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Playing the Election: What to do in Your Portfolio
🕑 Added 2020-09-08 01:35:39 +0000 UTCThe Hot Items
The 2020 election is the big catalyst remaining this year. Rightfully, people have reached out a number of times asking how to adjust their portfolios accordingly. This post will discuss what moves I am making, and what I am watching for.
The first thing I want to say is this: do not let your politics get in the way of your investments. We need to look at the election as investors, not as people, at least for our purposes here.
And since I know the question will come up, I'll state that the investor in me wants Trump to win, but the rest of me prefers Biden. Trump has made me substantially richer with his policies and tax cuts, but I don't think he's done anything great for most of the country at large. On the other hand, there is really nothing electrifying at all about Biden. It's not quite time to vote yet, so I have some time to change my mind. But if the election were today, I'd probably vote for Biden, but I would do so without enthusiasm.
With that out of the way, let's talk money.
tl;dr Trump is probably better for the market, at least in the immediate term. Congress is more important to policy than the president. Democrats in office outperform Republicans in terms of equities, but much of this can be attributed to George Bush Jr. having a rough go. JPow and the Fed's fate under a new administration is the most significant variable. Overall, the election will have a smaller effect on the market than you probably think. My specific portfolio expectations are at the very bottom.
What We Know
This section will hit a few important points to frame our assessment:
1) Stability: The market prefers stability. People are much more comfortable investing when they know the prevailing market conditions and there are no threatening catalysts ahead of us. We don't even need the best economy to have a strong market; we just need to know what we are getting.
2) Taxes: The market likes low corporate taxes, and corporations have been able to take advantage of lower taxes for the last several years which either boosted their net profits, boost dividends, run share buybacks, etc. Taxes do not affect EBITDA, obviously, but net profit is what allows companies to give back to shareholders. The House will quarterback tax changes more so than the president.
3) Partisan Performance: Democratic presidents have presided over stronger S&P 500 performances than Republicans, which seems counter-intuitive. The spread tightens to within any reasonable margin of error when you factor out an unlucky Republican.
Expectation Management
The election has many investors shaken, and I think that is because there are a lot of new investors who got started with Robinhood after 2016 and so have not traded stocks during an election before. Therefore, let's manage our expectations a little bit.
Overall Impact: By and large, the presidential elections in the post Great Depression era have had a lesser impact on markets than we think. Headlines and fears are the real drivers of post-election market moves, not immediate policy changes. After all, the president-elect doesn't even assume office until mid-January.
Biden's Politics: Biden is pretty centrist, and Harris is only slightly center-left despite Trump's accusations. Any real radical leftist policies are likely to originate in the Congress, not in the White House. Therefore, we needn't fear Biden assuming control of the presidency and declaring the Dow cancelled.
Congress: And let's not forget, the White House isn't the only political office having elections. We've got 435 elections in the House of Representatives and 35 elections in the Senate. Remember that when it comes to economic policy, Congress has more power than the president. The president has nearly universal control over the military, but when it comes to economic policy, the president is boxed into the bills promoted by Congress unless it can be framed as a national emergency, such as with Trump's tariffs.
As a result of the above, we must be mindful not only of Trump vs Biden, but also of the Congressional elections. Congress is where we are more likely to see radical, market-moving policies originate.
The House of Representatives 2020 status and race. Democrats currently hold majority and Republicans need to swing 20 seats to take control.
Where Policies Differ, and Where it Matters
Let's get into the meat and potatoes of this article: where do Trump and Biden differ, and where does it matter to us? What should we do as investors to prepare for either outcome?
1) Taxes: We know that Joe Biden intends to push for increasing the corporate tax rate to 28% from its current level of 21%. This is still lower than the 35% rate in 2016, but the fact remains that any Democratic-led increase in taxes will indeed affect corporate profits. And given that we are in a recession, I think the market will be particularly opposed to tax increases.
But let's keep in mind that the president can't increase taxes with the stroke of a pen. The president can push an agenda, but all taxation bills must originate in the House of Representatives. After the House pushes a bill, the Senate gets a vote, and then finally the president can sign the bill into law. Therefore when it comes to tax, don't expect that on January 20, 2021 taxes will suddenly increase.
All tax bills must originate in the House of Representatives. Therefore, it will pay to be mindful of who takes control of the House. Although Democrats have the majority incumbents, all 435 seats are up for grabs, so this is anyone's game. If Democrats do retain control of the House, pick up a majority in the Senate, and also win the White House, I think we are indeed looking at a situation in which increased corporate tax gets passed. And if that happens, I think the market will react negatively and cause companies to scale down future buybacks. And of course, that is bad for stocks. If Democrats sweep all the branches, look for a market correction in anticipation of increased corporate taxes.
2) Weed: Weed stocks like CGC and ACB will always be the wrong way to invest in weed stocks, in my opinion. And remember TLRY? It's a gamble. The best way to invest in weed is to buy an ETF like MJ, which holds many weed companies. That way, you don't have to pick a winner; your ETF will already have the winner in it, and you can benefit from industry-wide gains.
Going into the election, weed is a speculative investment. Further if you look at Biden and Harris' stance on marijuana legalization, you'll find a complicated past. Harris prosecuted people for possession of marijuana, some of whom ended up jailed. But now she is a senator in CA, which has pretty loose laws on cannabis. She also claims she would like to see decriminalized marijuana. In fact, in 2017, 2018, and 2019, she sponsored bills that would have been good for the weed industry, including a bill that would have moved cannabis off the controlled substances list. And Biden, of course, was Vice President when a large number of states passed decriminalization without contestation from the federal government.
