By Carol K.
In this post, I’m not going to talk politics or speculate on which Party wins or deserves to win the Presidency or control of Congress come January 2021. There are plenty of political pundits offering their take on the coming U.S. election, and if you’re like me, you’re exhausted by the non-stop negativity and political games. The purpose of this piece is to instill a sense of calm and help self-directed investors survive what we at GMM anticipate will be an epic political storm in the coming months.
While there is always increased market volatility around the time of presidential elections, we anticipate unprecedented nastiness, litigiousness, perhaps civil unrest, the likes of which we have never seen in the United States. If one has remotely been paying attention in 2020, it is evident that neither Party will politely concede and go quietly into the night.
Furthermore, we believe there is a high probability the final results will not be known for several days after election day. After that, it is highly likely the (apparent) losing Party will surely contest the results through the judiciary. Unless, of course, the initial voting count comes in so overwhelming for the frontrunner on November 3, it will leave little doubt about the winner.
Markets hate uncertainty. We believe uncertainty will dominate the markets from November 3 until mid-January. It could easily take until mid-November, for example, to determine who will control several hotly contested U.S. Senate seats that may flip the balance of power from the GOP to the Democrats in the upper chamber. It’s too close to call with any certainty, although the prediction markets are giving the Democrats around a 60 percent chance of a clean sweep.
If I could say just one thing as an investor who is “in it” for the long haul, it would be this: historically, time has been on your side, and we have no reason to believe that will change going forward. Stocks go up, stocks go down, but looking at the trajectory of the U.S. stock market over the past 90 years, as measured by the S&P 500 index, we see a dramatic rise in stock values.
Through wars, depressions, recessions, civil and social unrest, the stock market may be volatile but has remained a great wealth creator for those exercising the discipline and patience to play the long game.
Does the President’s Party Affiliation Impact Stock Returns?
Many investors hold preconceived notions of how stock returns should look under a Democrat or a Republican president, with most incorrectly believing stocks have historically outperformed under GOP presidents. Take a look at the table and charts below for market returns by presidential administration over the past 120 years; you may be surprised, I know I was!
It is essential to keep in context that initial valuation levels matter when new presidents take office. George W. Bush, for example, inherited the bursting dot.com bubble, which popped in March 2020. He then exited the Oval Office with the credit and housing bubble deflating. In both cases, the S&P500 fell around 50 percent.
Suppose the stock market doesn’t correct meaningfully in the next few months, and there is a President Biden. In that case, his new administration will inherit the most overvalued stock market in history, making it difficult for his tenure to be anywhere near the top of the presidential stock market return board.
Compounding the expected volatility surrounding the election, we expect continued fallout from Covid-19 to impact the economy, corporate earnings, and capital markets well into 2021. As of the date of this post, no additional fiscal stimulus funds for individuals, corporations, or small businesses have been approved by Congress as on-going talks between Speaker of the House Nancy Pelosi and Treasury Secretary Steve Mnuchin were abruptly called off by the White House on Tuesday (10/6). It’s anyone’s guess whether a second stimulus bill will pass and be signed by the President prior to the November 3rd election but the odds are decreasing by the day.
For long-term investors, volatility and the corresponding market corrections are an absolute gift. Volatility allows investors to buy stocks for less — often at a 10-20% discount from previous levels or even better, at a nice discount to a stock’s fair market value.
The key is maintaining the discipline to have a well-researched watchlist of stocks ready to go when corrections or volatility hit. One obviously needs to conduct due diligence and develop a good sense of each stock’s fair value. I like Morningstar’s estimated fair value because their analysts tend to be quite conservative in their valuations and assumptions.
Something I learned the hard way, by losing money or giving up a lot of upside, is when determining fair value, the entry price should incorporate a margin of safety or cushion. For example, if, say, ABC’s fair value is $70, you may examine it’s beta or it’s cyclicity and decide that a margin of safety of at least 10% or more is appropriate and your desired entry price would be $63 per share or lower.
Many stocks rarely offer a perceived margin of safety because markets place a premium on these stocks for any number of reasons — such as a long-running and well-covered dividend. Many of the less “sexy” stocks, such as Coca-Cola (K.O.), Pepsico (PEP) or Procter & Gamble (P.G.) trade higher than their expected fair value levels.
High-growth stocks, such as Amazon (AMZN), Tesla (TSLA), Nvidia (NVDA) trade at super high premiums to their book value or trailing 12-month earnings, because of expected future earnings potential merit the sky-high current price-to-earnings (P.E.) ratio. In other words, the high P.E. ratio is justified given potential explosive future growth.
The Coming Volatility
So then, the expected increase in market volatility we see materializing in the coming months should allow investors to add to existing positions or start new positions at more favorable entry points. This is a good time to carefully look over current holdings and possibly free up some cash if you lack the dry powder to put to work if/when the opportunity arises.
Decide which specific sectors you want to be in the near future, run some initial search screens to choose high-quality companies that merit further research. Then, voila, you are ready to construct your “shopping list” with fair values and margins of safety to jump on during the next correction.
If you have holdings with outsized profits (in a taxable account), and Democrats take the White House and both houses of Congress, you may want to take some profits by December 31, so your gains will be taxed at preferable 2020 capital gains rates. I am not a tax expert, just my opinion, and that is what I have been doing.
Quick Update on Previous Recommendations
ARK Invest ETFs: featured in our previous post here:
The ARK Invest family of actively managed ETFs remains on fire. Cathie Wood and her team have assembled a group of ETFs focused on the future economy, and at the market close on Friday (10/9), her ETFs comprise 5 of the top 10 performing ETFs YTD (leveraged ETFs excluded).
Looking at these returns, especially when compared to the major indices, I think you will agree what many consider a high expense ratio of 75 basis points (0.75%) is well earned by Cathie and her staff.
Expected returns for the risk-free bonds are likely to be negative or remain very low for several years, with returns on I.G. corporates only marginally better, which is forcing fixed-income investors to look elsewhere for income. REITs are an attractive option for income, but in the COVID-19 economy, investors must be very selective as to the type or classification of properties a REIT holds, including the quality of both the properties and, of course, management.
I plan a follow-up to my earlier post on REITs in the coming weeks as my health, and continuing treatment schedule allows.
However, REIT investors must consider that many REITs have cut or suspended their dividends since March when the COVID-forced shutdowns and rent collection woes set in.
Most notably, dividends were affected in the hotel, mall, office, shopping center, and prison REIT sub-sectors. Hoya Capital Real Estate does an awesome job tracking the current status of REIT dividends on their website, so take advantage of this wonderful resource in your due diligence.
I’ve suffered a setback in my treatment for recurrent Ovarian Cancer; the cancer has metastasized to the liver. My chemotherapy regimen has been adjusted and hopefully will be sufficient so I will not have to undergo surgery.
I am truly blessed to have such wonderful family, friends, and colleagues supporting me in my fight. I couldn’t do it without them! Special thanks also to my Twitter friends for regularly checking in on me and to Gregor and the GMM staff for entertaining me virtually while I’m receiving chemotherapy treatments. Another fallout from COVID protocols is patients aren’t allowed to have a family member or friends sit with them during treatments, which generally run 6-7 hours.
The information in this post represents our own personal opinions and are not investment recommendations. We may or may not hold positions or other interests in securities mentioned in the post or have acted upon what has been written.
All information posted is believed to be reliable and has been obtained from public sources believed to be reliable. We make no representation as to the accuracy or completeness of such information.