September 2020 Investment Commentary

Editor’s Note: The below information is current as of August 31 and does not reflect the tech selloff and ensuing volatility that occurred in early September.

Executive Summary

• Equity markets tend to prevail no matter which party sits in the White House, but policy changes can have a big impact on taxes and individual sectors.
• Global stocks rallied for the largest August returns in three decades, while bond yields edged higher on the Federal Reserve’s new inflation policy.
• The market’s return in the three months leading up to the election has shown predictive power; however, a disputed election may cause more volatility beyond November 3.

Winners and Losers in a Biden or Trump Economy

Let’s just get this out of the way: No matter who ends up winning the election in November, neither the economy nor the market is likely to implode based upon the results. In this highly partisan world we live in, it’s easy to get caught up in the rhetoric that one party or the other is going to destroy the country, especially when referring to our non-favored party. Hindsight tells us that pulling out of the market based upon election results is almost always a bad idea. If we look at the last 10 elections going back to 1980, the average return for the S&P 500 was 17.6% in the year after the presidential election, with only two negative years in the group (going back to 1926 yields an average 9.9% return).

At this point, it’s basically a coin toss as to who will prevail. We know a lot will change in the next two months as we build up to Election Day, so we are not going to make any bold predictions on who the victor might be. Though the polls currently favor Joe Biden, the gap has been narrowing as of late, particularly in several of the key battleground states won by President Trump in 2016. Also, despite having historically low popularity ratings, the power of incumbency favors the President, as incumbents tend to win about 70% of the time (though recessions muddy the picture). The President has an uphill battle and is facing harsh criticism on his handling of the pandemic, while several key demographic groups such as college-educated women and minorities appear to be aligned against him. However, if the market remains hot while the economy continues to improve, or if news of a readily available vaccine becomes imminent, these factors could help the President remain in office.

That being said, there are several election implications which we should consider in terms of tax policy, regulations, and impacts to individual sectors and industries. Regarding policy, it goes without saying the two parties are far apart and would have vastly different agendas. Because of these stark differences, there will certainly be sectors which benefit and those which will face hardships. Below is a brief look at how the markets and economy might fare in either scenario.

If President Trump Wins

Whether it’s a factor, or causation, or correlation, the market has remained incredibly resilient throughout President Trump’s term in office. Despite pullbacks of 10% and 19.8% in 2018, and 34% in 2020, the S&P 500 Index is still higher by more than 67% since our last election in 2016. Some may argue that the Fed’s extraordinary monetary policy may share some (if not most) of the credit for the remarkable recovery this year, but it’s hard to ignore the impact of the 2017 Tax Cuts and Jobs Act (TCJA) and President Trump’s pro-business and deregulatory efforts. Then again, most of the market volatility in 2018 was self-inflicted, as trade war tensions rattled the global economy, even though the markets recovered both of those losses well in advance of the pandemic.

If President Trump once again succeeds on Election Day, it is fair to assume a continuation of his first-term policies, although we shouldn’t bank on the market climbing another 70%. “America First” will be the continuing theme, and we may experience a renewed focus on trade with potential uncertainty ensuing. If you recall, trade tensions were starting to ramp up between the U.S. and Europe right before the pandemic hit, which could resume once the world normalizes. President Trump will also likely implement policies to help end our reliance on China, including tax credits for companies that bring jobs back to the U.S.

We also expect a continuation of President Trump’s deregulatory efforts, which should favor small businesses, along with the financial and energy sectors. While deregulation has been lauded by the business community, it has interestingly had little direct impact on stock prices. Financials and energy have been two of the most beleaguered sectors during Trump’s term (albeit mostly due to external factors). In addition, one can argue that increased regulation can actually benefit larger, publicly listed companies at the expense of smaller businesses, due to their size and scale to regulate themselves.

President Trump will almost certainly push to make the 2017 tax cuts permanent beyond 2025, but we predict he will fall short if the House remains in the Democrats’ control. It’s more likely we will see more calls for payroll tax relief and potentially an expansion of “Opportunity Zones,” which are designed to provide capital gains relief for those investing in qualified areas.

More realistically, the President will sustain the current low-tax, business-friendly environment, which would support small businesses looking to recover from the COVID-19 crisis. Additionally, if the House and/or Senate contains a Democrat majority, that would create a system of checks and balances to either party’s policies.

If Biden Wins

There is a widespread view that if Joe Biden takes the White House, he would usher in a leftist agenda that would send stocks tumbling. We could expect higher taxes, more regulation, big-tech scrutiny, and a renewed focus on centralized healthcare—all of which have a negative connotation when it comes to Wall Street. However, historically speaking, markets have generally performed slightly better when a Democrat sits in the Oval Office. Consider the following facts:

• 10 out of the past 11 recessions have begun during a Republican presidency
• Going back to 1926, the average calendar return for the S&P 500 was 14.9% with Democrats in the White House, as opposed to 9.1% for Republicans

So, going by history, a Biden presidency could be as good, if not better, than the status quo. For one, Biden would take a less hawkish stance on trade, which created tremendous uncertainty for businesses during President Trump’s term in office. Most notably, a Biden presidency will likely support higher taxes on the wealthiest Americans (those who make in excess of $400,000 per year), as well as corporations. Biden would almost certainly reinstate several Obama-era regulations and reengage with the international community on environmental pacts such as the Paris Agreement on climate change.

Given voters’ tendencies to vote party lines when calling for change, if Biden wins it is likely that voters will also elect a Democratic majority in the Senate and House. If this “Blue Wave” comes to fruition, a legislative agenda focused on infrastructure, healthcare and climate change becomes likely. While both parties agree that we need to invest in infrastructure, neither agree on how to pay for it or what to prioritize. While Trump would likely focus on traditional infrastructure such as bridges and highways, Biden would also sponsor clean energy initiatives (and both have expressed intent to invest in 5G cell towers).