And yet on the other hand, Biden is not a strong proponent of weed legalization, wrote bills that were very punitive to cannabis users when he was a senator, and said AT MOST he'd be interested in decriminalization.
So will a Biden/Harris victory send marijuana stocks up, given that mixed track record? I think it will. Despite the claims that Harris is all about jailing people, she seems to have come around to weed in recent years, and I don't think Biden has any intent to step in the way of states legalizing weed. There are more bills than I can count to diminish the criminal status of weed on ballots in 2020, and there are 5 states that are voting to legalize it altogether: AZ, FL, NJ, NM, and NY. AZ struck it down in 2016, but I don't see that happening twice, and I think the bigger states like NY and FL will certainly legalize it.
Also, congress is holding sessions in January that would decide if marijuana should be totally taken off the controlled substances list. If congress swings Democratic, I can certainly see that passing. I think a lot of states will legalize, and Harris and Biden are not stepping in to stop it. If congress goes Democratic, LEAPS on MJ. If Congress swings Republican, I think weed stocks keep doing what they're doing now- just wallowing without the congressional backing to make the weed industry something worthwhile.
3) Performance: Despite any arguments on weed investments or tax policy, we want an answer to our real question- what will happen to SPY post-election.
One thing in which I am confident is that if Trump wins reelection, the market will go up in the near-term. The market likes certainty. We know what we are getting with Trump, and therefore a Trump victory is a green light for equities.
Biden is more complicated. Markets generally do not like when challengers win, and even the non-incumbent party winning can rattle markets because it creates uncertainty, and thus volatility. However, this does not mean a Biden victory will shake down markets.
Fact is, equities return an average of 11% annualized under Democratic presidents vs 7% under Republicans, so we already are not seeing a massive disparity. And when you factor out George W. Bush both starting and ending his presidency with a recession, then the spread tightens further to the point at which one could argue there is no correlation.
Headlines can move markets based on which president wins, as we saw when Trump won in 2016 and the Dow dropped 1,000 points overnight. But markets bounced back quickly and flew higher all through 2017. People who let their personal views of a politician affect their investments underestimated the power of American capitalism and certainly missed out on a large rally. In short, expect any post-election sell-offs to be short lived, and expect markets to stabilize in the year following the election.
4) Fate of the Fed: Here is the biggest threat I see to markets post-election: Republicans become hawkish on the national debt and budget again in 2021. Republicans have been quiet on debt, trade, and budgeting for the last several years, but that is because Republicans have a majority all federal government seats except the House. If Biden wins, I can almost guarantee that Republicans will become hawkish again, and if that pressure causes a stonewalling in Congress, Biden and the Fed may experience enough to force them to turn off JPow's printers.
If that happens, what happens to the market? The Fed buying bonds from blue-chip to junk-caliber is tremendous for funding this economic recovery. I personally believe JPow will be remembered as the hero who prevented economic collapse, and I have no doubt that he has inspired confidence in the markets by demonstrating the Fed has our backs. If Republicans get hawkish and those printers stop humming, I see us losing momentum. And if JPow cuts those printers or takes the Fed out of the repo market, I see things melting off. If that happens, buy Put LEAPS.
Who Will Win?
The best question of all: Will Biden take the White House, and will Democrats sweep Congress? Or will the Republicans pull another upset and actually grab seats in Congress while retaining the presidency?
Here are the thoughts of Maria Paola Toschi. I have no idea who she is, but she said something interesting: Since 1932, an incumbent US president has never failed to win reelection unless a recession has occurred during his time in office.
This forces us to recognize that the economy likely controls our political elections more than any other factor. But specifically, we must ask ourselves if the 2020 recession is a real recession. Clearly, the market doesn't think so, as we had a month-long selloff followed by the fastest recovery ever.
And pair that with this: According to Dan Clifton of Strategas Research Partners, "If stocks are higher in the 3-month period before the election than they were at the beginning of the year, the incumbent party generally tends to win. If they are lower, it's the opposition that tends to take the White House."
It is looking pretty certain that stocks will be up in 2020, so if we are playing the odds, the recession is cancelled and stocks being up clears the way to Donald Trump's reelection. My bet is the the great Mango wins reelection and stocks go up.
If I am wrong, and Biden wins, I expect stocks to sell off through November and December, and then begin rising again around Christmas. I would plan on buying LEAPS on SPY and QQQ following a Biden-led selloff, because there is very little about Democratic-held White Houses that makes me think he's actually a danger to the stock market. It's all hype. Stocks do just fine under Democrats, and even if Biden's S&P does underperform, it's still almost certain to be up in the long term.
My Moves:
Trump wins: Buy equities and bullish options to continue the same strategy I pursued since 2017. Do not anticipate any significant market-shaking events. Same is true if Republicans sweep Congress.
Biden Wins: Anticipate a market sell-off until Christmas, and then markets recover through the following year. Buy more equities and bullish options in early 2021.
Democrats sweep Congress: Anticipate a slower recovery as corporations get hit with higher tax. If Republicans get hawkish enough to force the Fed to scale back its bond and treasury purchasing arrangements, expect a significant pullback in equities in anticipation of slowing economic expansion. LEAPS on MJ.
JPow Resigns: Puts.
