The Election and Your Money

In past years, I’ve written on this topic once the results of the Presidential election are known. This year, I’m posting prior to the election, because some of the potential short-term effects of the election results are worth considering, so as to be ready if market dislocation follows next Tuesday’s vote.

This is my eleventh presidential election, and surely the most contentious. I won’t tell you how to vote, or even touch the arguments against the two major-party candidates. Good luck to all of us when we step into that booth and confront the duties of our citizenship.

What I will comment on is the investment implications of this election. You can also watch a recording of our recent webinar, The Markets & The Election Season. How will the results affect our portfolios? Is there anything we should do in advance of the election, either to protect ourselves or to maximize our opportunities? Are there actions we should be prepared to take after the election, depending on the result?

As always, let’s start by examining the data. We have really good data going back to the presidential election of 1952 about how U.S. financial markets have reacted in the short-term, over the two months on either side of presidential votes, to different election outcomes.

Here’s a summary of some of the key points:

  • Markets usually go up slightly in the two months bracketing the presidential election.
  • They go up more if the election is close.
  • If the election is a landslide, they go down a bit.
  • If the party in the White House changes, they go down. If the White House remains with the same party, they go up.
  • If a Democrat wins, markets decline, while a Republican victory sends markets up by exactly the same margin.
  • None of these historical moves averages as much as 2% in either direction.

So the best scenario for the markets is if the Democrats retain the White House by a slim margin, and a Republican wins the presidency. Which is clearly self-contradictory, and thus no help at all.

Does either party have a longer-term advantage? Yes, there is a slight advantage for Democrats in long-term returns. But if you deduct the market crash of 1929-1932, the Republicans have a slight edge. As investors, we really have no reason to prefer either candidate based on historical market reactions to partisan outcomes.

Is there a more reliable metric we could apply?

As we often do, we fall back on valuation. Economist Robert Shiller of Yale University won the Nobel Prize in Economics for his insight, captured in the Shiller CAPE (Cyclically-Adjusted Price Earnings ratio), that when stock market valuations are high, future returns are lower, and when valuations are low, future returns are higher.

The last two times the presidency changed hands, in 2000 and 2008, we used Shiller CAPE to inform our broad perspective on the markets.

In 2000, when George W. Bush finally won, valuations were high, and we warned that risks were high and prospective returns likely to be low. We took a defensive posture. As the tech crash continued through 2003, our portfolios largely avoided the market decline.

In 2008, when Barack Obama won a compelling victory in the midst of the worst stock market decline since the Great Depression, we observed that stock prices were below average. With risks lower and opportunities higher, we pounded on the table in favor of buying stocks. At the market bottom in 2009, our stock holdings were the highest ever. We were ultimately well-paid for owning stocks, as Barack Obama’s first term was one of the most profitable for U.S. stock market investors in a generation.

Today, market prices are high. With Shiller CAPE at 26.5 times trailing earnings, we are in the top 7% of historical valuations (93.6th percentile). Our portfolios are defensive, just as they were in 2000 when Bush 43 was elected.

A little more than a week ago, a Hillary victory with limited “coattails” appeared to be priced in.[1] A sharply different result—either a Trump victory or a Hillary victory with big coattails, giving the Democrats control of the House and Senate, would have been surprising, and thus likely to lead to a short-term market decline. (For what little it is worth, historically market returns have been highest with a Democrat in the White House and Republicans in control of Congress, just as we have now.) As Trump closed the gap, the U.S. stock market declined for nine straight sessions, the longest losing sequence since 1980. We have done limited buying during this decline, mostly for clients who were over-weight cash.

There is an aspect of our portfolio strategy that may intersect in interesting ways with the election results. While U.S. valuations are very high, all foreign stock markets are cheaper as measured by CAPE, without exception. We are overweight foreign equities.

To evaluate how this positioning might perform after the election, let’s examine the reaction of markets to the British vote on whether to leave the European Union (Brexit). Immediately before the vote, the final polls predicted Brexit would fail and Britain would remain in the EU. Markets rallied sharply. But Britons actually voted for Brexit, against polling predictions. Markets fell sharply, both in the U. S. and in Great Britain. But within weeks, markets fully recovered in both the U.S. and overseas. So far, so unremarkable.

But one market fell sharply and has continued to fall in reaction to Brexit—the currency market for the British pound, which fell by 6.0% the next day and has fallen another 10.4% since, with no sign of recovery.

