With the presidential election only one week away, our team at Acumen has been researching a variety of topics relating to the potential impacts of the election and we are sharing this information with you in a three-part series called “The Election Effect.” In today’s final installment, we explore the policy implications on investment portfolios. We hope you find this information interesting and welcome your thoughts on the series.
The Election Effect: Part 3 of 3
Policy Implications on Investment Portfolios
Acumen has previously communicated our belief the broad understanding of the effect of presidential elections on financial markets is widely misinterpreted. From our research, we found the party holding control of the White House, or even sometimes the White House and Congress, does not have a high correlation with asset class returns in financial markets. This research does not discount the potential definitive effect this election could have on specific asset classes or industries. In fact, we believe we can better position portfolios for the future after assessing many of the potential policy moves by both candidates and after assessing the odds of each outcome.
One of the possible misunderstandings investors may have about this election season is the fear of sudden financial market turmoil if Joe Biden is elected president. Whether our research about political party correlation to financial market returns reigns true or not, we must be aware of the more progressive ideas a Biden presidency could bring. One factor we have focused on extensively is the sudden increase in the betting average Biden will become president over his polling average and the decrease in the betting average Trump will become president below his polling average. We saw this trend play out in 2016 with Trump and Hillary Clinton. Clinton’s polling average showed her in a significant lead over Trump, but their betting averages were much closer together. We saw the two measures begin a greater divergence after the first debate. Since then, the S&P 500 is up more than 6%, the 30-year yield is up 11 basis points, and the spread in high-yield bonds versus treasuries is down more than 10.5 basis points. These indicators are all financial market characteristics supporting the forecast that a Biden nomination will not crash financial markets. Granted, there will be long-term implications of a Biden presidency possibly producing slower nominal growth. The implications of a higher corporate tax rate, large fiscal spending, and more heavily regulated markets could be a reason to forecast slower (still positive) economic growth in the long-term. At the same time, industries within the stock market that will probably benefit more from a Biden presidency have outperformed the broad equity market. Sectors such as Industrials and Financials have been outperforming Technology – a sector which will likely face greater scrutiny under a Biden presidency. Those who believe in the forward-looking nature of the stock market are likely discounting a Biden win right now.
We believe understanding policy propositions from both parties and the effects they could have on financial markets is incredibly important. For starters, there are a few policy implications we believe will be realized no matter who is elected. In our eyes, the most important factor to watch would be the pace at which we continue to grow our fiscal deficit. For instance, both candidates are likely to impose a new infrastructure plan. Trump attempted to put an emphasis on the infrastructure during his first term. Biden has said he would propose a $2 trillion spending plan on infrastructure. Obviously, this action should generate better returns in infrastructure assets.
Both candidates also support another stimulus package for the coronavirus pandemic. This influx of liquidity leads us to believe that with the roughly 20% fiscal deficit the IMF has projected for 2020 will continue to grow. Our economy may not grow at the same rate, but we do not believe either candidate will be able to simply reverse the trend. There are major implications to this. For one, a higher than expected increase in economic growth could spark higher inflationary pressures. We believe alternative assets, like gold and real estate, should benefit from these pressures. At the same time, fixed income has become less attractive than both equities and alternatives due to the negative REAL rate of return investors will see across the bond market. This rate is truly one of the only ways governments know how to deal with large deficits – they “inflate it away”. In fact, we have already seen the Federal Reserve change the way they measure inflation targeting. During their last meeting, the Fed said they would now allow inflation to overshoot their typical 2% target after periods of extremely low inflation. This change likely speaks to the prospect of ever actually seeing inflation greater than 2%. Either way, we believe the rate of change towards greater deficits will continue. The other implication that may result from larger fiscal deficits is higher taxes. The Biden administration has offered insight into their plan to cut back much of the Trump administration’s tax cuts and jobs act. These cuts would likely increase the tax rate many “big-tech” companies are currently paying. One way we have begun diversifying this risk is by reaching out into tech disruptors, such as cloud computing and software-as-a-service companies, instead of the crowded trade seen in many large-cap technology stocks. We still believe a strategic allocation into these investments are prudent, but also do not believe it should be the primary source of allocation.
One of the largest policy implications on the horizon is the movement toward a greener future. While a Biden administration and a Trump administration will likely mean much different strategies in the short term regarding our dependence on fossil fuels, this difference is a policy area we believe we will make significant headwinds on in the near future no matter who controls the White House. Green and sustainable energy has become a much greater bipartisan issue over the last few years. We see this issue, as well as a lower dependence on oil and gas, continuing to cause disruption in the energy sector.
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Information used in this commentary was obtained via Bloomberg L.P as of 10/12/2020.
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