Like an old Jerry Lewis telethon (younger professionals reading this are asking who is Jerry Lewis and what is a telethon?) my phone started ringing after the first debate. One after another, the questions asked centered on if I agreed with the wisdom of moving into cash until we know the election results.
For those of you who know me, asking me if I believe in Emotional Market Timing is like asking me if I want to see a Dallas Cowboys victory. If the analogy is not clear, as a Giants fan, my favorite team is any team playing the Cowboys. (Sorry, I did not mean to get political.)
To answer this, let’s begin by examining two data points spanning over nearly the last 100 years:
- The performance of the S&P 500 when the White House transitions from a Republican to a Democrat and,
- The performance of the S&P 500 when a Republican president wins a second term
On average, the S&P 500 does much better when the Democrat wins the election. When we transitioned from a Republican to a Democrat, the S&P 500 moved from an average return of -2.79% the year before the transition to a whopping average return of 22.05% in the first year when a Democratic President redecorates the White House.
When a Republican President is reelected for a second term, the return of the S&P 500 was not as kind to investors, averaging a 2.8% return and a bit worse if you remove President Reagan’s performance.
So what have I proved?
The reason these types of analysis we keep reading are inconclusive is because they are all one dimensional – it does not include insight to what was going on in the economy at the time.
The key takeaway of this blog is to understand that the economy was more of a driver than the person sitting in the chair at the oval office. I will even go so far as to say that in the current economic environment, the head of the Federal Reserve is almost more important than the election night victor when it comes to the performance of the S&P 500 over the next 12 months.
Of course, the argument I hear is what Sir John Templeton (again the younger professionals are saying, “who?”) called the four most dangerous words in investing, This Time Is Different.
For those of you who attended any of my virtual Shareholder Meetings or read my blogs during the pandemic, you will recall I stressed the avoidance of the “This time is different” trap. Yes, the pandemic was different, but in my view, historically, the drivers of the market seldom change.
I believe that events like the elections and Covid-19 are noise and the real decision on jettisoning some or all of the equities from a properly diversified portfolio lies in the answer to one question; what are earnings going to look like? I am not referring to next quarter’s earnings. Historically the market will rise or fall in anticipation of the economy six to twelve months in the future.
Based on the conversations I have had, the real elephant in the room (yes, I could have said 800 pound gorilla but the elephant pun was there for the taking) is the issue of a contested election.
The US executive branch has seen four assassinations, four presidents dying of natural causes.(2) one resignation, and four contested elections.(3). In recent times, we had contested elections in 1960 and 2000.(3) In each instance, democracy prevailed. I have no reason to believe that this will change.
US Senate majority leader Mitch McConnell told Fox News there will be “an orderly transfer of power,”(4) and the Senate passed a resolution by unanimous consent to show support for a peaceful transition.(5) I believe our great nation and the democratic principles it was founded on will again prevail. I believe going to cash to protect assets in case of a contested election will prove to be an error as was going to cash because Trump was elected president back in 2016 or more recently, because of the pandemic.
In terms of Vice President Biden’s possible tax increases, the answer to that is no different from what I have said throughout this blog; keep your eyes on earnings.
The fear of a capital gains tax increase could certainly usher in a short term rush to sell assets that would otherwise be subject to the higher rates if Vice President Biden is elected president.
But will Apple sell less of its products and services if the capital gains tax increases? Will shoppers be less inclined to use Amazon if capital gains rates increase? Will streaming services see their subscriptions decline due to a higher capital gains rate?
If a company’s earnings continue to grow and if the potential year-end capital gains tax selling lowers prices on some of these stocks, doesn’t that create an entry point for investors who have been waiting for these stocks to become cheaper? Could a new wave of buying result in some stability to the market? Again, going to cash due to a possible capital gains increase could prove costly.
That leaves us with Vice President Biden’s proposal to raise corporate tax rates from 21% to 28%. While this increase is not catastrophic, it is not insignificant. But is it a reason to move out of equities?
To begin with, I would like to point out that we recently had the longest bull market with one of the best returns for the S&P 500. This was accomplished primarily under a 35% corporate tax system.(6) Also, 2018 was the first year of the lower corporate tax and yet it yielded a -4.38% return for the S&P 500, the only negative year since 2009 all of which carried much higher corporate tax rates.(1)
In terms of the fear of corporations keeping their money off shore or establishing their corporations offshore, keep in mind that even under the current 21% tax - Bermuda, the Bahamas, and the Cayman Islands are still a favorable destination for corporations. These locations are used as a parking spot for money or as the establishment of their companies because of their 0% tax rate and their simple structures for setting up offshore businesses. (7)
If Vice President Biden combines an increase in corporate taxes with an increase of infrastructure spending, the decision to go to cash for fear of a tax increase could be a mistake.
It is not difficult to get swept away with the emotion of the presidential election. However, in my view, Emotional Market Timing is not a great option and employing a calm, steady, and common sense approach to these times, in my opinion, seems to be a preferable way to approach investment decisions today.
Once again, to help you have a meaningful discussion with your clients, click here to receive a must have companion piece. This easy to read graphic includes a timeline and key economic stats and conditions for various transfers of power or the reelection of a U.S. president that contributed to the return of the S&P illustrated above.
(4) Fox News Clip