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Excerpts from Strategies for Election & Dow 100K
We're looking at the global stock market here since September 2022 and up to yesterday's close, and the trillion-dollar question to our team here is, do we go higher, or do we go lower from here?
James Demmert, Founder - CIO
One thing we do know for sure is that it won't stay the same. There are a lot of tailwinds that could propel it higher, and then there are some significant risks that could cause it to go lower. And that's really the point of our get-together today is to talk about how can the election affect this chart? Can the election push it further up? Will the election cause it to decline? We're going to examine that really closely. Also, it doesn't make sense to just talk about the election. Let's talk about some of the other risks that exist in today's world that could affect stocks in a negative fashion as well as some of those positives. Jack, I think it's a great idea to bring this chart because it really represents the beginning of this, what we call the new bull market, the new business cycle. And today we'll talk about, well yeah, it's new, but why is it different than past cycles? Because it is very different. Some of those differences are extreme positives, but again, there are some negatives in this cycle that we want to be aware of. So, as we go through today, again, we're going to talk about the election at length, but we're also going to talk about why we think this bull market could go higher. But what those risks are that might derail it, if you will. So, stay tuned. Let’s get through this. I hope you have your popcorn ready.
It's important to have that perspective, and let's continue. Let's go to everyone's favorite place, Vegas. Surprisingly, Vegas election odds usually are a great predictor of election outcomes, being correct pretty much almost every election cycle. The notable exception was 2016, so we can't rely on this every single time. Right now, we have Harris a little bit ahead. And how can we use this to sort of aid our research and plan going into this election year?
It's super close, huh? I think it was last week when we did this to the team, it was reversed. This is a close race. And what's interesting about it is, we'll talk about today, either candidate brings some different tone to parts of the market. I think that's probably the most interesting thing. And then we'll also look at, you know, historically, do markets really index more—the index of the stocks—does that get negatively or positively affected by elections? Or is it more just the sectors of the market? Because these two candidates have some very different ideas that can affect different types of companies and stocks in different fashions. The fact that it's close, I think, causes us as a team to be very aware of which one as we get closer it looks like they might take it. And even the day of, you know, maybe there are some adjustments that investors should be making. We're going to talk about those adjustments today. And right now it is definitely close. I don't know if my colleagues had any comments on this.
Lily Taft CFA, Partner - Portfolio Manager
I just think it's interesting to point out the debate between Trump and Biden. You can see how Biden's odds really fell, and Vegas priced that in pretty dramatically. And as soon as Harris got the ticket, that purple line shot up. So again, something to watch closely. We want to be aware of not only what betting markets are showing but also what policies these candidates bring to the table. We won’t need to be ready to make adjustments, if any, based on the outcome.
At Main Street Research, we're not just looking at the Vegas odds. We are looking at the polls, which are also relatively valid here as we get closer to the election day. And I would just say it's the perfect setup for the next slide, which is really regardless of who gets in, it looks like a lot more gridlock, right?
Benjamin Armellini, Partner - Portfolio Manager
Before we get to that, I did just want to bring up the Congress side of the latest odds for who will control the House and who will control the Senate, just to have that perspective here as well. And then we'll get to looking at those historical figures. So, I just wanted to bring this up before we go to this next slide. I don't know if anyone wanted to comment on this before I bring up the historical data. Now, just continue that thought where again you're seeing more of the same just in terms of gridlock. So this may relate to depending on which president ends up getting into office, what their ability to actually enact legislation is. So this is important. And again, I won't spoil any of the data as it relates to results specific to markets, but that's a really important note heading into this election.
Lily Taft CFA, Partner - Portfolio Manager
I can't recall which election it's been recently where one party had both the House and Senate, but it does change the tone of as Ben was sort of mentioning, getting things done, and this one looks like we're headed towards a division. And again, without letting out the results, that's important—it looks like we're going to run into a split.
