Breathe! We’re going to be just fine…
Breathe! The election is over… and hopefully the hype and hyperbole as well, at least for a while. Election seasons are one of the most volatile and unpredictable time periods that take place on a consistent basis around the world. The 2016 presidential election was no different, with investors wondering, “How should I rebalance my portfolio to protect my investments and take advantage of the election’s effect on the economy?” Believe it or not, I only received 2 inquiries and that’s a very good sign.
Why? We firmly believe that the most beneficial way to invest during this time period is the same as during any other time; with research-backed, factor-based strategies that are broadly diversified across markets, industries and nations. The bottom line is that although it may feel like we should cater our portfolios to presidential elections (or any other big world event), that is not supported by the data: we believe strategic, research-backed investment strategies are still the optimal choice. No one has a crystal ball to see future events and markets are forward looking – when something happens, the market prices in the event and moves on. There are distressed companies, but there no ‘mis-priced’ stocks. You sell your house or car for what the buyer is willing to pay. Stocks work similarly.
The economic impact of elections is difficult to predict due to the implementation lag associated with the transfer of power from one president to the next. Once a candidate wins a presidential election, there is a two-month window before he or she is inaugurated and able to implement policies that can influence the economy. This process often takes a considerable period of time.
Consider this: if you rearrange your portfolio prior to an election, you are essentially betting on a potential candidate to win. Similarly, you are also betting that the policy platform that the candidate is running on will ultimately be enacted into law, and that this will be immediately, or at least in the near term, reflected in the stock price. Investing your money on such uncertainties may result in exposing yourself to significantly higher levels of risk with little to no evidence to support such an investment decision.
The annual returns surrounding past presidential elections going back 80 years, suggest that this is not just theory, but rather a historical trend. If we examine the change in annual returns for the S&P 500 between the year of the election (the incumbent’s final year) and the year directly after the election (the first year the new president is in office) the change in returns is often large, sometimes for the better and other times for the worse. What is interesting about these numbers is that although from election to election they may be very large, the average change between the pre- and post-year election returns has been under 1 percent. This low average highlights that if you are investing for the long run, the best way to handle an election and avoid sustaining a potentially large loss would be to hold your course through the election just as we believe you should in any situation. By utilizing broadly diversified, factor-based portfolios, you may significantly hedge your risk associated with the U.S. election by being exposed to a variety of other nations, markets and investments that will not be nearly as volatile during our election season.
A great real-world example of the implementation, lag and investor psychology in action was the recent Brexit vote. When the news broke that the United Kingdom had in fact voted to exit the European Union (EU), investors across the globe immediately sought shelter from possible exposure to risks created by the UK’s exit. As safety was sought and money was pulled from risky investments, the markets initially dropped significantly. The S&P 500 dropped from a pre-Brexit level of 2113.32 to 2000.54, and the FTSE 100 fell from 6338.1 to 5982.2 over the two trading days following the vote. Just one week later, the markets had fully recovered and were on their way to new all-time highs.
The bottom line: markets are not predicable. When asked if I think the market will go up or down, I always answer ‘Yes!’. Because markets go up and down – ALL the time. There is no ‘bubble’ right now (just read an interesting piece on that – the ‘Bubble guru’ admits he was wrong about his prognostication). Markets also are not linear – if they were, none of us would make any money. Rebalancing back to set allocation targets assures that risk is measured and kept in check. A globally diversified portfolio, done properly, will always be your best ‘bet’ for long term investing success.
And isn’t that what you’re trying to accomplish?