Investment Tips
12/11/2020
Morningstar Views: How We Deal With Political Leaders as Investors

Key Takeaways:

 × Our answer to political instability is often simple … manage risks, stay informed and—if in doubt—stay the course.

× That doesn't mean that offering a steady hand is simple, but we strive to stick to our principled approach to disciplined buying and selling.

× We should not discount the risk of further market turbulence. If this happens, it may create buying opportunities that could add meaningfully to returns in the future.

Political Events and Investing

It should not be controversial to say that this election cycle was unusual. Here are just a few unique factors: COVID-19, economic loss, polarizing political views/policies, related health concerns, and now legal battles. As a result, investors have been quick to link the election result with investment failure or success. That is, we believe in the power of a leader, including their ability to impact business. But the link is not always so straight forward, as we’re about to find out.

Chief among the many problems related to political forecasting is the temptation to react too quickly or with too much confidence at the time of major trigger points. Whether that be the COVID-19 pathway or trade talks with China, it is important to identify the difference between political developments and investment impact.

To do this, we can be grounded by two key questions:

  • Are long-term asset class returns likely to be much different given the unique nature of the election?
  • Should we behave differently, as investors in this environment, to deal with any future uncertainty?

In our mind, the answer is that we are unusual times, where there are a wide range of outcomes; potentially wider than in the past. This is motivating for our team, as we understand our clients need a steady hand.

The Problem Most Investors Face

Perhaps the biggest challenge for those making investment decisions post-election is that you must get two things right: 1) you must guess the outcome of the next political developments, and 2) you must guess the market participant reaction to that outcome. We’d caution that this is extremely difficult way to obtain returns. To illustrate this point, consider expert insights on what markets would do following two recent political events, the election of Donald Trump in 2016 and the approval of the Brexit referendum.

U.S. Election Predictions (U.S. stocks rallied 2.22% on the day after the election and around 9% in the three months following)

We would expect a small global stock market rally if Clinton wins (about 2%) and a large decline if Trump wins (about 10%) —Eric Zitzewitz, professor of economics at Dartmouth College

The S&P 500 will fall by 3% to 5% immediately if Trump is elected —Tobias Levkovich, Citigroup's chief U.S. equity analyst

If investors are wrong and Trump wins, we should expect a big markdown in expected future earnings for a wide range of stocks—and a likely crash in the broader market —Simon Johnson, professor at MIT Sloan School of Management and former chief economist of the International Monetary Fund

Brexit Referendum Predictions (U.K. stocks fell 3.15% the day after the referendum but gained around 13% in the six months following. Economic growth also continued to rise, albeit slowly, until COVID-19).

A vote to leave would tip our economy into a yearlong recession with at least 500,000 U.K. jobs lost —George Osborne, former chancellor of the exchequer under Prime Minister David Cameron

Leaving Europe would tip the country into recession —David Cameron, former prime minister

Brexit would trigger recession —IMF forecasts for Q3 2016 that predicted -0.3% GDP growth

 

Keep in mind these errant predictions were made from intelligent, determined and informed individuals. They aren't the first to get short-term predictions wrong and certainly won't be the last. If nothing else, this help us to remember that political uncertainty is nothing new. As always, we must choose research over reaction and urge individuals to stick to their financial plans made at calmer times.

Political biases aside, it is always easy to build an ugly bear case for the election implications—no matter which scenario you look at—and therefore it is important to balance longer term sources of return that derive primarily from the pessimism of investors with the realization that in the short term, pessimism may increase leading to lower asset prices and consequently better investment opportunities.

It is for this reason that we take a diversified approach when managing money for clients. We don’t go “all in” on a given outcome, because we can mitigate the risks by spreading an investor’s eggs across multiple baskets representing our expectation of superior returns in a variety of outcomes. While some of these scenarios may be directly impacted by the outcome of the election, such as US government bonds, the returns of others will be determined by entirely separate factors, such as Korean equities and European financial companies. 

Last, we leave you with a few key points.

× Remember, the answer to political instability is often simple… manage risks, stay informed and—if in doubt—stay the course.

× Any turbulence in markets may create great opportunities to purchase assets that will add meaningfully to returns in the future. We are not there yet, but we should look at this opportunistically.

 


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