Oct 18, 2016 The Effect of the Election on Your Portfolio

With the presidential election only a few weeks away, investors may be wondering how their portfolios could be affected by this year’s outcome.

Most Americans have an unfavorable view on the federal government. Only 19% say they can trust the government always or most of the time, among the lowest levels in the past half-century[1]. However, our views on our government shouldn’t affect the way we view our investment portfolios.

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Warren Buffet on Elections

Before we start discussing how investors could be affected by this year’s election, it’s helpful to remember the wise words of Warren Buffet. In this year’s letter to Berkshire Hathaway shareholders he wrote the following:

“It’s an election year, and candidates can’t stop speaking about our country’s problems (which of course, only they can solve). As a result of the negative drumbeat, many Americans now believe that their children will not live as well as they themselves do. That view is dead wrong: The babies being born in America today are the luckiest crop in history.

American GDP per capita is a staggering six times the amount in 1930, the year I was born. All families in my upper middle-class neighborhood regularly enjoy a living standard better than that achieved by John D. Rockefeller Sr. at the time of my birth. His unparalleled fortune couldn’t buy what we now take for granted. Rockefeller certainly had power and fame; he could not, however, live as well as my neighbors now do.

Though the pie to be shared by the next generation will be far larger than today’s, how it will be divided will remain fiercely contentious. Just as is now the case, there will be struggles for the increased output of goods and services between those people in their productive years and retirees, between the healthy and the infirm, between the inheritors and the Horatio Algers, between investors and workers and, in particular, between those with talents that are valued highly by the marketplace and the equally decent hard-working Americans who lack the skills the market prizes. Clashes of that sort have forever been with us – and will forever continue. Congress will be the battlefield; money and votes will be the weapons. Lobbying will remain a growth industry.

The good news, however, is that even members of the “losing” sides will almost certainly enjoy – as they should – far more goods and services in the future than they have in the past. The quality of their increased bounty will also dramatically improve. Nothing rivals the market system in producing what people want – nor, even more so, in delivering what people don’t yet know they want. My parents, when young, could not envision a television set, nor did I, in my 50s, think I needed a personal computer. Both products, once people saw what they could do, quickly revolutionized their lives. I now spend ten hours a week playing bridge online. And, as I write this letter, “search” is invaluable to me. (I’m not ready for Tinder, however.) For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs. America’s social security promises will be honored and perhaps made more generous. And, yes, America’s kids will live far better than their parents did”.[2]

How do Presidential Elections affect my portfolio?

The answer – based on decades of historical data – is that presidential elections typically don’t have a long-term effect on market performance. However, elections can have a short-term effect on markets mainly because markets don’t like uncertainty. Stock market volatility tends to spike in a presidential election year but then dissipates shortly afterwards, returning to more normal levels once the uncertainty is gone.[3] So far this year, volatility hasn’t exceeded normal levels for a presidential election year.

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Election years have on average generated positive returns and are positive 68% of the time.[4] Stocks can certainly go down before or after a presidential election but we don’t recommend altering your allocation based on politics.

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Many readers may want to credit or blame the president for stock market performance, but the truth is that their policies have little impact on stock market returns. Ultimately fundamentals – not elections – are the more important drivers of asset prices. Valuations, the health of corporate balance sheets, the level of interest rates, technology, demographics and the economy are some of the more important influences on market behavior.

For example, the four worst bear markets in history (1929-32, 1973-74, 2000-02 and 2007-09) all occurred mostly under Republican presidencies. This could be due to the relatively high valuations making returns expectations lower.[5] Valuations in the U.S. stock market are high once again, which means the next president is likely to inherit one of the highest starting valuations in history. Historically, that has meant below average returns going forward, regardless if it’s a Democrat or Republican.

Can market data tell us anything useful about who will win?

Looking over the last 22 election cycles (since 1928), in the three months leading up to the election, a rising stock market accurately predicted a victory by the incumbent party’s candidate, while a down market predicted a victory by the challenger party in 86% of all observations[6].

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In addition, the strength of the economy has been a big determinant of whether the incumbent party has won or lost. The economy has been in a recession on Election Day or within one year of Election Day nine times since 1900. Of those nine times, eight times the incumbent party lost. The only time this didn’t occur was in 1948, when Harry Truman was elected. Furthermore, when the economy was not in recession or soon to be in a recession, the odds of the incumbent party retaining control of the White House has been 85%[7].

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2016 Nominees

In this election cycle, the prospect of a Trump victory represents the more uncertain outcome for markets because of the uncertainty about his final policy proposals, some of his extreme rhetoric and the fact that the probability of his proposals actually happening vary widely. His tough rhetoric on trade relations with Mexico and China could have negative economic implications. A possible trade war with China could be negative for economic growth in China, which could have ripple effects throughout the Asia-Pacific region. He has also proposed to lower tax rates (see graph below[8]), including the capital gains rate. This could be market friendly in the short term. He also says he want to roll back financial regulations that were put into place after the financial crisis.

If Clinton wins, there would likely be little change in the direction of current policy. She wants to raise taxes, including the capital gains rate, and further regulate the financial industry. We might also see some corporate tax reform involving lower rates and fewer loopholes.

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Regardless of who wins, investors should remember that Congress will likely act to muffle the impact of either president’s proposals. Congress has often proven to be a useful buffer between the president’s aspirations and the economy. Our political system is defined by the separation of powers (executive, legislative and judicial) which ensures that checks and balances are applied and that no individual leader or party can wield autonomous power. This means that proposals for key policy changes that would impact investment strategy – such as tax reform, trade protectionism and fiscal stimulus – are likely to be worries rather than catalysts.

Conclusion

If you are worried about a particularly party winning, it important to remember that we don’t invest in presidents or governments, but corporations. Our system of divided government helps ensure that no one leader consolidates all power. Regardless of who wins, short-term developments are less important to your investment success than the big picture trends that will shape markets in the years ahead. So while we will be paying attention to the news, we will also continue to make sure that your portfolio is well diversified, that your investment costs are kept low and that you are on your best path forward.

 

Disclosures

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Past performance is no guarantee of future results. Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any particular strategy or investment will prove profitable.   As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.

Stock investing includes numerous specific risks including the fluctuations of dividend, loss of principal, and potential illiquidity of the investment in a falling market. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. This newsletter should not be regarded as a complete analysis of the subjects discussed.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy.

The fast price swings in commodities and currencies can result in significant volatility in an investor’s holdings.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.

For additional information about LRIA, including fees and services, send for our disclosure statement as set forth on Form ADV using our contact information below. Please read the disclosure statement carefully before you invest or send money.

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(800)-627-4340

 

INDEX DEFINITON

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

[1] Pew Research Center, Beyond Distrust: How Americans View Their Government, 11/23/15

[2] www.berkshirehathaway.com/letters

[3] Vanguard, based on data from Thomson Reuters, 2016.

[4] Ned Davis Research, based on data from S&P Dow Jones Indices

[5] Pension Partners: Presidents, Cape Ratios and Stock Market Returns, 8/5/2016

[6] JPMorgan: Market Insights, 9/9/2016

[7] Ned Davis Research

[8] Morgan Stanley Research. Shows the highest marginal rate for capital gains under each plan.

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Important Disclosures

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein and take no responsibility therefore.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.

For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.