One Month to Go: All Eyes on the Election

Mike Loewengart, VP of Investment Strategy

E*TRADE Capital Management, LLC

10/06/16

The Facts:

Most markets were flat to slightly higher in September. But that doesn’t mean there wasn’t a lot happening. The U.S. Fed decided—for now—to leave interest rates unchanged, and the U.S. election dominated headlines from coast to coast.

The Impact:

  • U.S. small caps outperformed large caps in September, but both gained.
  • Emerging markets continued their big run—and are now up more than 16% year to date.
  • Bond sectors were mixed as investors reacted to news from the Fed.

What It Means for Investors:

It’s easy to get worked up by election-year politics. We all do. But when it comes to your investments, it’s usually best to keep cool. We’ll take a look at possible election outcomes, and how they might affect a range of asset classes.

 

A Closer Look

Markets breathed a sigh of relief in September when the U.S. Federal Reserve (U.S. Fed) announced it was not yet ready to raise interest rates. As a result, the volatility that had defined markets during the first half of September faded, and both domestic and international equity indexes finished the month higher. U.S. bonds, however, ticked down on losses in long-term U.S. Treasuries, where investors may have been reacting to hints of stronger-than-expected economic growth.

Fed inaction buoys markets: While the U.S. Fed said it would leave its benchmark interest rate unchanged in a range of 0.25–0.50%, or 25–50 basis points, the Fed also highlighted strength in economic activity and the labor market, suggesting that a near-term rate hike is firmly on the table. Equity markets moved higher on news of the Fed’s decision to hold steady.

OPEC to cut production—maybe: For the first time in eight years, the Organization of the Petroleum Exporting Countries (OPEC) agreed in September to consider a cut in oil production, spurring a rally in oil and energy investments. Just a day or two later, however, skepticism prevailed, and oil retreated as investors realized no definitive agreement had yet been reached. (OPEC will revisit the matter in November.) In spite of all the drama, oil closed sharply higher for the month.

Clinton/Trump vs. the markets: While most markets ended higher in September, volatility also increased. A lot of this may be due to anxiety among investors over this year’s unusual presidential election. In this special edition of our regular monthly commentary, we’ll consider how investors may position themselves to weather election-related volatility. Plus, while we caution against making sweeping investment changes ahead of the election, we’ll offer ideas on how various asset classes may be impacted by either a Clinton or Trump presidency.

major asset class trailing returns graph as of 9/30/16 test

Domestic Equities

U.S. equities were slightly higher in September, though in the case of large caps, just barely.

The large-cap-oriented S&P 500® inched up 0.02% for the month—for a year-to-date gain of 7.84%. The advance in U.S. small caps was somewhat more pronounced, as the Russell 2000 Index gained 1.11% in September, and 11.46% year to date.

But how did individual sectors perform? Let’s take a look. Based on the S&P 500 sector indexes, September’s strongest sectors were energy, IT, and utilities (the first benefiting, in part, by the OPEC news). Financials were the worst performers, pressured lower by a number of concerns, including the Fed’s interest rate decision, a sharp sell-off in Deutsche Bank shares, and the start of an ongoing investigation into sales practices at Wells Fargo. Year to date, energy, telecom, and utilities have been the strongest performers, while health care, financials, and consumer discretionary have been soft.

According to the Russell 3000 Growth and Value Indexes, growth stocks were modest outperformers in September, though year to date, value is still significantly ahead.

The election and domestic equities

There’s been a lot of discussion lately about how this year’s election may affect the U.S. market as a whole, as well as individual sectors. Here’s our take.

If Clinton wins:

  • A push to reduce reliance on fossil fuels could boost alternative energy companies while putting pressure on traditional oil- and gas-based ventures.
  • Certain health care companies could benefit from Clinton’s commitment to refining or expanding the Affordable Care Act of 2010.
  • Clinton’s advocacy of various new regulations could pose challenges for certain sectors and industries—for example, financials and pharmaceuticals, the latter of which could be affected by her stated desire to curb drug costs.
  • Because Clinton has proposed an increase in corporate taxes, there could be at least slight downward pressure on overall corporate earnings, while a possible increase in taxes on high earners could trigger a shift in corporate dividend policies.

If Trump wins:

  • Biotechnology and financial stocks could benefit from less regulation, including a possible repeal of the Dodd-Frank Act (though Trump has also suggested he’d consider a return of Glass-Steagall).
  • Trump’s America First Energy Plan could expand domestic exploration and production, benefiting traditional domestic energy companies.
  • The potential repeal of the Affordable Care Act (as indicated by Trump’s campaign) could cause volatility in the health care sector, especially for hospital and managed care companies.
  • Reduced corporate and individual taxes, if passed, could support corporate earnings and stoke further demand for dividends.
  • News of Trump’s election could trigger short-term market volatility, as Trump is relatively new to the political scene, and investors may be less certain about how his policies may play out.

