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Five Diversification Issues That Could Dwarf Election Concerns

Steve GibsonSeptember 11, 2020

Markets

The November 3rd U.S. elections will climax what is sure to be a circus of misinformation, angry partisanship and endless political ads. Investors hoping to find actions to preserve or grow their retirement portfolios are grasping for investment ideas or searching for a hideout. Having had four decades of watching such macro events, I propose that the election outcome may not even make the top five investment issues for the remainder of 2020 and into 2021. The number one issue for markets is the impact of the historic Federal Reserve promise of low rates into 2022. The trillions of stimulus and backstop should ensure stock prices well above what the anemic economy normally deserves. While more upside may be slowed by the lofty valuations Fed actions have produced, a vaccine announcement might power another uptick.

Number two of important considerations is the pandemic and consumer sentiment. The Conference Board measures have dropped below 90, which is not a good sign since 2/3 of the U.S. economy is related to consumer spending. If the public believes that the pandemic is likely to be controlled, then sentiment and the markets will rise. That is probably a function of a vaccine. If Joe Biden is elected, a vaccine should overwhelm any negativity about his plans, and the same is true of President Trump.  One reason an investor should avoid excessive retreat from stocks is apparent.  A vaccine will be highly likely to boost stocks in the next six to nine months. To address shaky consumer confidence, our firm has recently added the J.P. Morgan Hedged Equity fund which targets up 5% to down 5% but buys quarterly put options to protect significantly on the downside.  We might achieve a couple of quarters of 5% returns but lag a surprise uptick. That result could be quite nice given the current environment of downside anxiety.

Number three as a major driver of stock market outcomes is the remarkable performance of growth stocks that are technology or stay-at-home technology driven. While September finally has seen a pull back, the top ten such companies are driving all the 2020 double-digit gains in stocks. The 95% of the remaining market is still down 5% in 2020. If you exit the market or do not own large growth leaders, you will likely impact your portfolio returns far more than outcomes of the election. The technology revolution that has led to a 100% increase in online shopping and at least a 200% gain in video access is the most likely longer-term driver of stock market results. It is doubtful that the election outcome will impact this somewhat secular trend.

A fourth consideration in navigating the rest of 2020 is the impact of company size in the current pandemic economy. If the pandemic economic impact persists, banks face increasing loan losses and lending may dry up. If that happens, small cap and even some midcap companies that are not growing, can be damaged due to their reliance on credit. Failing to underweight them could be more costly than trying to time the election. Our firm has used the QQQ Invesco ETF offering to both target larger companies and include those top growth firms mentioned earlier.

My number five important suggested consideration, ahead of guessing about the election, is the need to hold non-U.S. stocks that are growing. The U.S. dollar has weakened by about 10% in 2020 due to failures to cope with COVID-19 successfully. This is positive for international stocks but only in areas that are coping well. North Asia and China are growing again with the Chinese consumer sector up 47%. But it is not a time to own Brazil, Russia or India where the virus still rages. Having some international growth is an excellent boost to portfolio diversification away from just the U.S.  Non-U.S. investing is the most logical way to diversify away from the election results inside the U.S.

Having been smart about constructing a timely portfolio, the election itself is generally a minor bump in the road. In 2000, Bush arrived just in time for a “dot com” bubble and later a housing financial slam in 2008. Except for Bush, no modern ten-year time horizon following elections has failed to be solidly positive for stocks. Most election years also tend to be positive as well. Biden has proposed raising the corporate tax rate from 23% to 28%. Should he win and get a cooperative blue wave Congress (that may be doubtful), he also wants to raise the capital gains tax to the same level as ordinary income. If all other things were equal, this might reduce corporate earnings by an estimated 12% and maybe also reduce stock market returns by another 5%. This must be weighed against the plans to raise the minimum wage which will boost consumer spending. Biden wants to put more than $1 trillion into infrastructure and that would likely cause a big jump in Caterpillar, Deere and even digital firms needed to build his vision of low cost national high-speed Internet service. He would constrain energy projects, yet plans to boost green energy investment. Healthcare spending would increase while defense spending might slow. I will stop with that as so many considerations are “on the one hand” versus “on the other hand.” A Biden victory might mean spending that boosts the economy while we could initially see a short period of negative market reaction. Trump’s election in 2016 started an immediate cratering of stocks that did not even make it over-night. It was not long before the global stock market rethought its initial projections and the S&P surged into 2017 for its best year in recent times. The current Fed posture will likely outlast whatever the short-term impact of the election of either Presidential candidate. A divided Congress seems the most likely outcome limiting what either President might accomplish. Republicans more frequently seem focused on stock market outcomes, but Democratic administrations have seen the biggest historical stock gains. Investors with retirement portfolios have a longer time horizon and most financial plans allow for a wide range of short-term events.

Please reach out to your HFA advisor with any questions or to discuss further.  Have a nice weekend and stay well!

 

This outlook is meant to provide longer term context and does not constitute investment advice which should come from a client’s advisor. It contains certain forward-looking statements which may not prove accurate. Investment risks must be considered, and all investments can lose money under certain conditions.

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