What is the similar scenario in the U.S.? It would be a Trump victory, against the indications of the majority of polls. If we followed the Brexit path afterwards (no guarantees of that at all), we would see a sharp decline in the S&P 500, followed by a full recovery in stock prices, but we would also see a sharp and persistent  decline in the value of the U.S. dollar.

That single, entirely speculative scenario would actually benefit our target portfolios, because we are strongly over-weight foreign equities. A falling dollar increases the price of foreign stocks. Of course, there are multiple other scenarios under which we would not benefit.

Our advice is to exercise your franchise in line with your moral, political, and philosophical convictions, and to expect markets to react to the election results in unpredictable ways. Know that our portfolios are defensive and diversified, that we have cash available to invest in the event of a large market decline, and that we remain committed to a global perspective on investing. As always, we are devoted to your lifetime financial success, and none of our personal political perspectives will ever deflect us from making decisions solely based on what we believe to be your best long-term interests.

[1] A President’s election is said to have “coattails” when it also results in large gains for down-ticket candidates for Congress, Governorships, or state-house races. Examples during my lifetime were Johnson in 1964, Reagan in 1980, and Obama in 2008.

Trump: Less Than Meets the Eye

“There is no there there.”

                                                                                                Gertrude Stein

Many years ago, Saturday Night Live did a bit called “The Thing that Wouldn’t Leave.” As I recall, John Belushi played the part of the dinner guest who refused to get the hint, hanging around long after his exhausted hosts were clearly ready for bed.

I feel that way about Donald Trump. His persistence atop the polls, despite statements that to me appear radioactive, and debate performances that combine ignorance with bombast, continually confounds my expectations.

So as a citizen, Republican, and conservative, I’m going to take another swing at the noisy excrescence that is The Donald.

A considerable part of Trump’s raison d’etre (reason for being, not just reason for running) is his oft-repeated claim to be smart and rich. “I’m, like, a really smart guy…I’m worth ten billion dollars.”

At the moment, Trump is in fact quite rich. Probably about one-third as rich as he claims, as discussed here. But almost certainly a billionaire. And surely he must have been pretty darn smart to get there…or perhaps not.

Recently several substantial news organizations have looked at a fairly simple question. How has Trump done as a businessman/investor, compared to how he might have done if he had simply taken the money he inherited from his father, a highly-successful real estate developer, and placed it into an utterly passive investment, a S&P 500 Index Fund?

The answer, pretty clearly, is not very well, as noted and here and here. Long story short, Trump has made about half as much, with all of his Trump-branding of casinos, office buildings, golf courses and condos, as if he had simply taken his inheritance, bought the Vanguard Index 500 mutual fund, and wandered off to spend the next few decades playing golf on a course he did not own.

And this is before adjusting for risk, and for opportunity set. In terms of risk, Trump has used leverage freely. He has swung for the fences, not once but many times. He’s taken enough risk to have his public company, once Trump Casinos and Hotels, more recently Trump Entertainment, go bankrupt four times.

And consider the opportunity set Trump confronted when he got started. Trump’s father put him in charge of a successful New York real estate development company in 1975. New York has, in the years since, floated atop a tidal wave of investment success. The stock market went up more than twenty-fold. When we talk about the richest 1% in the United States, we are talking largely about New York City. Surely there can have been few better places on the planet to have owned and developed real estate. Surely there can have been few better-heeled customers than Wall Street and its moguls. And yet Trump earned returns roughly half as large as those realized by a sensible mail carrier who put his Federal savings plan into a stock index fund.

One of the great ironies of Donald Trump’s life is his own utter lack of irony. It is entirely clear that Trump believes every one of his self-aggrandizing assertions. He believes himself to be the Titan of the age, one of the great businessmen of his time. It simply isn’t true. He is a guy who inherited a pile of money and a single-syllable Anglo-Saxon last name, engaged in a whirlwind of activity, relentlessly promoted his name and brand, and after four decades ended up with a larger pile of money, which he believes wrongly to be the result of his own activity, but which was actually simply the consequence of the swiftly-rising tide that made many others richer still.

Donald Trump was born on third base, re-named it Trump Terrace, and believes he hit a triple. He got thrown out four times trying to steal home. And he proclaims himself, to everyone who will listen (far, far too many of my fellow Republicans) one of the greatest hitters of all time. He is a fraud.

If Trump remains a player in the Republican field, at some point I promise to share what I really think about him.