Politics, Stock Prices, and the Economy
Since the summer of 2016 the upside in global stock prices has surprised most investors, particularly in relation to the tumultuous political landscape. Now that we are in our third year of this healthy economic cycle and bull market, there is renewed concern that the upcoming midterm elections on November 6th may derail the economy and/or this powerful bull market. We have some thoughts for you about the likely implications for investors resulting from November 6th and the opportunities and risks which will surround that outcome.
First and foremost, we want to reiterate that investors would be wise to disconnect the political cycle from the business cycle and bull markets. If the last few years haven’t convinced you, a look further back in history may be of assistance. Bear markets and recessions have never been associated with political change, but rather economic factors such as Central Bank policy. However, political changes can “tweak” the economy and the performance of market sectors, which is where the savvy investor should be focusing their attention. What are the odds of the political outcomes and what risks and opportunities will arise from these changes?
From our view, and those of our research partners, we would suggest that there is more than a 75% chance that the House of Representatives will fall to the hands of the Democrats, and that the Republicans will retain the Senate. The odds of the Democrats taking both the House and Senate are extremely low. So from a perspective of “drama” we believe this will play out as much less exciting than many investors, pundits and much of the media currently believe. In many ways a split Congress is a return to “business as usual” – gridlock! However, this may create some opportunities for investors in certain sectors of the market – but will unlikely derail the economy or the bull market.
A House of Representatives controlled by Democrats may bring a few battles that we should be aware of. The first will be to attempt to repeal tax cuts, which we believe will be unsuccessful, given that the tax cuts have in fact spurred significant corporate profit growth. However, there will likely be a push for greater spending on infrastructure and an expansion of Medicaid in certain states. This is a plus for many industrial and healthcare stocks and we are already hard at work sifting through companies that we think may benefit the most. A more divided government will very likely invite greater scrutiny of the president and impeachment talk and action. Basically…a lot more of the same. Lastly, we believe that regardless of the result of the November midterm elections, there will be an increased interest in regulating big technology companies – think Facebook and Google. So as the world turns, and we head towards November, we would not put the midterm elections on our list of the biggest risks to the current very healthy business cycle and bull market.
When it comes to “things to worry about,” we would suggest that investors should be more concerned about Fed policy. Last week’s hike in rates was no surprise and another is expected in December. However, should the Fed get too aggressive with this approach, the risk of a recession and bear market will become greater. We will be watching this closely. Another important economic factor is the current slowdown in the real estate market – mostly due to the rise in rates. This can have negative implications for many investors and consumers as the “wealth effect” of rising real estate prices begins to dissipate…another metric we will be sure to watch.
In recent years, some of your stocks in the consumer discretionary, healthcare and technology sectors have gone up significantly more than others. As these positions become a bigger percentage of your portfolio it is important to scale them back a bit by doing some profit taking. This reduces risk, and allows us to free up cash for new investment opportunities.
As you know, in spite of our optimistic view, we are very aware that circumstances can change and that we are dealing with the knowable and the unknown. Therefore, we continue to be adamant about managing the risk of each stock in your portfolio, and the portfolio as a whole through your portfolio’s asset allocation, sector management and the use of carefully placed stop loss orders. Though we do not think that any of these risk management tools will be necessary through the midterm elections, keep in mind that they are currently in place.
As always if you have any questions about your portfolio or you have experienced a significant change in your financial situation please let us know.
Once again, thank you from all of us on the team for your continued vote of confidence. If you have any friends or colleagues who you feel may benefit from our services, we would be happy to introduce ourselves to them with a no-obligation introductory meeting.
Your Team at Main Street Research