Politics & Investing
There are few events as uncertain and long-lasting as a run-up to a presidential election. It’s a trying time for investors in the best of years, and 2020 has certainly been no exception. The combination of events we’ve faced this year provides a perfect recipe for investors of all persuasions to be nervous about what the future holds and to consider modifying their portfolios.
However, we believe tactical adjustments that deviate from the long-term strategic direction of a portfolio are rarely beneficial. This year was a perfect case study of that, as we witnessed both the fastest developing bear market in history, followed by the fastest recovery in history. Additionally, numerous studies analyzing market returns and elections have shown little correlation with election results.
No matter how contentious or polarizing the election, or no matter how convicted the consensus view is of what will happen if one candidate wins the election over the other, the final results of the election have not materially nor predictably determined what happens in the global market.
The chart below is from a Vanguard study analyzing more than 150 years of asset returns to determine whether a standard 60/40 portfolio (representing 60% stocks and 40% bonds) performed significantly better under one party over the other. What they found was that annualized returns under Republican presidents were +8.2% versus +8.4% under Democratic presidential terms – virtually the same.
The same study found that market returns during election years are slightly higher than those in non-election years, and that volatility actually fell during the 100 days before and 100 days after an election, debunking the notion that election years were necessarily negative events for investors.
Which begs the question “Why?” Shouldn’t a change or potential change in the leader of the free world have a relatively large impact on business in the future? History has demonstrated two things:
- Dramatic changes to policies are somewhat rare.
- Most American businesses (especially the largest ones which make up the public stock market) and consumers are remarkably adaptable and resilient to changes in policies.
While we acknowledge there are areas of social and political concern in the world today (especially in the short term), there are also a number of longer-term structural advances underway. These are the types of changes that ultimately impact the trajectory of the markets because markets react to how well companies are doing.
Markets are then much more correlated to marginal rates of change in sales growth and profitability. If a company sells more products – whether they be paper towels, hand sanitizer, groceries, laptops/tablets for distance learning, computer chips or other hardware that go into equipment that will advance us into the future of 5G telecommunications standards – then that company’s stock will rise. If a company increases its profitability by embracing new technologies that reduce the costs of doing business, then that company’s stock will rise.
That said, the short list of items below may have far greater consequences, in our opinion, for the sales growth and profitability of companies than the policies of either political party:
- COVID-19 Vaccine – As much as COVID-19 has impacted the economy and markets so far this year, the announcement that there is an effective vaccine or treatment will be a significant positive factor. Currently, according to The New York Times, there are 20 vaccines in phase 1 testing, 13 in phase 2 testing, 8 in phase 3 testing, and 2 already approved (one from China and one from Russia). The unprecedented level of focus from scientists and governments has compressed the vaccine testing and development timeline down to less than one year from what is normally a multi-year, nearly decade or longer process. Given the resiliency of the US economy and the adaptability of citizens and businesses during this pandemic, we believe a more meaningful rebound could loom on the other side of a medical breakthrough.
- Election Outcome – First of all, polls are wrong. This is not a new phenomenon. The famous statistician Nate Silver and his analytical website FiveThirtyEight studied over 8,500 polls of gubernatorial and congressional elections since 1998 and presidential primaries and general elections since 2000. They found the average polling error to be 5.9 percentage points, which means the true “margin of error” that polls mention (a measure defined by the statistically important “95% confidence interval”) is closer to 14-15 percentage points – not the 3-5% they usually note. This means no matter what the polls currently predict, there’s about a 50% chance they are ultimately wrong. Regardless of that and what happens in the Presidential election, significant changes in policies require the cooperation of the legislative branch. If the House and Senate remain divided then, it would suggest less fundamental change, which markets favor.
- Fiscal Stimulus – While the next round of stimulus is taking longer than expected to get passed, it is in process and is likely to be approved in the next few weeks in our opinion. Additional government assistance for those impacted by job losses will obviously help those families bridge the gap during this pandemic – a period which, as we noted earlier, we believe is nearing the end.
