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Pacific Capital Associates

Financial Advisors in San Diego, CA

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The investment impact of the election

October 29, 2020 By Victoria Hooker

October 29, 2020

We’ve been getting a lot of questions about the election and its potential impact on the stock market, so we wanted to write some thoughts on the topic.

To begin with, we should mention that we have very low exposure to US stocks. This has nothing to do with the election, and everything to do with our belief that US stocks are just very expensive compared to many other investment options that we think offer better likely long-term returns.(1)

We will go into a lot more detail on that topic in an article to come in a few weeks. For now, we just want to cover the election question.

Election results don’t predict stock performance

In our view, it really isn’t possible to reliably map election outcomes onto investment outcomes. There are many, many factors influencing the market at any given time; an election or other political event is just one such factor and can easily be overwhelmed by the others. We’ve written about this often in recent years, citing numerous examples where even if you’d known the political outcome, the market reaction was the opposite of what was commonly expected.(2)

Regarding the US presidency in particular, there hasn’t been any reliable relationship between the presidential party and market performance:

The same is true for the party holding Congress (although split Congresses have coincided with notably lower, though still positive, average returns):

There is often extra concern at the prospect of a new party taking over and changing policy, and 2020 is no exception on that front. We’ve gotten many questions about the potential for tax increases under a possible Biden administration and Democratic-majority Congress.

In our view, this is falling into the trap of focusing too much on just one piece of a very complex puzzle. Higher taxes could be offset, for instance, by a larger stimulus program that would likely result with the Democrats at the helm. Outside of the legislative realm, other important factors include Fed policy (which is extremely stimulative and looks set to stay that way for a while), developments regarding the pandemic, international economic or political events outside the control of the US government, and the ever-wild swings in investor mood. There’s no way to reliably predict where this infinitely complex mix of influences will lead.

It’s also worth noting that tax hikes have not historically led to market downturns: In 5 out of the 6 biggest tax increases of the past 80 years, the stock market was up during the calendar year of the increase.(3) It’s not that markets like tax increases, it’s just that they are one factor out of many.

The company that created the charts above, Investech Research, puts it in perspective with these three bullet points (emphasis ours):

  • Tax increases and decreases have occurred at all points of the economic and stock market cycle.
  • Tax increases have not historically triggered bear markets.
  • Roaring bull markets and severe bear markets have occurred under both Republican and Democrat presidents and Congresses alike.

Long-term investors benefit from short-term uncertainty

Of course, markets could very well decline after the election, regardless of the results. We aren’t arguing that it won’t happen. We are simply arguing that – even if you knew the election outcome for sure – it is impossible to know how the markets will react.

Most importantly: If there is a dramatic market reaction, it’s likely to be a blip on the long-term trend. While prices can act crazy in the short term, the long-term underlying value of markets is quite steady. And prices tend, eventually, to make their way back towards fair value. We made this argument at the depths of the Covid-19 panic, and it applies just as well to the back-and-forth between political parties.

In fact, a downturn could be very beneficial for our portfolios in the long run. Our allocations are on the conservative side right now, for reasons described in our last letter, so we have room to add stock exposure. A market decline would give us the opportunity to increase our stock holdings at lower valuations.

Regarding the US stock market in specific: If it does experience a serious decline, the most likely cause is that it was too expensive to begin with.(4) But this is not the case for the international investments we own, which range anywhere between reasonably valued and very cheap. We feel confident about their long-term prospects and we’d welcome a chance to increase our investment at even better prices. If the US election provides such an opportunity, we will be ready to take advantage of it.

 


1- We do have significant exposure to international stocks, which could decline in the event of an election-induced downturn. But their valuations are low enough, and their prospective returns high enough, that we are willing to accept the risk of short-term selloffs to own them.

2- In fact, this happened in the 2016 presidential election, when many people predicted that a Trump win would lead to chaos and crashes in the markets. And markets did actually plummet initially on the night of Trump’s come-from-behind win (we got a few panicked phone calls too). But markets had calmed down by the next morning, and they went on to rally powerfully for nearly 2 years.

3- Source: Investech Research

4- There are pockets of the US stock market that are more reasonably valued, and we have some exposure there. But the US market as a whole is quite expensive compared to its history.

Excerpted from a letter sent to clients on October 27, 2020

Filed Under: Uncategorized

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