One sector which may face pressure with Biden in control could be Big Tech, which has had a tremendous run in 2020 and over the past several years. Just five companies represent almost 25% of the broad U.S. market, but they could be challenged under a more onerous tax regime. Biden has proposed doubling the global minimum tax on offshore income (currently 10.5%) to 21%, which would notably hurt the bottom line for these and other multinational corporations. We could also see more scrutiny from an antitrust perspective, as many view these businesses as monopolies and harmful to small businesses.

Finally, if Democrats control both the Executive and Legislative branches, there could be an increased focus on using fiscal policies to help the current economic recovery and on a go-forward basis. In the long run, this could relieve some of the Fed’s monetary burden, allowing interest rates to normalize more quickly than most anticipate. In addition, Biden would almost certainly be less critical of the Fed, relieving some of the politics that lately have influenced our Central Bank, a traditionally independent institution.

Market Recap

Though it was widely anticipated, an important revelation came out of the annual Jackson Hole Economic Policy symposium, which was held virtually in late August. Fed Chair Jerome Powell revealed the Fed’s new strategy of allowing inflation to run above target, assuming it had remained well below target for a sustained period. This new strategy focuses more on maximizing employment and is less rigid about raising rates the moment 2% inflation is reached. This means that the Fed will be less likely to tighten money supply in anticipation of inflation that may not materialize, and they have given themselves cover to maintain a zero-rate interest rate policy and inflated balance sheet for the foreseeable future.

Global equities responded by rallying 6.12% for the month, capping off the largest August return dating back to the mid-1980s. This is especially notable given what might be coming, as September tends to be a poor month for stocks, averaging a 0.5% decline going back to World War II. The S&P 500 gained 7.19% in August, closing at new all-time highs on seven different occasions. Leading the charge (surprise, surprise!), the Technology sector gained over 12% and is now up almost 36% year to date (YTD). Consumer discretionary (+9.5%) and Communication Services (+9.1%) also rallied impressively, while Utilities (-2.7%) and Energy (-1.0%) lagged. The divide between Growth stocks and Value stocks continues to widen, as the Russell 1000 Growth index is now up over 30.4% YTD, while the corresponding Value index is down -9.4%. International stocks performed admirably as well, however, they again failed to keep pace with the U.S. The MSCI All-Country World ex-U.S. index went up 4.28% last month and is now -3.05% YTD. The Emerging Market index gained 2.21% in August, trailing both the FTSE Developed Europe index (+6.6%) and Developed Asia/Pacific (+4.5%). The U.S. dollar declined once again, down -1.3% versus a basket of major currencies, and is now off -4.4% on the year.

The Bloomberg/Barclays U.S. Aggregate Bond index pulled back -0.81% in August, as yields nudged slightly higher on news of the Fed’s new inflation policy. The yield on the 10-year Treasury closed at 0.70%, up from 0.54% at the end of July. The curve steepened for the first time since early June, as the 10-year-3-month spread went from 0.40% to 0.63%, although it did decline the last two days in August. The corporate high-yield index climbed another 0.95%, as below-investment grade bonds continue to claw their way back as the economy reopens. Municipal bond indices also fell on the month, down 0.47%, however, the spread of the ICE/BAML Municipal Composite index remains over 2% higher than the comparable treasury index, reflecting relative attractiveness on a historical basis.

Turning to commodities, the Bloomberg Commodity Index rallied by 6.76% in August, though the broad index is still down -9.04% on the year. Gold was slightly down (-0.37%) but remains positive year to date (+29.9%) as investors have flocked towards precious metals due to fears of monetary expansion and low opportunity costs. Natural gas surged by 46% in August—its strongest monthly gain in more than a decade. However, the spike was driven by a surge in demand after storms created power outages, so the rally may be short lived. The GSCI Agricultural Spot index rose by 7.28%, which was the second-best performer behind Natural Gas.

Closing Thoughts

It has been widely cited that the market can have predictive value over who wins the White House. A positive U.S. stock market in the three months leading up to the election typically favors the incumbent party, whereas a negative return over the same span usually suggests a change in administration is coming. According to data from Goldman Sachs, going back to 1928, the average three-month return for the market leading up to election day was +5.2% when the incumbent party won and -2.7% when the incumbent party lost. For current reference, the market gained 6.42% from August 3 through 31, but as we mentioned above, much can happen between now and Election Day (Editor’s note: On September 3, just before publishing this commentary, the market fell 3.5%).

Another factor to consider: Remember the contested election of Bush vs. Gore back in 2000? While all eyes turned to Florida as votes were recounted, the markets tanked due to the uncertainty. The S&P 500 fell almost 10% in November 2000, while the Nasdaq fell 19%. Given the high likelihood that a significant portion of votes will be mail-in or absentee ballots, we could be in store for a similar experience. According to the New York Times, at least three-quarters of all Americans will be eligible to vote by mail this November. Unfortunately, this election has the potential to drag on for weeks, if not months, and the market could drastically waver while we wait for an outcome.

At the end of the day, the underlying economic conditions along with monetary policy will largely decide where the stock market is four years from now, as opposed to which party presides in the White House. We believe in the long-term resiliency of the market and recommend voting with your ballots, not through your investments. Uncertainty surrounding the election has the potential to create considerable volatility, but it shouldn’t get in the way of your investment plan.

More importantly, if there is a regime change in Washington, it could be a good time to review your tax planning strategy with a financial advisor. We could be in store for a capital gains increase, the return of SALT deductions, or one of many other policy changes, so talk to a Wealth Enhancement Group advisor today about how to plan for whatever the future might bring.