Quarterly commentary: October 2016

Despite an initial pullback following June’s unexpected Brexit vote, global markets steadied in the third quarter as central banks remained accommodative and economic fundamentals generally improved.

However, familiar macroeconomic themes, such as geopolitical risks and uncertainties, anemic global growth and persistently low returns causing yield seekers to inflate asset prices, continue to weigh on market sentiment. Global monetary policy remained center stage, with many pundits stepping up their challenge of the wisdom and efficacy of esoteric monetary tools at this stage of the global recovery, the latest being negative interest rates.
US equity markets showed some bounce in the third quarter, despite rather tepid September trends. The S&P 500 was up almost 4% for the quarter, while the small cap Russell 2000 index outpaced large caps, gaining 9.1% for the period. Overseas markets followed suit with the MSCI EAFE’s up 6.4%, while emerging markets, as represented by the MSCI Emerging Markets Index, jumped 9.2% for the quarter. Real estate, per the DJ US Select REIT, cooled down in the quarter finishing -1.2%, but still up 9.5% year to date. Fixed income markets continued their modest positive trend with the Barclays Capital Aggregate Bond Index gaining 0.5%.

As we enter the fourth quarter, there seems to be a general sense of uneasiness about which way market winds might blow. October has historically brought lots of surprises and many think that this year will be no different. Perhaps third quarter earnings come in higher than expected, rates remain relatively low, the threat of instability around the globe lessens and our bull market continues moving forward. Or maybe we see signs of an economic slowdown, earnings worsen, central banks raise rates or some exogenous global event unfolds, such as an escalation of US/Soviet tension in Syria or another successful terrorist attack somewhere in the world which roils the markets.

These global dynamics notwithstanding, the elephant in the room (no pun intended), is the unprecedentedly contentious presidential election in November, which has heightened fears and added drama as we approach Election Day. No matter which poll you believe, the reality is that both Secretary Clinton and Mr. Trump have a chance to be our next President, thus giving rise to much speculation as to how the economy and the markets will do under their respective reign. As such, we will devote some time to the issue of how elections cycles affect markets and what, if anything, you should do about it.


 Bulls & Bears ≠ Donkeys & Elephants

bull-bearAmerican election illustration

One could argue that the election of the President of the United States is one of the most important political events on the globe. As the leader of the free world, decisions made under our president could potentially impact global peace, security or prosperity, so it is no wonder that it receives the amount of scrutiny and angst that it does. But speaking strictly as investors, is there any strategy to employ or wisdom to be gained by studying election cycles to look for clues for managing outcomes?


Comparing the presidents by partyrep-dem-sign

There is a popular notion that the stock market will perform better with a Republican in the White House because they tend to be more pro-business. An equally popular notion is that Democrats—who tend to support higher taxes, and more stiff regulation—hinder economic and market growth. However, the historical evidence does not support either notion. Princeton economists Alan Binder and Mark Watson prepared a detailed study, “Presidents and the Economy: A Forensic Investigation,” analyzing the economy’s performance under presidents of the different parties. Measuring economic data from 1947 through 2nd quarter 2013, they concluded the following:

Despite this data, Binder, a prominent liberal, conceded that the differential between Democratic and Republican performance is due mostly to “good luck.” “Democratic presidents have experienced, on average, better oil shocks than Republicans, a better legacy of (utilization-adjusted) productivity shocks, and more optimistic consumer expectations.”

Republicans also carry the statistical burden of presiding over market conditions under the Great Depression where returns under President Hoover were down 24%, whereas no such economic conditions have existed under democratic watch. Further, if we assume a two-year lag before a president’s policies affect growth, there is virtually no difference between Republican and Democratic administrations in terms of GDP growth, according to the Wall Street Journal. In the 1948-2008 period, applying this lag leads to 3.4% GDP growth under Republican presidents and 3.5% under Democrats.

It does not appear to make much of a difference whether the president is in their first or second term of presidency. According to MarketWatch, from 1940-2008, the stock market rose 7.8% in a president’s first term and just 6.4% in the second term. However, only 5 of the 12 presidents had full/near full second terms in this time period, so the data sampling is not ideal. An interesting, additional finding is that stock markets rise the most, for whatever reason, in year three of both the first and second presidential terms, yet this statistic is muted when there is no incumbent running.

Congressional influence

Obviously, the office of the President is not the only decision-making body which affects the economy and the markets. The political division of Congress has a meaningful influence on the numbers as well. According to the Wall Street Journal, from 1948-2008, Republican-controlled Congresses averaged stock returns 7.1% higher than Democratic-controlled Congresses. Real GDP grew 3.7% during Republican congresses and 3.2% during Democratic ones.

