The year 2020 has certainly been an interesting one so far. (I can think of plenty of other adjectives that would be even more fitting.) And just when I start to think that maybe the second half of this year will be a little less eventful, I remember we have an election coming up.
I’m often asked by advisors and their clients about the impact that election results may have on markets, or how the economy will be affected if this side or that side wins. Normally, I try to answer such questions in a very measured and objective way, because political discussions in a polarized climate don’t always bring out the best in people.
But, especially in these fraught times, such generic, neutral answers aren’t always satisfying.
I should say upfront that politics is a particular interest for me. I grew up in Washington, D.C., and my late father worked for many years on legislation in the office of a moderate U.S. senator (remember when such elected officials used to exist)? My father advised me not to choose politics as a career, and I’m continually grateful that I listened to him. Still, over the years, I have become something of a political junkie
If clients ask your opinion, I think there is value in addressing the elephant — and donkey — in the room, so let’s go ahead and take on that controversial topic.
Which party?
Why not start with a seemingly simple question a client might ask: Which political party delivers better stock market performance?
The answer is … it’s not at all clear.
You can compare market returns under different administrations, but which starting point you choose can alter the data significantly.
If you start in 1923, for example, stocks did extremely well under GOP president Calvin Coolidge. But move the starting point up to 1929 and instead lead off with the Republican Herbert Hoover’s administration, markets were horrendous. Maybe you throw that out and start with 1933 — now you’re incorporating Democrat FDR’s first term, when stocks staged a strong recovery.
Clearly, the start date can be manipulated to make either party look better, since several outliers, both positive and negative, fall within this general time frame.
But perhaps the party controlling the White House matters less than we think. After all, we can identify several favorable market environments that took place during Republican administrations (Trump, Reagan, Ike) as well as Democratic ones (Obama, Clinton, JFK, LBJ). Interestingly, many of these administrations featured a divided government, when the House of Representatives held a majority in the opposite party from the president.
Remember that legislation normally originates in the House and is then approved or modified in the Senate before being sent to the president’s desk for signature (that ceremony which often involves a ridiculous number of official pens) or veto. It’s possible that an opposite party speaker of the house (e.g., O’Neill, Gingrich, Boehner, Pelosi) can serve as a check on presidential power and prevent, or at least mitigate, overarching economic policies from being enacted.
Divide and conquer
Since markets tend to dislike uncertainty, perhaps a divided government serves as a hedge against excessive or unpredictable change by favoring compromise and preserving more of the status quo.
It's also worth challenging client assumptions about why markets are expected to do better under one party than another. For example, are higher taxes always the death knell for stocks or do markets worry more about out-of-control federal spending? Should or shouldn’t tax cuts be thought of as a form of increased spending? What kinds of spending (e.g., infrastructure, defense) are most associated with economic growth and/or higher stock prices? What is the role of federal regulation? How influential is the Fed, especially its chairperson, and is it a truly independent institution?
Perhaps more important to ponder: Are markets driven primarily by actual economic policy, or more by the perception that a particular party or candidate is seen as “business-friendly?” I’ve always suspected that it’s more the latter than the former. And what happens when actual policy implementation falls short of the campaign rhetoric?
The blame for such a shortfall may be assigned to the president, or it may get redirected towards an obstructionist or do-nothing Congress, depending on the messaging skill of the individuals involved. In this sense, too, perception may be more important than reality.
Here’s a recent example: Election day, 2016. Recall that as the surprising presidential results started to come into focus, U.S. and European stock futures fell sharply overnight, at one point going down to somewhere in the neighborhood of -4%. By the time U.S. markets opened on Wednesday morning, however, sentiment had changed dramatically and stocks rose slightly for the day.
Should we assume that in the span of a few hours investors suddenly gained clarity about what economic policies would likely be enacted, and immediately made the rational decision to revise their future equity target prices higher? I’m skeptical of this explanation.
Post-hoc rationales
Market participants are human beings, with all of the biases and emotional decision-making flaws that are part of our wiring. Markets can move in a particular direction for no particular objective reason: a bull trend may start or persist because, as some say, “markets just want to go up.”
When observers and pundits use phrases like this, they may be more accurate than they realize. Just as people often make decisions quickly and intuitively, and then develop post-hoc rationales for these decisions; markets too may rise or fall, and then look for explanations or justifications afterwards. The narrative surrounding market action may have little or nothing to do with the actual cause.
I believe this to be good news, because if true, then markets are not preordained to move in a certain direction solely because this politician or that one wins an election, even if it is for president of the United States. Neither all Democrats nor all Republicans support the same policies with equal fervor or have the same economic vision for the country. And whichever party controls the White House still has to work with the House and Senate to ensure that legislation can be created and get passed.
Plus, there’s no guarantee that federal legislation will bring about its intended results. To say nothing of exogenous shocks that can and do occur without warning — COVID-19 being just the most recent example.
Reality is much more complicated and nuanced than certain parts of our brains would like to admit. As humans, we like to be in control (or at least believe that we are), and we aren’t big fans of uncertainty.
In my opinion, a critical aspect of sensible investing is to accept the reality that there are many things that we can’t predict or control, and some of them may move markets. Regardless of who wins which elections in November, market cycles will assert themselves, unexpected events will occur, some companies will thrive and some will fail.
Through it all, we continue to believe that the best way to address both the known risks that are inherent to the capital markets, and the unpredictability that so often rears its head, is through the alignment of client portfolios to their goals, implemented in a sensibly diversified manner.
