. However, it could have negative implications for some sectors of the economy such as healthcare and financials down the road. A Republican sweep of the House and Senate would likely bring extended trade conflicts but continued pro-market growth policies. If the House and Senate remain divided, as is their current state, it would provide the best balance for financial markets.
When it comes to politics and the stock market, we are regularly surprised by investor’s – individuals and professionals alike – lack of memory or research on this subject so we will clarify two issues. Stock performance during Democratic presidencies is superior to Republican’s. Also, a Democrat controlled House and Senate is not necessarily a negative for stocks – think back to the first stage bull market of 2009-13.
Investor Fear
The level of investor concern regarding the election is historic and can be measured by investor sentiment polls and the amount of cash on the sidelines (over $5 trillion) that normally should be invested in stocks. This along with our team’s exposure to the plethora of negative research reports and investment news marks this as one of those historically heightened periods of investor concern. We get it. Most investors have been beaten down by COVID-19, a recession, and now what looks to be a complicated election. However, we would suggest that fears based on what’s happened in the past and the uncertainty of what’s to come in the election may be too extreme. When it comes to crowd psychology and the stock market – the crowd (and in this case a very large crowd) is usually wrong.
COVID-19 and The Market Cycle
When our team considers the future, we see signs of potential progress in parts of the economy and significant potential in segments of the stock market – another reason that the “crowd” may be wrong. As the pandemic is evolving our behavior is as well. We have learned that wearing masks and social distancing allows us to manage the virus. At the same time the world has made significant inroads to testing and each day we get closer to a vaccine. There is no question that the world economy is being reshaped by COVID-19. Some things will never be the same as they were. This is also very true about the economy and the stock market. In the context of the stock market cycle, investors have just experienced a bear market and a recession of staggering depths. However, with appropriate human behavior in regard to managing life with the virus, parts of the economy can begin to grow. In light of this discussion of potential economic improvement, investors should prepare themselves for the Commerce Department’s October 29th report on US economic growth last quarter – which is estimated to be in excess of a whopping 30%! This may stabilize markets and it reminds us of the famous quote by the 1990s political advisor, James Carville, regarding elections: “It’s the economy stupid!” Should this be the case we believe we would be entering, or may have already entered, a new and very different business cycle and bull market. Many investors think stocks are too overpriced for this to be possible. However, only a very narrow segment of the stock market is overpriced – most stocks are currently trading near or lower than they were at the beginning of 2018, almost three years ago! Long periods of stock market underperformance are usually followed by new bull markets cycles that can last years. Our team looks forward to this period.
Reshaped Economy Creates Opportunity
In the mid-1700s the Industrial Revolution began and left certain industries and companies in the “dust,” while others, as well as new entrants, were able to thrive – and the same may be true for COVID-19. We believe that the new business cycle and bull market we envision will be led by a different group of companies than those in the past. This “survival of the fittest” environment creates opportunities for astute investors, particularly those of us that focus on individual companies and industries through the use of individual stocks. In this new bull market broad stock index performance may suffer in comparison to investment portfolios that can focus on the winners and avoid the vulnerable.
Low Rates, Fixed Income and Our Team’s Creativity
Interest rates are at historically low levels – again! Thankfully our high quality, individual, legacy bond positions continue to generate income far in excess of what is available today. In terms of investing new money in traditional fixed income (ex. bonds), it is a challenge to find yield that adds value. In that spirit, we will continue to add securities that can provide attractive yield compared to current bond market rates and have historically low levels of volatility, such as preferred shares, utility stocks and real estate investment trusts (REITs).
2020 has been full of negative surprises that can understandably wear on even the most optimistic of humankind. It is no wonder to us that investors have developed a generally negative bias at this point and we worry about mental health in the face of so many global concerns all at once. Though we are optimistic that the worst may be behind us, we stand ready to protect your investment portfolio should our view not come to fruition. Our team understands that we are all dealing with the “unknowable” and we have our Active Risk Management process firmly in place to ward off the possibility of a catastrophic market decline. This includes our flexibility in reducing your allocation to stocks, sector management and the use of carefully placed stop loss orders. This process has proven valuable in past significant market declines and we see no reason that it should not continue to add value should markets start declining more than normal. It is this distinct risk management process that allows us to avoid the precipitous mindset of “sell everything” or “buy and hold no matter what” – and deliver the long term performance you need to allow your assets to last generations.
All of us on the team thank you for your continued vote of confidence, particularly during these very trying times. As always we appreciate any feedback on our work, communication and your client experience. If you have experienced any changes in your financial situation or have questions about your portfolio, please feel free to reach out to the team.
Your Team at Main Street Research
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