Trump vs. Clinton
Elections, and the political campaigns leading up to them are a fascinating, if painfully long, process of measuring a population’s mood. Hillary Clinton has essentially been running for president since she finished runner-up to Barack Obama in 2008 while it’s been over a year and a half since Donald Trump entered the race as an almost completely overlooked candidate. This 2016 presidential election is an unusually stark contrast seemingly between the ultimate outsider and the ultimate insider. Given this, hysteria and hyperbole are to be expected (see recent Brexit similarities). This race is emotional, and that makes it even more interesting than usual.
The electorate’s mood has darkened in recent years. Hope has been largely replaced by anger. Both Bernie Sanders and Donald Trump used anger against the establishment, against corruption, and lack of economic progress for the middle class to fuel their surprisingly strong candidacies. With elections and markets both performing as barometers of mass psychology, it shouldn’t come as much of a surprise that there is a correlation between them. However, the degree of correlation between market performance leading up to elections and the results of those elections may indeed be surprising.
The chart above by Strategas Research Partners shows that the stock market performance over the three months preceding a general election has predicted whether the incumbent party has won or lost the election with amazing accuracy. In an astonishing 19 out of 20 elections since 1928, positive stock market performance in the August-October time-frame has led to an incumbent win and poor stock market performance over those months has resulted in “throwing the bums out”.
Now some statistically well-versed readers may note that “correlation does not imply causation”. Of course, it doesn’t. In fact, we think is that market performance and election outcomes are likely to be coincident symptoms of either optimistic or sour public sentiment. No guarantee this coincident statistic will “work” again, but for those of you interested, 2170 on the S&P 500 is the number to keep in mind. Current prices levels around that same level lends support to recent media reports of essentially a dead heat.
Interest rates and monetary policy
For the first time in recent years, the US Federal Reserve and its interest rate policies have become an important political topic. The markets have undoubtedly become focused on central bank policy. Long term return forecasts are increasingly driven by outlooks for interest rates with much ink being spilled arguing the how and why of interest rates, inflation (or lack of inflation), and monetary policy.
Since 1990, inflation and unemployment have fluctuated, but neither increased nor decreased substantially when measured over the entire period. However, interest rates have declined markedly. Why? By aligning the starting points and stripping out all labeling, the following chart attempts to break down the conundrum into the simplest possible graphic:
Unemployment spiked up following the recession of the early 1990s, the bursting dotcom bubble, and the Great Recession of 2008-2009. Inflation reacted during these events but both of these primary indicators of Federal Reserve Policy (the dual mandate) are at roughly the same levels today as they were nearly 27 years ago. However, interest rates are much, much lower. Why?
We’ll leave this question unanswered for now, as it is a complex subject requiring more nuance than the duration of this letter allows. However, we do feel that one primary driver is the fact that short term interest rates are set by human central bankers and not the free market. Humans have a (usually quite reasonable) tendency to “error on the side of caution”. However, as Milton Friedman noted, there is no free lunch in economics. Avoidance of short term risks can have substantial longer term effects.
Furthermore, policy (both political and monetary) has the ability to time-shift consequences. This makes ex-post facto determination of cause and effect difficult. Finally, the tremendous demographic, geopolitical, and technological changes seen in recent decades have probably masked certain feedback processes and allowed the low interest rate trend to persist longer than it otherwise might have.
Regardless of the reasons for low interest rates, the fact remains that real returns are much more elusive today than they were in the past. As investors, we need to address this in our strategy and also in our expectations. The strategy implications are to monitor and limit overall portfolio risk, focus on reducing interest rate exposure to the extent possible, and looking for opportunities to invest in unloved and underappreciated assets.
Oasis of growth?
Speaking of unloved, when was the last time you read a positive news story about any of the emerging market countries (or the group as a whole for that matter?) From impeachment in Brazil, to corruption in Russia, to bubble fears in China and the attempted coup in Turkey, the news has been fairly negative. Compare the recent news drumbeat to the following chart of estimated future economic growth put out by Fidelity (time-frame 2016-2035):
Of course the above numbers are only forecasts. Individual outcomes will absolutely vary from a priori estimates. However, we can often increase our odds by taking a long look at asset classes that seem to have decent long term fundamentals, and are also temporarily “disliked” by the market. Emerging countries are good examples this concept.
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