As November 3rd draws nearer, the election looms larger in the minds of all investors. Recently, one of my clients and a friend of his brought a question to me. It might be similar to thoughts that you or some of your friends may be having, and I hoped it would be a benefit to share my reply. Please let me know if you'd like to discuss further!
Best regards, Frank
Thank you very much for bringing your friend's question to me. Recently, it has become a common sentiment, and it is perfectly understandable why that is so. Your friend's statement was: "I am considering moving more to a neutral position until after the election."
I think that this idea can be separated into two components, and that each deserves to be addressed on its own:
- "Moving to a more neutral position", and
- "After the Election"
I'd like to begin with the second part, which is the relevance of November's election. Acadium is monitoring the range of potential outcomes and the shifting sentiment concerning the election very closely. Back in early August - which seems like a year ago the way this year is going - I touched on this aspect of the question in an article called ""Investing and the 2020 Presidential Election." I wrote then that "neither party in power nor policy have predictive potential in portfolio planning". Looking through history, there is zero correlation between stock or bond returns in the United States or abroad and the party or politician occupying the White House. Regardless of the election or its outcome, companies continue to find ways to make money, and the market exhibits a long-term growth rate that is relatively unperturbed by elections or regime changes.
This is true because the President of the United States is only one among innumerable variables that influence market prices on a daily basis, along with the leaders of other countries, what companies are doing, natural resources, supply and demand, et cetera ad infinitum.
What is unfortunately happening now is that the media political machine is on full volume, creating a distortion field in which the outcome of the election appears to be far (far, far, far..) more relevant to market returns than it actually is. This is a deliberate, perennial attention-hacking process that is impossible to totally insulate yourself from, especially in a year like 2020. Every time I hear the word "unprecedented" now, it makes me want to bang my head on my desk! Of course this election is significant and, dare I say, unprecedented (::bang::); as was the last election. And the one before that as well. If you look back at the administrations listed in the article linked above, you will see nothing but elections of immense importance and impact.
We are also living in the age of social media, which serves to amplify the noise to levels never before seen. The key is to not allow the media, whether social or mainstream, to deprive you of the one advantage that a successful investor can have: perspective.
I'll turn now to the second component of the question, which is whether to move to a "more neutralposition". Presumably, this means making a change to a portfolio asset allocation that has less stocks in anticipation of heightened market volatility stemming from the election this November. There are several problems with doing this:
1. What would we move to? Interest rates are historically low, so cash and bonds are poor alternatives if the goal is growth. This is really the ransaction being proposed, and moving to a more neutral position is a more sophisticated way of saying "I prefer cash over equities." As I'll discuss, this is not our view.
2. When would we move back? It is tempting to answer that we would move back into equities after the election, even though we have no reason to assume that markets will be less unpredictablethen than they are now. Just as we traded Chinese tariffs for COVID and COVID for the election,
there will be something else that arises. We will never get an "all clear" signal. It's always something. Assuming a portfolio is properly diversified and appropriately allocated for the investor, the long-term outcome of moving between stocks and cash is overwhelmingly likely to be inferior to the long-term outcome of doing nothing and relying on the portfolio structure and capitalism to carry you through even before you factor in trading costs and taxes.
The most important issue is:
3. What if we are wrong? This is always a profoundly troubling question on its own, but I offer the following two charts to make it even more troubling in this context:
The first chart1 shows every daily return of the S&P500 going back to January 1970. There is an immense amount of noisy data in this chart, but one of the things that jumps out to me is that the up and down days are like the mirror image of trees in a lake. What this illustrates is that volatility goes up as well as down, and that the best days occur during the most volatile times.
1Daily closing values are not adjusted for dividends. Source: S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results.
This second chart2 shows what happens to an investor's long-term returns if we exclude the handful of the biggest return days over the past three decades. Again, these days occurred during the most volatile times! The lesson here is that trying to avoid volatility by timing the market makes it nearly unavoidable that you will critically injure your returns.
Regardless of party affiliation, it seems to me that everyone is anticipating some kind of controversy or dispute following the election. This is the seed of worry about market prices in the conversations I have had. I haven't actually spoken to any person recently who thinks that the election will be fair and that the results will be accepted by the losing party, or that we won't have a period of recounts at the very least. If everyone feels this way, isn't it obvious that this sentiment in aggregate should already be incorporated into market prices?
Furthermore, what if we are wrong? What if the losing party accepts the results of the election as they stand on election night and concedes, as Clinton did in 2016 despite winning the popular vote? How do you think the stock market would react to such an outcome this year? How might cash or bonds perform on the same outcome?
The biggest problem with reducing equity exposure at any time is that it reduces your exposure to good surprises, which tend to occur when it appears least likely. Black swans are good more often than they're bad!
I understand where your friend is coming from, and I would be lying if I said that I never felt the same way, about this election or any other uncertain thing. I would love to be able to pull assets to the side, wait for the coast to clear, and then reinvest at the bottom. However, we don't live in a world that goes from crisis to calm. We live – and must find a way to prosper – in a world of perpetual uncertainty. Add the media to this and the carousel from one crisis to the next becomes inevitable.
One of the most important differences between successful and unsuccessful investors is patience. The price that we pay for excellent long-term returns is having to endure the uncertainty of short-term returns. As my partner Lindsey Hansen, Financial Advisor RJFS said earlier today: "Investment wisdom begins with the realization that long-term returns are the only ones that matter."
Many investors will succumb to the media noise machine over the next few months. I hope that this helps your friend avoid joining their number, and instead allows him or her to benefit from any unpredictable good surprises that are coming. Let me know if there is anything else that you need.
Frank Hujsa, CFP®, CLU®
Partner, Acadium Financial Partners
Financial Advisor, RJFS
Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Acadium Financial Partners is not a registered broker/dealer and is independent of Raymond James Financial Services.
Any opinions are those of Frank Hujsa are not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.
Past performance does not guarantee future results. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.
2In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. "One-Month US T- Bills" is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.