This is a pretty short-term chart. So really just looking at right in the aftermath of an election. How does the market react? And the answer is pretty much the same. No matter what, gridlock can definitely be good. There's a reason that adage has stayed for so many years. Whether it's one party, whether it's all divided, there are a lot of reasons to be optimistic. Also, a lot of reasons to manage risk. You can slice and dice data when it comes to elections and stock markets in so many different ways. Ultimately, you still get to the same place, which is that you really just got to focus on the specific policies and, of course, the economic data.
James Demmert, Founder - CIO
I think in my career, I've seen more angst by investors heading towards elections or particularly who wins the House or Senate. Most of that is usually not really well served. It appears in particular the statistics show us that divided or one party again isn’t the issue. It’s a question of the policies. Lily, I think that’s a very good point you made.
I love whoever put this, "Harris: business as usual; Trump: business as unusual," and that’s because the next four years would be different under a Trump administration. There are some glaring differences here. Corporate tax rates would certainly be more favorable under Trump. Everybody knows that both parties are very tariff-oriented. Biden didn’t let loose a lot of those, but Trump would be much more significant, and that’s important for certain U.S. companies and foreign companies to really think about this. So as we start to think about and talk about how should your investment strategy change, we really want to start to hone in on some of these policy differences, and I'll let my colleagues maybe walk through some of these others.
I’ll just emphasize to that. It’s not just China when we talk about tariffs, right? Notice that bullet point where it includes Mexico and the EU. These are significant economies we do business with, and many of the companies in client portfolios trade on the S&P 500 or New York Stock Exchange. There’s significant exposure there, so we definitely want to watch the tariff policy. Also, the energy policy has some really divisive rhetoric when it comes to both Trump and Harris. The market itself, the way energy prices and demand are headed, tells us that things can be flipped on a dime. We need to understand this and use risk management very in-depth. Lily, maybe there’s one point here I’d like you to touch on a little bit further. We always get questions on this: We’ve got "pro-crypto under Trump." Maybe you want to talk about why that's the case.
Lily Taft CFA, Partner - Portfolio Manager
Trump really wants to be the pro-crypto vote because there are a lot of fans in that area. It’s a budding industry. There are a lot of Silicon Valley executives involved in growing that industry. But we also know that Harris is very pro-tech. She’s very business-friendly when it comes to startups. She’s from California, so she is familiar with the Silicon Valley landscape. It actually isn’t clear where she would stand. She hasn’t been very vocal about crypto, but Trump is very vocal about wanting to make sure that U.S. regulation does not push crypto offshore. So while he is positioned as the pro-crypto candidate, I think it’ll be interesting as we get closer to the election to see if Harris has anything further to say. You know, these candidates are looking for votes.
James Demmert, Founder - CIO
Exactly. It's politics. It's a game. If somebody is not favoring crypto, then the other person is going to, and I think we have to be careful there as well, as we consider these different asset classes. But you know, as investors, all of us and those viewing, you can see the fossil fuel companies might benefit from a Trump election, or, you know, certainly the Republicans would be a little bit more lax on financial regulation. What does that mean? We'll talk about sectors in a moment and how each of these candidates might affect the sectors that we're invested in. Defense contractors probably would do better under a Trump administration—not that they've done poorly. These are all those things that, as a team, we're analyzing closely, and it could cause us to adjust portfolios. I don't think any of these candidates are going to cause us to make major changes, but changes on the edges are probably going to be likely, which is going to hopefully give you better performance.
Economic sectors are the biggest driver of performance above stock selection in the long run. Meaning, if you were not in tech, like for instance in the last 18 months, you'd have terrible performance. In the longer run, it's true your sectors are going to drive most of your performance. And of course, your individual securities within those sectors can continue to add alpha and value. I think this is where we say the rubber hits the road as we get closer. And I think, you know, for all of you, if you haven't noticed, once Harris started to get the lead in the Vegas odds or the polls recently, what you've seen in the market is you've seen the healthcare stocks sort of get humbled and come down a bit. I think that is truly the market listening and watching these polls and recognizing that typically the Democrats can be a little more sensitive about reducing pricing for healthcare products and pharmaceuticals. Some of these stocks are acting as if, well, if that were to happen, there’s discounting that possibility by those stocks being a little weaker recently. There is a lot of truth in market mirroring here with these policies, and it’s going to be much more pronounced once they’re elected.
