Regardless of who wins the presidential election, tax rates are likely to increase.
The election in November may prove to be one of the most consequential in modern history. With all of the problems we currently face – the pandemic and resulting economic recession, social unrest and the national discussion on long-festering racial tensions, the decline of U.S. influence on the world stage and many other challenges – voters in November are expected to turn out (or mail in) in record numbers to set our course for the next four years. What might this mean for the stock market?
The Presidential Election Cycle Theory was first proposed by Yale Hirsch, founder of the Stock Trader’s Almanac. Professor Marshall Nickles of Pepperdine University further developed the theory in his paper “Presidential Elections and Stock Market Cycles.” In a nutshell, the theory posits that the back half of a president’s term shows the strongest stock market returns, while years one and two of their term generally experiences weaker returns. Many attribute this phenomenon to the idea that presidents attempt to push through their key policy initiatives in the first two years of their terms, while spending the last two years either campaigning for reelection or becoming a lame duck as their presidency comes to a close. In other words, the first two years of a president’s term bring potentially greater uncertainty to markets as new policy initiatives are enacted. And markets do not like uncertainty.
Although this all makes some sense, this theory is far from perfect. In fact, recent history has shown just the opposite: in each of Obama’s terms, the first two years were most profitable, while under Trump, the market was stronger in his first year than the second, followed by a huge surge in his third year (2019) and then derailed by the global pandemic in his fourth year.
Putting political ideology aside, the history of the Presidential Election Cycle Theory shows that markets tend to perform similarly under Republican and Democratic control. Despite Republicans being considered more “business-friendly,” the data actually shows markets do slightly better when Democrats are in control.
From our perspective, what matters to markets – aside from economic fundamentals, valuations, monetary policy, earnings growth, inflation and investor sentiment – are the actual policy changes that take place during a president’s term. As we look ahead to 2021 and beyond, regardless of who wins the presidential election, it is clear that tax rates (especially U.S. corporate, state and local tax rates) are likely to go up to help finance the massive deficits our government is racking up due to the pandemic. And given our current fiscal situation and a muddled coronavirus response by our government compared to other countries around the world, it isn’t hard to envision a dollar headwind from here.
With that as a backdrop, we believe the next few years could favor foreign stocks and natural resources (which are priced in dollars) over U.S. stocks. Additionally, interest rates are likely to stay low for the foreseeable future, making our real estate asset class a more attractive alternative for income than bonds.
No matter what happens in November, utilizing a multi-asset class approach to investing will continue to provide the opportunity to capitalize on asset classes that perform well, while reducing risk through diversification. Using this discipline consistently over time has proven to be the most successful approach to managing wealth and reducing portfolio risk – and will continue to be – regardless of who occupies the White House.