Client Letter: Third Quarter 2016 Review – Trump v. Clinton, Will the Markets Get Spooked?Submitted by Alsworth Capital Management, LLC on October 24th, 2016
As we look back on the last three months, what stands out is how quiet financial markets were during the summer, despite a new government being installed in the United Kingdom (post BREXIT), an unsuccessful coup attempt in Turkey, and despite the circus freak show of a presidential campaign we have been forced to endure. In September, market fluctuations picked up a bit, but they were spread to different sectors of the market and diversification paid off in limiting the impact. We are pleased with our overall results and by how our positions and active managers performed. Broader financial market returns have also been positive with larger sized U.S. stocks, represented by the S&P 500 Index, up nearly 4% for the quarter and over 7% year to date. During the past quarter, our emerging-market position performed well, continuing a turnaround that began during the second quarter of this year. Its year-to-date double-digit gains outpaced those of nearly every other investment category. Additionally, other areas of the portfolio such as European stocks, flexible bond funds, and floating-rate loans added value. While performance was mixed for our managed futures positions during the quarter, the investments we hold in this category are fulfilling their longer-term role as portfolio diversifiers, namely by reducing risk. Overall, positive contributors outweighed negative ones in the portfolio.
The dominant topic over the quarter was politics and I’m often asked what impact the presidential election will have on the markets. Normally, I would say very little impact on net. Some sectors would win, some sectors would lose based on the victor, but the net impact is typically muted and more weight is given to the business cycle and geopolitical landscape. Traditionally, we have had relatively conventional candidates. Their governance styles were well recognized, their party leaders vetted and anointed them and they were relatively predictable. As they worked their way through the ranks of political life, mentored and financially supported by their party elders, they developed relationships, a record of votes and a trail of promises. This career path builds and trains a candidate, but it also puts handcuffs on their decision making and makes their policy leanings more predictable, if not manageable. Their probable policy directions get priced into individual company share prices along with the probabilities of a candidate’s success. As an example, If I was an investor in big oil companies in 1996, I would probably model lower profits if Ralph Nader was elected president, but I would have given it a small probability of occurring, thus not moving my price targets markedly as a result of his candidacy.
With the Republicans nominating Donald Trump, we have a non-traditional candidate that does not have a history in politics or a voting record to scour. His campaign message has been unfiltered and unpredictable. Normally, such unpredictability would be expected to upend financial markets, but it hasn’t. The Democrat’s candidate, Hillary Clinton is considered more conventional, despite being the first female candidate for the Presidency of the United States, because she has a long political career to parse. The markets have not reacted to the erratic gyrations of this campaign season, largely because they have priced in the higher probability of the more traditional candidate, Hillary Clinton, winning the election. This is not a merit judgment. I am an independent with no party affiliation, so I don’t have a pony in the race. Financial markets don’t have feelings or political leanings. Financial markets care only about making money and pricing in probabilities of events in an unpredictable future. Throughout the campaign, the margins in the polls for the popular vote have sounded kind of close, reflecting a very divided and relatively equally split electorate. However, taking this into account, the statistical probability of Hillary Clinton winning, based on the poll results, has remained relatively high. This has been priced into the market calm, since there is a trove of data from thirty years of public exposure with which to develop opinions on how her presidency would impact various companies and market sectors. If Donald Trump does ultimately win the presidency, it would be unforeseen in the polling data and it would be a surprise to investors. I would expect some market volatility in reaction to the uncertainty as everyone recalibrates. However, I would not expect the market reaction to his presidency to remain volatile longer term. As we learned more about his cabinet and approach to decision making, I would expect financial markets to settle down and build less margin for uncertainty into the fundamental price of companies.
As I have looked at this question, I don’t believe I have any better insights into the probability of the outcome for the presidential election than what is currently being priced into the market. As such, I have not made alterations to our portfolio allocations based on the election factor. Just like you, I will continue to watch closely as the campaign winds down to a close and I will take the information as it is presented. The recent BREXIT vote should serve as a reminder that, despite all the polls and statistics, we can’t predict the future. The election is not over until it is over and all of the ballots have been counted. We all have a duty and privilege to vote and have our voices heard.
I remain confident that while political fighting sometimes brings out the worst in our character, we will ultimately rally behind the victor and reconcile. Whatever the results, the defeated will surely be disappointed and their supporters disheartened. The victor’s supporters will be overjoyed by either the historic rise of a political underdog or the election of our first female President. Gracefully accepting the victory and making a smooth transition of power to the next President represents the pinnacle of all developed democracies. However, it is the concession that really defines ours, the most revered democracy. We have a long history of fierce campaigns, including the astoundingly close and hard fought campaign of 2000. But, it is the dignified and humble acceptance of the results in the concession that allows our country to move quickly to the next chapter and maintain stability no matter which candidate loses. This isn’t something that is easy or inherent in our nature, but it is an exceptionally important tradition in our democracy. I am confident that this election will end with the same dignified, peaceful and stable transfer of power. In the heat of the campaign, it seems like reconciliation is an impossible task. But, history proves that we can overcome our disappointments and that very few of us actually move to Canada. We stick it out together, find common ground and move forward to the best of our abilities. I hope your candidate wins, but if they don’t, I hope they exit with grace.
The next President will have plenty of important decisions to make that will ultimately impact investment markets. However, regardless of who our next President is, valuations will continue to be a significant driver of long term portfolio returns. Interest rates set by the Federal Reserve will also continue to be an important factor. Economic growth rates in Europe and China are significant developing stories as well. These factors, and others, continue to be what drive most of our portfolio decisions. We maintain a well balanced portfolio that reflects areas where we think the market is mispricing sectors, as well as diversified holdings, to reflect our humble recognition that we can’t predict the future. If you would like to discuss recent market events or have questions specific to your financial situation, please do not hesitate to setup a meeting to review. I look forward to hearing your concerns and answering your questions.
Shane M. Alsworth, MBA, CFP®, CLU®, CIMA®
The views and opinions presented in this article are only those of Shane Alsworth and Alsworth Capital Management, LLC
Investments are subject to market risks including the potential loss of principal invested.
Asset Allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
Sources: Wall Street Journal, Morningstar/Ibbotson data