THOUGHT FOR THE WEEK
Mike Sorrentino, CFA
Aviance Capital Management
- The worst part about my job as a money manager is the requirement to follow the political scene in Washington DC.
- The presidential election is a year away, and many investors are anxious to determine the implications of a new administration arriving in the White House.
- History shows us that presidential campaigns can ignite volatility during election years but never really impacts the overall economy over the long run.
THE WORST PART ABOUT MY JOB
Without question, the most annoying and frustrating part of my job as a money manager is following the dysfunction in the U.S. government. I cringe when reading a newspaper or watching a television segment involving politics because I feel as if the incentives of most who service public offices are positioned solely to benefit themselves and not their constituents. To make matters worse, we are a year away from another presidential election, and this one is setting up to be a real nail-biter. There seems to be more uncertainty around this upcoming election than perhaps any other in recent history.
The byproduct of such uncertainty has led many investors to question the ramifications of a new presidential administration on their portfolios. What will happen if the Republicans take back the White House? Will a Democrat win be good or bad for stocks? These and several other questions have made it to my desk in recent weeks, so let’s spend some time discussing the impact of elections on financial markets (specifically equities).
Before I go any further, it’s important that I go through my “political disclaimer” so that investors know where I stand:
I despise both parties equally but for very different reasons. Furthermore, I am not a registered voter of either party, and my only motivation for following politics is to better serve my investors. The ability to reverse the direction of an $18 trillion economy takes much more than just the President’s political platform.
Investors pay money managers for only one reason and that is to make them money. Politics stir up incredibly powerful emotions, which are extremely dangerous to the investment process, and simply must be excluded from any investment decision. Hence, when discussing political issues, personal opinions must be checked at the door in order to shield the investment process from unnecessary risk.
For example, whether I am a Democrat or a Republican bears no value whatsoever when it comes to assessing a company’s ability to increase sales or raise their dividend over time. Personal opinions only complicate the process because they are irrelevant to the fundamentals.
NOTE: The danger of incorporating political views is evident over the last seven years. Had an investor avoided stocks because their belief that a Democratic president is bad for the economy, he/ she would have missed out on phenomenal returns.
That being said, history has shown the propensity for elevated volatility going into a major election year. Financial markets despise uncertainty, and elections often create a layer of ambiguity until the victor is announced. However, history has also shown that this volatility typically dissipates rather quickly after election day, and equities usually perform well going into the following year.
A common misconception is that a Republican win is good for stocks, and a Democrat is bad. There is no data to support this notion, and we don’t have to go any further back than the last two presidential elections in 2008 and 2012. An Obama win caused the market to fall days after each election, but markets quickly recovered both times.
The U.S. is an $18 trillion economy with a force so great, that not even the President can do much to reverse its course. Besides, our system of government is set up in a way that prevents the President from wielding enough power to
do so through various checks and balances and separation of power.
Long-term investors know this fact, and when the market sells off due to fear, they swoop in to buy from those who sell into the panic. Hence, the market rarely stays down for too long when the future direction of the economy is positive.
NOTE: The only force powerful enough to truly drive the U.S. economy into a recession quickly is the Fed. They control interest rates, which is the life and blood of our economy. However, the Fed has no interest in any policy that would cause our economy to slow down at the moment.
WHERE GOVERNMENT CAN IMPACT
Although a new president rarely changes the direction of our economy as a whole, an administration certainly has the power to destroy and/or grow smaller portions of our economy. For example, in the summer of 2012, we made the decision to sell all coal stocks and buy solar energy stocks, only if President Obama were to win a second term in November of that year. Our thesis was built on the belief that if Obama were to win re-election, he would lead a gruesome attack against the coal industry. The Democratic Party dislikes coal because the pollution created from power plants fueled by coal is an environmental concern.
As we moved closer to Election Day, we became more certain that Obama would win, but we still remained disciplined and waited for all the votes to get counted. We finally made our move the day after the election, and the chart below shows the results of our strategy over the following two years:
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