I think another one to watch is homebuilders. The homebuilding stocks have done pretty well with the interest rate environment, and that demand is starting to come back online. Harris is really vocal about supporting first-time homebuyers. So some really interesting policies—again, bringing it back to the policies and understanding what is important to each of these candidates.
And if anybody's thinking, "Well, maybe it's a temporary move in some of these sectors," it really isn't. Some of these policies are long-term in nature. I'll go back to 1994 when the Clinton administration came in and Hillary Clinton led the sort of attack on drug makers to reduce prices. Those stocks, the big names, fell 40–50% that year. So, it is important. I know a lot of investors say, "Oh, don’t worry about the election. It’s not going to affect anything." That is not true. It's really important to look inside the portfolio at the sectors and make sure you're not overweighted in a place that can be vulnerable or, as we'll talk about today, at least use some risk management tools if things fall more than normal because we want to avoid any kind of catastrophic decline in a sector or individual stock.
What leads us to Dow 100,000 is going to be somewhat determined by the election, right? The Trump administration could be looser on regulations for financials, and you’d probably see financials really take a big position toward Dow 100K. So, elections are really relative here. If anybody wants one of these fabulous Dow 100K hats, this is how passionate we are about DOW 100K. If you’d like a hat, send us an email. They’re very popular. But besides the hat, how do we get to that? And you know, we say over the next seven to nine years, I'd even say it might be over the next seven to eight years. We did some specific math. We said to ourselves, “Look at indexes today. We looked at normal business cycles that last around eight years, and we looked at how much can corporate profits grow in a new business cycle, particularly one with AI tailwinds.” Now, you may remember that transformational technologies increased productivity, not just for companies but for economies. Then we do believe that the artificial intelligence wave is going to have that kind of result in this business cycle. So it’s a business cycle that won't be normal, but it'll probably be a little stronger than normal. During that period, we can see corporate profits most likely going up two and a half to three times where they are now, and then we link that to the index prices, right? And that's how we extrapolate, “Okay, how far can indexes go?” And that takes us to Dow 100,000 in six or seven years, which is more than a double, as you know, and it takes the NASDAQ over 50,000, which is a significant amount. And that's because it is a tech-led new business cycle bull market. So, I know that sounds crazy. We get the Dow 100,000, but let me remind some people out there when I started the business, I know I’m old, but the Dow was at 800. So, time will do that, and really it’s basically corporate profits that can drive us to those levels, and it's really exciting. But, you know, in all that excitement, as you know at Main Street Research, we’re prepped for Dow 100K, but we're also very aware of the things that might derail this, and we're going to talk about those today as well.
Lily Taft CFA, Partner - Portfolio Manager
I love the AI story. I mean, we're already seeing it show up pretty clearly in markets, right? It’s not just semiconductors; it’s actually multi-global businesses that are seeing improved profit margins. So this is already playing out. It’s great that we’re on the train heading to that destination of Dow 100K.
And as James just mentioned, something that is always on our mind with any target or good financial plan, of course, there are always risks that can derail that. One thing that we’re known for is actively managing risks. So how are we going about researching, and maybe before we talk about those risks out there, we are also talking about being active relative to where we are in the business cycle. One thing that we’ve discussed in previous updates is why we think this business cycle in particular is different.
Benjamin Armellini, Partner - Portfolio Manager
Well, it is. It’s very different. It’s a good point. There are just some specific themes that investors should be aware of. Every business cycle is different than the one before this one. Specifically, many of you know, in the last business cycle before we had the inflationary bear market, we had interest rates at zero for 10–12 years. We’re not going back there. Take it from us. Rates are going to fall from where they currently are. We expect that rates will probably be more like where I grew up, where money markets are three to four, and bonds are five to six. That has a different impact on different businesses and investments in your portfolio. Clearly, we’re also moving toward a more globally protectionist environment. So it's not invest in manufacturing in China these days; it’s bring it back home. How does that affect your portfolio? How does that affect our team looking for new ideas? And I know a lot of you, if you're probably worried as we are about the U.S. debt level, it’s exceedingly high and rising. Neither party looks like they were willing to do much about that. We're going to talk about that risk further in our conversation.