So, what is the most productive political combination of Congress and the President? According to The Street, since 1950, here is a rundown of the performance of the S&P with various combinations of government.

Democratic
president and
Democratic control
of the House
and Senate:
Democratic
president and
Democratic control
of the Senate, with
Republican control
of the House:
Democratic president, Republican control
of the Senate,
Democratic control of the House:
Democratic president, Republican control
of the House
and Senate:
19 years,
average gain of
9.10 percent
3 years,
average gain of
13.66 percent
No occurrences
since 1950
 6 years,
average gain of
19.25 percent
Republican
president and Republican control of the House
and Senate:
 Republican president and Republican control of the Senate, with Democratic control
of the House:
Republican
president and Democratic control
of the House
and Senate:
Republican president, Democratic control
of the Senate,
Republican control
of the House:
 6 years,
average gain of
13.81 percent
 6 years,
average gain of
10.13 percent
22 years,
average gain of
2.91 percent
 2 years,
average gain of
-18.37 percent

 

Six truths that won’t be affected by the election’s outcome

In light of the futility of trying to second guess the markets, we did see an interesting piece about some things that are more dependable when it comes to post-election outcomes from Oppenheimer Funds. We thought it would be worth sharing some excerpts from this communication.

 

1. Gridlock Doesn’t Mean Nothing Gets Done

The volume of legislation that can get passed will be lessened if the occupant of the White House doesn’t have a majority in the House of Representatives and a filibuster-proof majority in the Senate. Still, gridlock doesn’t mean inaction.

Example
Progress on a Budget Deficit Reduction During a Period of Gridlock
Federal Budget Deficit as 

Percentage of GDP for Fiscal 2009 – 10.8%
Budget Deficit as of 9/30/15 – 2.3%

How Did It Happen

2. Changes in Washington Don’t Typically Come All at Once But in Increments

Emigration concept.Isolated on white background.3d rendered.

With few exceptions (like Obamacare or Dodd-Frank), the United States changes policy, not with one broad, sweeping effort, but rather with small steps. Consider the examples that have been debated for decades but have seen few major changes: energy, transportation and immigration policy. We’ve made significant policy changes – for better or worse – in each of those areas, but we’ve done so with repeated small steps, rather than one great leap forward.

3. Campaign Rhetoric Doesn’t Always Influence What Happens During a President’s Tenure 

The Promise
In support of environmental issues, 2008 candidate Barack Obama promised to:

The Reality

The Reason
Mainly affected by economic changes:
Advanced techniques for oil extraction drove production to a 45-year high. Also partly influenced by government – in the form of favorable tax treatment

The Conclusion
Any assumption a Democratic administration would have been unfriendly to the petroleum industry proved irrelevant – because of economic forces at work during a president’s time in office.

4. Consumers and Businesses Have a Far Greater Impact on the Economy than the Government

The overwhelming majority of what happens in the U.S. economy depends on you, me, and the businesses we work for and patronize.

5. The State of the Economy Influences Who is President

Decades of history prove that the state of the economy determines the president, not the other way around. In fact, the economy’s impact on elections can be stated in a fairly simple equation. Strong economy (declining employment and inflation) = A win for the incumbent party candidate.

6. The Stock Market Doesn’t Care If the Public is Happy with Who’s Pelection-stock-market-graphresident

Finally, one lingering fear investors may have is that the markets could suffer if the public elects a president who becomes unpopular while in office. Here again, though, history suggests the market is resilient and indifferent to a president’s current approval rate.

 


In summary

Research around historical data about election cycles, combinations of parties in various branches of government, etc. makes for interesting reading, but for the most part, it bears no actionable fruit in terms of prudent actions. Frankly, it seemed that the more digging we did, the more confusing and contradictory the data became, which brought us to the most practical conclusion: trying to predict the outcome of an election or positioning your portfolio according to historical patterns is simply another form of market timing, which most often has proven to be a fool’s errand.

Regardless of the outcome of the election, the best path to prosperity is having a disciplined financial plan and an efficient, well diversified portfolio that is monitored and recalibrated when market, economic or life circumstances change.

We feel privileged to have provided these services to our valued clients for over 30 years. In this, our 30th year, we want to give special thanks to all of you who have made this milestone possible. We are firmly committed to the next 30 years of growth at Wealth Dimensions, so we can continue serving you and your families.