With the election fast approaching, the tension in the United States is palpable. Markets are reflecting some of this apprehension as deposits to money market funds have risen substantially, gold and Bitcoin are hitting new highs, and a measure of impending volatility (the VIX Index, also known as the “fear index”) is increasing. Everyone is waiting for an election that appears razor tight, and may not be resolved on election night, or for months afterward if certain scenarios unfold. We are making no prediction about this election, as we have no clue as to what voters may decide on the Presidential race, the key Senate battles, or numerous, hotly contested races for the U.S. House. But we will outline the electoral strategies of the major parties and likely investor reaction to possible outcomes.
The two major parties are largely focused on turning out their own base voters, while furiously picking at the weak seams in the opposition’s coalition. The Democratic Party has tried to expand its coalition by welcoming disaffected Republicans, exemplified by Liz Cheney and many former staff members of the Trump administration. How many suburban women, and men, who may have recently voted Republican will follow their lead is anyone’s guess. The Democrats feel that stressing the rule of law and respect for democracy will win over some of these voters as it did with Liz Cheney. And they believe that others may be attracted to the Party’s strong stance on women’s rights and protecting the rights of marginalized, minority groups. It doesn’t hurt that most of these persuadable Republicans and Independents are doing well financially in a period of high home values, record stock prices, and high interest rates on bonds and money market funds.
The Republican Party senses that there are quite a few vulnerabilities to exploit in the Democratic coalition. Republicans have been hammering on the inflation rate of 2021-2023 in an attempt to peel off some lower income voters, including younger men of color who come from traditionally Democratic families. This demographic is less likely to own a home or stocks and bonds, so the buoyant state of asset prices holds no interest for them, maybe just resentment. They may have jobs where wage increases have not kept up with the rising costs of food, cars, and rent. The Democrats have done a poor job of explaining that inflation comes with a lag effect measured in years. The seeds of inflation were planted in 2020 when governments throughout the world rapidly poured funds into their economies to fight the War on Covid. While the financial markets have been celebrating the successful inflation-fighting efforts of the Biden Administration and the Federal Reserve, consumers harbor anger over the price rise that occurred on Biden’s watch. A populace that doesn’t understand economic lag effects will often assign blame or give credit to the wrong party. In addition to inflation, twelve months of conflict in the Middle East has created fissures in the Democratic Party. Looking to exploit these divisions, Donald Trump recently appeared on stage with the Arab-American mayor of Dearborn, Michigan, once a Democratic stronghold.
Individual investors have electoral preferences and their emotions are running high, but markets in the aggregate are cold and calculating when measuring political impact. Markets have done well for the past two years of the Biden-Harris term. Business leaders and shareholders of businesses prefer to operate under a system of laws and policies that are fairly predictable. Kamala Harris has been part of an administration that telegraphed its moves and did nothing to alarm or confuse the business community. There is every reason to believe that the markets would be content with a Harris victory and a continuation of known, favorable policies. The re-election of Donald Trump could be another matter, as his tariff proposals have no recent precedent. At a recent rally he said that all income taxes could be abolished and replaced by trillions of dollars in annual tariff revenue paid to the U.S. by other countries. It sounds good on the stump, may even pick up a few votes, but there is a reason why this hasn’t been the funding policy of the United States since the 19th century.
The markets did not react negatively when Trump was President, and they are not reacting negatively to the possibility of a second Trump term, mostly because investors ignore much of what he says and proposes. The big, beautiful health care plan that he was dreaming up to replace the Affordable Care Act (Obamacare) never made it out of his mind, and he doesn’t talk about it anymore. The idea that Mexico would pay for a wall never happened, and Trump doesn’t pitch that anymore either. He did push some tariffs through in his term, but even those were watered down. The Trump tariffs specifically exempted most products that Americans care about, such as cell phones. It would seem that Trump always accedes to power, whether it be powerful companies such as Apple, or leaders such as Putin. If that holds true then he becomes predictable, and the markets like predictable. But if reports that he was blocked by his staff or the military on hundreds of occasions are correct, then who knows what he might try to do unchecked by a more pliant staff, particularly given his advancing years. That prospect, in time, could put some fear into the markets should he be re-elected.
Current Strategy
The stock market continued to push higher in the third quarter, helped by the first interest rate cut at the Federal Reserve and encouraging economic data. A year ago, there was considerable debate over whether the economy would suffer a soft landing or an all-out recession. But employment remains healthy, consumer spending has held up, and inflation is subsiding. The stock market reflects this positive news flow, and encouragingly, the breadth of the market rally has increased in the last quarter. When we wrote our update in the summer, the market was thinly supported by a few giant tech stocks, while most stock prices languished. Since then stocks across a variety of industries have picked up ground. It has become a little easier for all investors, not just tech investors, to make money in this market.
Many of the investments we hold have performed well during this expanding rally, and we took some profits during the quarter. Opportunities for buying still exist, and we have bought into some new investments for many clients. But our enthusiasm for new purchases is balanced by the knowledge that little is given away cheaply in highly optimistic markets. Put another way, investors should be careful with stocks that look like “deals” as markets set all-time highs. The overall position we maintain continues to be cautiously balanced across bonds, stocks and cash for most clients.
The bond market rallied in the wake of the interest rate cut from the Federal Reserve in September. Bonds of all maturity lengths rose, but in the weeks since the bond market has exhibited notable caution, even concern. Some of this stems from language out of the Federal Reserve indicating that they are going to move slowly, meaning that the bond market may have gotten a little ahead of itself. But also, there are significant ramifications for long bond investors around the upcoming election. Neither candidate presents themselves as a deficit hawk, but independent analyses estimate far more debt being added by Trump’s proposed policies. Longer-dated Treasury bonds, the investment perhaps most sensitive to the U.S. structural deficits and growing debt burden, have weakened as Trump’s election chances have improved. We will consider shorter-term treasuries at attractive yields, but will avoid longer-dated treasuries until the election has concluded.