Note that stocks in the defense industry could benefit from either a Clinton or Trump presidency, as both candidates have expressed interest in maintaining—or, in Mr. Trump’s case, significantly expanding—investments in the U.S. military.

 

International Equities

International equity markets continued their upward momentum in September. Investors shrugged off talk of a real estate bubble in China, and cheered as the Bank of Japan vowed to keep 10-year interest rates steady as part of its aggressive fight against deflation.

Once again, emerging markets outperformed in September, making them one of the year’s standout investments. The MSCI Emerging Markets Index finished the month 1.29% higher—and is now up 16.02% for the year so far. Developed markets weren’t far behind, though, as the MSCI EAFE Index advanced 1.23% in September—for a modest year-to-date gain of 1.73%.

The election and international equities

If Clinton wins:

If elected, Clinton would likely continue to espouse globalism and the U.S. role in the world economy. As a result, U.S. and foreign multinational corporations could benefit.

If Trump wins:

Many of Trump’s campaign proposals have been isolationist in nature, which—if he’s elected—could create challenges for U.S. and foreign multinationals. Currency markets could also be volatile, at least temporarily, as investors weigh how policies under Trump could shift the existing dynamic between countries.

 

Fixed Income

U.S. bonds had another down month in September—though just slightly. The Barclays U.S. Aggregate Index ticked down 0.06%. For the year, however, it’s still securely in positive territory, now up 5.80%.

Among U.S. Treasuries, the yield on the benchmark 10-year note increased 2 basis points in September to 1.60%—and is now down 67 basis points year to date. (A basis point is one one-hundredth of a percent.) The yield curve steepened slightly in response to generally encouraging news about the U.S. economy.

Turning to the U.S. fixed income sectors, high-yield bonds (also known as junk bonds) were the month’s best performers, as investors continued to search for yield. Treasury-Inflation Protected Securities and short-term Treasuries also outperformed. The month’s weakest securities—by far—were long-term Treasuries. On a year-to-date basis, high-yield bonds and long-term Treasuries have been the best performers, while T-bills and short-term Treasuries have lagged. All sectors, however, remain in positive territory for the year.

The election and fixed income securities

Because lower interest rates may minimize government debt payments, it’s unlikely either Clinton or Trump would want to see rates rise significantly from today’s levels. That said, there are some important differences between the candidates.

If Clinton wins:

Clinton has proposed increased infrastructure spending, which, if passed, would expand government debt. Plus, her advocacy of higher taxes on top brackets may benefit municipal bonds, as some wealthy investors may seek to shield earnings.

If Trump wins:

Like Clinton, Trump has also proposed increased infrastructure spending, though his plans are more ambitious (about two-times the size—$275 million over five years). This, too, would increase government debt, and as a result could pressure rates at least slightly higher.

 

The Bottom Line

You may be wondering: Which candidate would be better for investors? As it turns out, from a purely investment perspective, it may not matter all that much in the long run. That’s because there’s little meaningful evidence that markets prefer one political party over the other. Nonpolitical macro factors—things like economic growth, interest rates, inflation, and the pace of innovation—will likely have a much greater impact.

What’s more, investors should keep in mind that the promises politicians make while campaigning are often different from what they actually do once elected. And in the likely event of congressional opposition, it may be hard for either candidate to see his or her campaign promises become reality. As a result, we caution against making investment decisions based on what one may hear on the campaign trail.

So what’s our advice? In short: Stay calm. Take a deep breath and look beyond the moment. As mentioned above, history shows that elections generally have little impact on the market’s long-term returns.

In closing, here are a few general tips to keep you on track through what’s likely to be a highly charged election season:

  • Try not to let your emotions get the best of you. While this may be easier said than done, it’s likely to pay off in the long run. Investment decisions driven by emotion are often ill-advised.
  • Keep expenses in check. Unlike many other factors, this is something within each investor’s direct control. Consider mutual funds or managed investments with lower costs to help keep more of your returns. Plus, when it comes to taxes, be as efficient as possible—for example, by considering municipal bonds or mutual funds, ETFs, and other investments managed with an eye for minimizing tax exposure.
  • Remain diversified and think long term. Maintaining a long-term investment horizon will help investors stay on track for their important financial goals.

 

Thank you for reading.

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management, LLC

 

Additional contributor:

Andrew Cohen, CFA

Director, Investment Strategy

E*TRADE Capital Management, LLC

 

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Mike started his career as a research analyst and an investment manager due diligence analyst for the consulting divisions of several high-profile investment firms. He is a graduate of Middlebury College with a degree in economics.

Andrew Cohen is a Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a B.S. in Finance.