James Demmert, Founder - CIO
We already talked about AI—really the big thing to remember here is that this is leading to higher productivity growth. So, we're able to do more with less. But it requires a tremendous amount of electricity. These data centers suck up power like nothing we've seen before. So we're already starting to see the first significant increase in electricity demand in the last few decades. Of course, there’s always seasonal demand; you know people traveling in the summer and things like that, but these data centers need to be running 24/7, 365 days a year. So, we’re already starting to see some pretty big deals being signed to power the grid and to power EVs as that continues to be a trend. But yeah, a lot of all these themes are going to impact how we get to Dow 100K, and I think are going to be hot-button topics for our politicians to address as well.
Benjamin Armellini, Partner - Portfolio Manager
These themes really drive our stock selection and you know what to sort of go after but also what to avoid. We’re all going to be living longer. That's great to hear. Let’s just make sure we can live in a good economy with enough electricity, I guess is one of the messages here. So maybe we can go to the next slide and talk about some of the risks that are out there. And you could walk us through how we're researching those risks and planning for them. There's always risks out there that our team is looking at. And of course, we're known for actively managing that part of the portfolio.
James Demmert, Founder - CIO
You know as we go towards Dow 100,000 and with whoever the president might be in their administration, the portfolios are going to be hopefully set in the tone to really take advantage of the policies that that president is putting in place so that we're picking the right sectors as we talked about earlier and the right stocks beyond that. There are risks that have nothing to do with the presidency. One is the Federal Reserve policy. As you know, many of you, they’ve started cutting rates to be more accommodating. We think that was the right thing to do, but the Fed can have a lot to do with the economy and the market, and they have made errors in the past. They’re human. I think if they were to cut too aggressively here, we could have an inflation spiral right back in our hands. We're hopeful that Fed policy will be sort of moderate and careful, and we'll be watching this very, very closely. And that’s a risk that, to our Dow 100,000, could be sort of coming to a halt. Another one, a very large one is the deficit. And mostly, you know, if the U.S. credit quality gets reduced, that can cause a real run on U.S. assets and the dollar. This is a very significant risk that I think all of us should be very careful about. We're at 130 percent of GDP. It’s the highest in the history of credit problems that the U.S. has ever had. This is another reminder that investors need to go out there with risk management, stop-losses, any kind of hedges to ensure the money lasts through long-term challenges. The deficit is an issue. We're all aware of the geopolitics heating up, particularly in the Middle East and Ukraine. Sometimes those things can topple a business cycle. And again, you want to protect your assets. We’re excited about Dow 100,000, but be very candidly aware that that could get derailed and we could go the other way. And of course, we’re always aware that there’s a risk of the unknown, right? Who knew that COVID would even come into our lives? And there’s other things like that. So, again, as we’re really excited, we think that 100,000 is highly likely. These are those risks that are there, and we are going to have a plan B should any of them arise.
Of course. It’s a good reminder. And speaking of active risk management, we want to remind clients about the importance of risk management and how our team goes about this process, particularly in today’s market. We can forget that these tools are always on in the background. Can we talk through why risk matters and how our active risk management process works?
