For investment management, the election outcome doesn’t really matter, but other market data has led to some significant portfolio changes.
Emotional storms are rocking the country post-election and strong feelings are being expressed across the political spectrum. We at CWM have no interest in trying to argue for one political side or the other, but we do need to consider how election outcomes might affect future portfolio performance. While history never repeats itself, it frequently rhymes, and can give us some potential context and understanding of current events.
As stated in CWM post-election alert, history shows us that markets, since 1853, have grown an average of 11% per year regardless of which party the presidency belongs to.
Source: Lemco, J. (October 6th, 2016). Election: Markets are nonpartisan long term. Vanguard.
Congress is an equally important part of the government and the party control there can produce significantly different legislation and regulatory rules. Based on a limited sample size, history shows us that markets have been strongest under Republican control and weakest during periods of a Democratic controlled congress, regardless of Whitehouse control.
Source: Market Know-How. (Q2 2016). Goldman Sachs Asset Management
Though the above chart would seem to suggest Republican policy making is somehow economically superior to that of the Democrats, at least as far as stock market outcomes are concerned, this is not necessarily the case. All that can really be garnered from the above is correlation, meaning it just happened to be that markets have been stronger during times with a Republican majority congress, but that performance cannot be directly attributed to any legislative change by one party or the other. The old saying that, “correlation is not causation” aptly applies to the above data.
When examined further, it has been found that there is a very weak statistical relationship between market outcomes and party control (see the graphic below). What this represents is that while strong markets have been correlated with Republican congressional control, there is very little statistical evidence to support that these strong markets are caused by that party control. Again, correlation is not necessarily reflective of causation.
Source: Market Know-How. (Q2 2016). Goldman Sachs Asset Management
Party control of congress and the Whitehouse seem to have very little influence on investment market outcomes and are of little consequence to investment management. Considering today’s polarized political climate, the worst since the early 1900s, it is probably a good thing that future market growth is not dependent on government actually accomplishing anything. My best guess at this point, subject to drastic change with new data, is the next four years are going to look a lot like the last four years where nothing gets done legislatively (perhaps a good thing?) because of partisan bickering in Washington D.C.
Source: Kelly, D et. al. (September 30th, 2016). Guide to the Markets. J.P.Morgan Asset Management.
CWM clients who read our election alert know that at the time the results were being announced, we were very concerned about the potential for a significant negative stock market fluctuation. Fortunately our worst fears did not come to pass and the market did not perform nearly as badly as it appeared it might on the day after the election. At one point on election night, the Dow Jones Industrial Average market futures (investment contracts that seek to predict future market outcomes) were forecasting a drop over 800 points, which would have been a loss of more than -4%, for the following trading session. That would have been a massive single day’s loss, although we believe most CWM clients would have been mostly insulated due to the conservative positioning of investment allocations at the time. However, once the surprise of the election outcome wore off, markets regained their composure and actually ended up positive the following day. It was the oddest single 24-hour market period I have ever witnessed, and I was involved in the business during both the dot-com bust in the early 2000s and the 2008 great recession. What looked like an oncoming market storm ended up being just a tempest in a teapot. The post-election market strength triggered our indicators toward less conservative positioning for the near-term future and we have made some small changes.
Most CWM clients likely noticed the recent uptick in trading activity within their accounts. The trades altered the portfolio composition with the new positions raising the expected model correlations with the stock market and lessening interest rate sensitivity. We still remain very concerned about high stock market valuations and remain firm in our belief that caution is the best course for the foreseeable future. However, price momentum has shifted post-election among many assets we were utilizing for clients, which we believe was an indication that our previous asset mix had become a bit too cautious. When asset risks become elevated, it is time to make some changes.
To exemplify the effect of recent trading activity, let us examine a sample CWM model prior to the election, and after the completion of our trades. The majority of clients are in some version of the CWM Growth model and the below data is an example of how recent allocation changes have altered some of the important measures of that model. For those not familiar with these metrics, beta reflects correlation of the model with the S&P 500 stock index (a higher number reflects a higher correlation), standard deviation is a measure of expected volatility (bigger numbers reflect higher volatility expectations), and yield is the expected annual percentage of portfolio income.
*Beta and Standard Deviation (Std. Dev.) are based on three-year market data. Yield reflects the 12-month expected percentage portfolio yield payout. Data source: Morningstar® The above data is for example purposes only and may not reflect every individual CWM client portfolio.Please contact us for a personalized discussion of your exact situation.
To simply explain the above, we expect daily and long-term portfolio outcomes to generate higher levels of income, be more volatile, and more closely track with how the S&P 500 stock index behaves than it would have prior to the recent changes. Current positioning is still relatively conservative compared to more normalized model asset exposures.
For now, caution is still warranted as risks remain elevated. CWM PTS™ models continue to be invested conservatively, as they have been all year, though slightly less after November. Your CWM team will continue to be disciplined in our efforts to provide the best risk adjusted returns possible for clients; a goal we have achieved so far during this year’s bout of volatility.
Please pass this article on to any one you know who may be interested in or might benefit from the information. We are always looking for more great clients just like you and would welcome any opportunity to assist them.
If you have questions or comments about the above subjects or other investment topics, I would love to have a conversation with you! Feel free to email me at MorganA@CWMnw.com or if you are interested in more regular financial tidbits, follow me on Twitter.
Chief Investment Officer, Principal
P.S. May we all have many things to be thankful for and a very happy holiday season.
This article has been prepared and distributed for informational purposes only and is not a solicitation or an offer to buy any security or investment or to participate in any trading strategy. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a financial professional. Past performance is no guarantee of future results.