- Medical Advancement – The biotech and pharmaceutical industries have great potential as DNA sequencing continues to open new opportunities. While the cost to sequence a whole human genome has dropped from nearly $14 million in 2006 to less than $1,500 now (source). Continued progress in DNA sequencing should provide volumes of data to aid researchers in finding and treating all kinds of medical and agricultural problems. Already, this has led to instruments that can detect even subtle mutations found within oncology and rare diseases, and therapies that can modify a patient’s T-cells to target and kill malignant cells while keeping healthy cells intact. The possibilities in healthcare are endless and growing exponentially.
- New Battery Technology – Batteries have entered a virtuous cycle where the cost to produce them is falling, stimulating growth in demand which, in turn, pushes costs even lower. As these costs continue to fall, the applicable market for batteries will grow. Recently, battery storage energy became economic for utility-scale energy storage, making them already competitive with newly built natural gas plants. As energy storage continues to become more cost-effective and efficient there will be numerous consequences that will dramatically shift the nature of energy usage and create entirely new industries.
- Artificial Intelligence – Unlike traditional software coded by human programmers, “deep learning” is a form of artificial intelligence where machines use data to train themselves. With more data, deep learning is in a state of continual improvement and often exceeds human performance, expanding the reach of software into massive industries like healthcare, transportation, and manufacturing. Examples of machine learning include Netflix movie suggestions, personalized news feeds and advertisements based on your social media profiles, the Apple Watch’s ability to predict atrial fibrillation, diabetes and sleep apnea, and the Tesla Model 3’s autopilot capability. Expectations are that it will impact virtually every industry and lead to an acceleration in the rate of advancements.
- Robotics – Meaningful advancements are being made in robotics engineering that leverage the power of deep learning – so-called “collaborative robots” (or “cobots”), which share a workspace with humans with whom they may have direct physical interaction – will lower production costs and improve profitability.
- Blockchain – This is the underlying “distributed ledger” process behind cryptocurrencies. Although the success of cryptocurrencies remains questionable in our view, the technology underpinning them is already having positive implications for industries ranging from shipping and inventory management to financial services and other sectors. Continued adoption of the concept is expected to further improve speed and efficiency for many businesses, enhancing corporate profitability and future growth prospects.
- Entrepreneurial Spirit – The foundation of capitalism is the entrepreneurial spirit and it is alive and well. Recently, Bloomberg reported that the number of people applying for Employer Identification Numbers (EINs) has doubled year-over-year. This indicates a rise in the number of new businesses filed with the IRS. Inevitably, there will be challenges, but entrepreneurs tend to solve those challenges with new products and services or adjustments to current processes.
There are many more potential positive factors, but hopefully, this brief list makes the point that there are plenty of things to be excited about while admitting there are always things to be concerned about.
A few things that are helpful to remember…
- No matter how certain polls look one way or another, they actually contain a high degree of uncertainty.
- Even if investors knew with certainty which candidate would win, markets don’t care about elections as much as voters do.
- The bickering you see on TV is politics – not your portfolio.
- The most time-tested advice in investing is to avoid market timing (as evidenced by 2020), maintain discipline, don’t worry about the things you can’t control, and be prepared to make changes to the things you can control in a downturn (e.g. spending and savings levels).
As advisors, we know that volatility presents opportunity, and this year was a textbook example. Whether that was harvesting losses to help offset client taxes, or rebalancing to purchase equities at attractive prices, or even expediting Roth conversions (or some combination of the above), these actions can create real value for clients.
As we head into the final stretch of the runup to the election, now is a great time to affirm that we are ready to take advantage of volatility again if it presents itself, and recommend to clients they do all they can to be prepared themselves (e.g. preparing mentally for increased political rhetoric and sensationalized social media posts).
Don’t be discouraged by what you see on TV. We may be in the midst of challenging and potentially scary times, but we are here to help you filter the noise and maintain your discipline.