I'd like to just share a couple of comments about this chart. If you had a credit default by the U.S. government, I think you could easily see a 2008 type of scenario. In that case, the market went down 55%. Going down 50%, as many of you know, is going to feel horrible. It’s going to be very damaging to long-term wealth building. And the recovery is the real problem. When you're down 50%, going up 50 doesn’t get you to even. You actually have to double your money or go up a hundred percent in financial markets. Usually, it takes seven or eight years to do that, so you have a time problem and also a downside risk problem. We want to make sure that we help you avoid ugly math if, in fact, any of those risks were to occur that we discussed earlier. When you're down 10 to 15%, it's easy to recover; it doesn't take a long time. And that's why we're such sticklers about mitigating risk. There are certainly tax payments to pay for capital gains, but as our colleague Aaron wrote out very nicely in my first book, it's better to pay taxes, which can be maybe 2 to 4% of your portfolio, than it is to sustain 40 to 50% declines, which completely wipe out the success of your long-term financial planning. Of course, we can always adjust for individual clients how much of that selling we want to do, but generally speaking, wealth building over the long run is about picking the right stocks and being in bull markets and mitigating those terrifically bad bear markets that are part of history. So, risk matters. Most of you are very aware of how you manage risk. Well, let’s say that one of these big risks occur. Maybe the election does go awry, right? Maybe the market doesn’t like the way the election comes up. We can reduce your stock allocation. So instead of having 70 or 80% or 50% stock, we can have less. We can be in sectors that would do okay in that environment, which is utilities and healthcare as an example. Using those stop losses is very important to take our own human brain out of the equation when things start to fall more than normal to have a discipline. That’s very important—a discipline to mitigate declines that are further than normal or even become catastrophic. That’s why we have a history of long-term good returns with less risk in the bad markets. So that’s going to always be in the background. I just think it’s a really important thing to chat about as we talk about the election and all these other risks.
Benjamin Armellini, Partner - Portfolio Manager
The big takeaway here is that elections matter. There will be significant investment implications depending on who gets elected. But ultimately, the economy is what drives stock markets, not who gets elected. The history of our economy is growth. Of course, there are risks along the way. There will be volatility. But if we can manage that and pick the right sectors, we can grow our wealth in a very powerful way, as this chart shows. So, I’m excited about the years to come and the journey to Dow 100K, and doing more of these to talk about all the fun things that are going to happen in between now and then.
James Demmert, Founder - CIO
I'll say one other thing that I think is important from a standpoint of the economic cycle. We are really in the early stages. I want all investors to be aware that this is the early stages of a new business cycle, a new bull market, and that has most likely this six to seven year runway. This is an opportune time to be an investor in equities, to be very careful about being in those sectors like for instance in technology, the companies that are making AI work. The companies that are using AI to be more profitable, in other sectors that can do so. And then also, you know, make sure that we are aware of the election and tilt the portfolios a little bit here and there based on who comes in. But this could be a fabulous decade ahead for stock investors who are careful and astute about what they're investing in. But also, as we've said, to be a very astute risk manager is going to be critical.
Business cycles, you know, they tend to reflect an expanding economy. What brings the expansions of the business cycle to an end is usually one of a few things, and usually, it’s a recession. That’s usually what we most commonly see. We have a recession, people lose their jobs, companies pull back. That’s kind of common. What I think that there’s a bit of a misunderstanding with this one is that very rarely, but it does happen, you end a business cycle with an inflationary spiral, which is what we saw in 21 and 22, and that has also the same effect of basically stopping a business cycle on its tracks until it gets resolved. I call the disequilibrium with the economy having something weird like a recession or inflation and the stock market not being priced right. So, what you get when that gets disrupted is a bear market, and stocks start to reflect that profitability is going to go down. Inflation was the culprit here, and the Fed needs to raise rates, which is also really bad for stocks. But once you get past those periods, let’s say the inflationary spiral, and the stock market, you know, getting down to valuations that are cheap enough, you start a new business cycle. It’s sort of like a cycle of corporate psychology where, in 22 and parts of 23, corporations were scaling back and reducing workers. You start to have the animal spirit return once that inflation is down where it is. You're already seeing animal spirits come back. Companies are reinvesting; they’re rehiring, and we are starting all over again. Fortunately, business cycles last seven to nine years. They’re longer than the recessions and inflation periods, which are typically 18 months. So again, that’s why we’re just right at the beginning of this one. We’re probably 18 months into it with a long runway going forward.
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