Waiting for Election Resolution — October 2016

October 27, 2016

Dow Jones Average: 18,199
S&P 500 Index: 2,139

Waiting for Election Resolution

The presidential election has become an event about which there is nothing left to say, at the same time that it rightfully dominates the national conversation. Even though polls show that a majority of Americans are unhappy with the choices in this election, people seem to have taken firm, unshakeable positions. A kind of paralysis has taken over the body politic pending the resolution of this election.

The financial markets, as evidenced by price movement after polls, favor a Clinton victory. Hillary Clinton is a smart, predictable individual, who has a long record of decision making in the public sector. While that lengthy record has provided ammunition for detractors, most Democrats and many highly regarded Republicans see her as eminently qualified to lead the country. On the other hand, her opponent casts himself as a cagy, unpredictable negotiator, who has been able to recover from many reversals of fortune. In our opinion, Donald Trump’s multiple bankruptcies, his litigious, vindictive nature, his attitude toward women, and his constant attempt to scapegoat others, make him an unacceptable choice for leader of the world’s most powerful democracy. The financial markets have always preferred steady and predictable over reckless and unpredictable.

The stock market has been surprisingly quiet, given the noise coming from the political arena. This may be partly due to the odds of Clinton winning (forecasters say 85%), and to the fact that presidents do not control large swaths of the economy. The president has great power over Supreme Court appointments and foreign policy, but much less over the day-to-day workings of the economy. Business executives are the ones who make the daily decisions of hiring and retaining employees, sourcing materials, setting prices, creating customer loyalty, and reinvesting profits. These decisions have both an immediate and long-term impact that transcends the changing political fortunes of the major parties. There are some exceptions, in areas such as renewable energy and health care, where the government holds substantial power over tax credits and pricing that affects those industries. As the prospects of a Clinton victory have increased, there has been a modest rise in alternative energy stocks and a general decline in pharmaceutical companies. These are the outliers though, as most industries are not so directly impacted by government, and have been seemingly unaffected by the political noise this year.

Current Strategy

Since our last strategy update the Standard & Poor’s 500 Index declined by about one percent and volatility returned to yearly lows, with only one day in seventy that could be described as a large move. Late summer is often a quiet time for the stock market. Many traders go on vacation in August, and in some years the market feels as though it is left on autopilot for weeks on end. This past quarter epitomized that familiar pattern. Corporate earnings have stagnated and the Federal Reserve has left low interest rates in place, both of which contributed to a very narrow ceiling and floor for stocks. This lethargic and sleepy market may sit on a dangerously weak foundation of stagnant earnings growth and highly stretched stock valuations. The continuing support for stock prices is the super-low interest rate environment, which renders bonds and cash uncompetitive.

In recent months we sold or reduced a few positions where the investment thesis had largely run its course, and we added to a couple positions where declines in price warranted greater investment. We took gains on a few of our largest dividend paying stocks, as we felt that they had moved to high valuations, and were vulnerable to a Fed rate increase. Those sales turned out to be timely, and the funds were redeployed to companies with greater growth prospects.

Our hope and expectation is that the Federal Reserve will lift the federal funds rate, which directly affects short-term interest rates. At a minimum, this will make short-term bonds more attractive and potentially bonds of all lengths more appealing to buyers. We know that many clients have a reserve of cash in their accounts, and while cash is still the preferred safe-haven asset in our view, the time to reallocate it to shorter-term bonds feels closer at hand with rising interest rates.

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