Macro Wrap-Up

Portfolio Politics

Topics - Macroeconomics

${ numberSection } ${ text }
Portfolio Politics

Elections are overrated. This is not a criticism of representative government or a suggestion that you abandon your civic duties. It’s an observation that investors spend too much time thinking about how elections will affect their portfolios. While elections create uncertainty and potential opportunity, timing them is more likely to create frustration and unnecessary transaction costs than excess returns. The first and most obvious problem is that in many years we don’t know who will win. But even a model that could predict the outcome perfectly (in advance) would still be difficult to capitalize on because market reactions to elections are notoriously unpredictable. 1 1 Close Even in retrospect, they can be difficult to evaluate.   As quantitative investors, we take economic theory and try to evaluate its effects on market data. The problem with applying this approach to U.S. Presidential elections is that there isn’t much data. They only happen once every four years. Sure, the U.S. has been holding elections for centuries, but the early ones don’t have much relevance. Can we learn anything about current market reaction from James Polk’s election? Probably not. 2 2 Close If there were a dispute about the Oregon border, it might. 5440 or fight!   It’s equally difficult to apply lessons from elections in other countries. Maybe the FTSE’s reaction to Boris Johnson’s victory can provide some kind of analogy, but it’s unlikely there’s much we can get from Konrad Adenauer’s victory over Kurt Schumacher. 3 3 Close I was trying to think of the most random election and that’s what came to mind.   This gives us very little to work with. 

Many investors look to the 2016 election as a guide, but even four years later that example creates confusion. It was a peculiar case in which many investors got it so wrong that they were able to profit from it. Clinton was favored to win, and many strategists thought the market would react negatively if she lost. You have to wonder how many people did well by buying stocks to bet on a Clinton victory or lost money shorting the market on a contrarian bet that Trump would win. 4 4 Close In fairness, a trader would have had a few hours to get out of either position before the market rallied.   A similar effect occurred in 2012 when some investors bet on a stock market rally on a Romney win. He lost, and the market was up over the next four years.

The challenges in investing on elections go well beyond just the direction of the market. In 2016, one of the biggest perceived differences between the candidates’ economic plans was the use of regulation. Many analysts saw Clinton as championing more rules for businesses while Trump was considered the deregulation candidate. They reasoned that the heavily regulated financial and energy sectors would benefit from his presidency. As we know, those sectors have underperformed despite a significant rollback of rules. Other factors, such as interest rate compression and the collapse of jet fuel and gasoline demand, have overwhelmed those effects. This means that it was possible to get the results of the election and the likely policies correct, and still have the wrong trade.   

This year folks are making all kinds of predictions about the election. They include forecasts on the House and Senate in combination with the Presidency. They draw up complex matrices of outcomes and market reactions. 5 5 Close They look like zoom calls but with numbers in each box.   Then they add another page for a contested result. And despite all of the possibilities, they still can’t agree on what will happen in any individual outcome. The debate seems to center on tax policy and how that will affect markets, but a clear consensus is elusive. Some argue that if Biden wins it will result in higher corporate taxes which will hurt equities. Others are saying that his proposed spending programs will give money to those with higher marginal propensity to consume which will help growth – consistent with what’s occurred in the past two quarters.  

So, what should you do? The answer is not to worry about the election. Or if you do, worry about the direction of the country, but not your portfolio. You can look at the polls and look at your accounts, but not at the same time. 6 6 Close DO NOT USE THE SECOND MONITOR!   There are too many variables in play to make betting on the election a clear strategy for investing. While there is likely to be some volatility on Tuesday and after, it is not worth making wholesale changes to your asset allocation. Doing that would be little better than a coin flip. The same discipline and diversification that it takes to build a good portfolio will still apply after the election regardless of who wins. And besides, we all need one less thing to think about.  


What We Are Watching


U.S. Services PMI (Wednesday)
While both the U.S. and Europe have seen strong rebounds in economic activity from the lows of March and April, some indicators have pointed to divergence in economic trends more recently. In the U.S., a second wave of coronavirus cases over the summer appears to have had little impact on growth, as manufacturing and service sector PMIs have continued to improve. In Europe, however, increased coronavirus prevalence in recent months appears to have weighed on service sector activity, as Services PMIs have dipped down into contractionary territory. The pandemic has worsened in recent weeks across large portions of the U.S., and economists and market participants will be watching this week’s Services PMI data to see if more cautious behavior is starting to impact business activity here as well. Signs of slower recovery in the service sector might be negative for equity markets while providing a boost to Treasuries. 

U.S. Employment Report (Friday)
Despite large monthly job growth figures in the last few employment reports, the U.S. labor market remains in a dire situation. In September, total employment was still down by more than 10 million jobs from pre-pandemic levels, while the unemployment rate remained at 7.9%, up from 3.5% in February. If the worsening public health situation in much of the country causes the labor market rebound to slow down or stall, it would suggest that a large degree of labor market slack may persist for some time. Such a development would likely be negative for risk sentiment until/unless it motivates political leaders to pass additional stimulus measures to alleviate the strain on household finances. 

Reserve Bank of Australia (Monday)
Expectations for RBA easing have been rising in recent weeks on the back of dovish comments from Governor Lowe and Deputy Governor Debelle. While the policy rate appears unlikely to be set at a negative level in the next meeting, a reduction to a slightly positive value could lead to some other money market rates to fall below zero. While the RBA may be comfortable with this scenario, it does introduce uncertainty around the policy mix changes that the RBA would deliver on Monday. Among the options available to the central bank are additional balance sheet expansions, maturity extension of the yield curve control framework, a rate cut, and/or some form of forward guidance. Market participants will monitor closely the RBA’s decision not only for its impact on Australian markets but also as a potential leading indicator for other central bank moves amid weakening Q4 outlook.  

This material has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and AQR Capital Management, LLC (“AQR”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision.

 

Past performance is not a guarantee of future performance.

 

This document is not research and should not be treated as research. This document does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR.

 

The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein. It should not be assumed that the author or AQR will make investment recommendations in the future that are consistent with the views expressed herein, or use any or all of the techniques or methods of analysis described herein in managing client accounts. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only.

 

The information in this document may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.