by Neil Azous, Chief Investment Officer
- Timeline – When to Care
- The Two Opposing Views
- Investing in Practice
Timeline – When to Care
The US Presidential Election is Tuesday, November 3, 2020 – 119 days from now. To date, the stock market has not discounted the significant rise of Vice-President Biden in most well-followed polls. Therefore, a critical question is when does the market in a discernable way begin to care about it?
In our experience, sentiment typically begins to shift, and investors start to adjust positioning, albeit incrementally, 30-60 days prior to the Election. One catalyst for that to begin is the result of the first Presidential debate, which occurs on September 29th.
Sidebar: For this post, we assume there will be no surprise at the Democratic National Convention regarding Vice-President Joe Biden stepping aside or the impact his Vice-President selection will have on the outcome.
The Two Opposing Views
At a minimum, you should recognize that the investment debate is not only about the pedestrian view that Vice-President Biden will roll back tax policy and the S&P 500 will see a material drop in 2021 operating earnings. The discussion also includes a constructive viewpoint.
View 1 – Bearish
One camp believes the key risk for the remainder of 2020 is President Trump losing his re-election bid and the Democrats taking back the Senate. President Trump’s agenda is supportive of financial conditions – high stock prices, low interest rates, loose credit, reduced regulation, and low gas prices. Undoing the lower corporate tax, changing the GAAP accounting benefits, not running a large budget deficit, adding the wealth tax back, increasing regulations, etc. would be negative for growth and earnings, at a time when the economy is trying to recover from the pandemic. They believe that a Democratic President that rolls back President Trump’s economic policies could lead to materially lower equity prices. This shock to the market may be amplified if the Senate race results in a Democratic majority. Note, if this outcome were to materialize alongside the start of the flu season being mistaken for a second wave of the pandemic, this would be the worst-case scenario. However, the difference this time is that the Fed is not able to respond by lowering interest rates to ease financial conditions unless they are willing to cross the Rubicon and cut them into negative territory.
View 2 – Constructive
Wartime: The other camp believes that elections, either at the Presidential or Senate level, matters less during a time of war, such as the fight versus the pandemic currently. Said differently, economic orthodoxy has changed with the Government quasi socializing the capital markets.
Polls & Trump: Based on the poor predictive value of the last Presidential Election, there is a high degree of skepticism regarding Vice-President Biden’s rise in the polls or online gambling websites. Also, from a financial market standpoint, betting against President Trump, especially at his darkest hours, has proven costly each time.
Spending: The question “How will we pay for it?” is no longer part of the conversation. Instead, the subconscious attitude is: The deficit horse has left the barn. Therefore, regardless of what party wins, the 2021 spending policy will look similar – that is, spend big and keep spending.
Taxes: At worst, federal statutory corporate taxes may climb to 26% from 21%, not the proposed 28%. Also, capital gains will likely not rise substantially. Regarding timing, the unrealistic demands from the far left of the Democratic party will likely lead to the negotiations extending beyond 2021. Remember, it took the Republicans all of 2017 to overhaul the tax code even though the Administration and both bodies of Congress were unified and moved at an extremely fast pace.
Overall, other than some token, politically motivated tax hikes from President Biden, increased focus on antitrust lawsuits that potentially hurts the “FANG’s”, restrictions on share repurchases, or a ban on shale exploration, few believe the economic policy will differ all that much between parties.
Investing in Practice
Making investment decisions prior to the election sounds good on paper. However, in practice, portfolio construction is quite different.
Anecdotally, investors have a difficult time making significant portfolio shifts when there are two unrelated themes occurring simultaneously. In this case, a pandemic and Presidential Election. This is especially true regarding the pandemic given its magnitude and because there is no historical blueprint.
Also, even if you knew in advance which of the two opposing views would prevail, what would you do with that information? Meaning, in the weeks following George Bush, Barack Obama, and Donald Trump winning the Presidential Election, the stock market fluctuated violently. For example, following President Bush’s victory, the S&P 500 closed November 2000 down -8.01%. In President Obama’s case, he won during the height of the Global Financial Crisis, and the S&P 500 closed November 2008 down -7.48%. Conversely, the S&P 500 closed November 2016 up +3.42% when President Trump won. The key point here is that you have time to adjust a portfolio following the election outcome.
In practice, we expect large long-only institutions to “hug” their benchmarks in the weeks leading up to the Presidential Election. That will allow them to make key asset allocation decisions in the hours/days after the outcome is known.
Otherwise, at best, a view could be expressed at the micro-level and in a measured way. For example, tactical or alternative strategies may allocate a small amount of their assets (i.e., <5%) towards the following themes:
- Democratic Sweep Tax Strategy: Short High Tax vs. Long Low Tax equities in a sector or factor neutral manner.
- Sector Winners & Losers: Industries that would likely be more challenged under Democrat control, include traditional Energy, Chemicals, Banks, Utilities, Autos, Drugs, and Tech (i.e., antitrust, privacy, etc.). Winners would likely include Clean Energy, infrastructure-related areas (i.e., machinery, Build America Bonds (BABS), etc.), and education.
- Opportunistic Value – Long Utilities and Palladium: New green legislation from President Joe Biden potentially creates two significant positives for the equity and debt of electric utilities. For example, they could benefit from Increased rate-base spending on wind and solar and the transmission to bring those to market. That would benefit equity holders from higher EPS growth rates and support bondholders by increasing asset coverage as they lock in new 30-year returns on investment. Palladium is a key commodity that could benefit from an entire new avenue of spending from electric vehicles.
- Long US 30-year US Treasury Breakevens or US 5yr/30yr steepener as the probability of a Democratic sweep could mean higher inflation expectations and steeper yield curves.
- Covered-Call or Overwrite Strategies: Selling expensive implied volatility on the view that a close race will likely keep equity index upside constrained until the Election. Also, this may be a suitable approach to monetize the recent stock market recovery and reduce market beta beforehand.
This list is not meant to be all-inclusive but rather to provide you a train of thought regarding anticipatory portfolio construction.
We believe it would be misguided for investors to make signification shifts to their portfolio leading up to the Election. The past few elections have shown that you have time to adjust following the event.
We would be interested in discussing your investment outlook and believe you would find value in the discussion. At Rareview Capital, our goal is to become a trusted resource and the first call for your questions. Please call us at 203-539-6067 or email us at email@example.com.
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- Generally accepted accounting principles, or GAAP, are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices
- Beta: A quantitative measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
- A covered call is a popular options strategy used to generate income in the form of options premiums. To execute a covered call, an investor holding a long position in an asset then writes (sells) call options on that same asset.
- Steepening Yield Curve: If the yield curve steepens, this means that the spread between long- and short-term interest rates widens.
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