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(Runtime: 5 min, 21 sec; size: 3.71 MB)
Paul Roukis, portfolio manager of the large-cap value strategy at Rothschild & Co.
As it relates to the upcoming election and U.S. equity markets, it appears the consensus among investors right now is the incumbent will win. As a result, the upcoming elections have had little influence on stock prices to date other than maybe certain healthcare stocks have been affected, but the narrative could change as we get closer to November. If you think about it, the election is a binary outcome event that could materially alter policy actions for years to come.
What’s interesting about this upcoming election is the fundamental philosophical differences between the incumbent party and the extremes of the opposing party. While there are centrist candidates in the running, proposals by the party extremes are what have gained the traction to this point, which is what create market uncertainty as we approach the elections. As we saw from the last election, anything can happen, and we simply can’t rule out any of the potential outcomes at this point.
It goes without saying the uncertainty is never good for markets, which is why I’m concerned about the potential impact will be on consumer and corporate spending as we approach election day. The results from various polls are likely to create noise as we move along in the coming months. For corporate boards and consumers alike, it’s tough to develop a game plan if you don’t know what the rules of the game are going to be. A potential slowdown in spending could prove to be a headwind for what I consider to be a generally healthy U.S. economy led by a very strong consumer.
Something that gets little attention, but we should be mindful as well: the current administration is often viewed as pro-business and ultimately pro-market. But even here if the incumbent wins, there’s a question about what the second term would look like as well. I’m not sure we can count on the status quo. Could trade protectionism increase if one doesn’t have to worry about re-election? Again, it’s very tough as investors to handicap the probability of outcomes and the reaction by investors to such outcomes.
A big question comes up is what companies or industries could be most impacted by the upcoming election? From my standpoint, it’s still way too early to quantify the impact on individual companies since it’s more complicated than simply saying who wins the presidency. How the results unfold in Congress will also play a part in determining what campaign promises actually become reality. Right now, the consensus holds that healthcare industry, particularly health insurers, the drug manufacturers, and some of the healthcare service providers, could be most at risk since there’s bipartisan support for better healthcare at lower prices, and some of the proposals by candidates on the Democratic side have come up with a proposal that materially could uproot the current system. However, the market already started to discount this scenario last year, at least partially. It’s never fully discounted, but it’s something that the market is thinking about.
Another area is certain technology companies are also potential targets, given their size, influence, and concern by politicians over privacy rules. As a general rule of thumb, as investors we should understand our risk exposures to a variety of different outcomes, and that applies to macro events beyond just the upcoming elections.
Another thing is about what else can investors expect as we approach and move through 2020? Well, first, investors should expect a pickup in volatility from 2019 levels in my view. Markets are pretty calm right now and trading at record highs. However, leverage has ballooned throughout the system and there are no shortages of macro headwinds to talk about. That’s what we know. History tells us that the most impactful events on investor sentiment usually are the ones that surprise us. In other words, the first domino to fall is usually not the one investors expect.
Second, I would say trade worries should continue to moderate. We have phase one completed, but the odds of a phase two deal are relatively low. Now, that’s a positive in my view, and I think investors have come to the realization that an agreement with China will take time and maybe even years, so as long as the trade war doesn’t escalate between these two superpowers, the market should be unfazed.
Then finally, one thing that few people are talking about, but I think is one of the biggest potential risks to the markets out there, is inflation. The good news is that the probability is low that inflation will increase to levels that will concern the Fed. However, that probability is greater than zero in my view. The Fed is being given cover to this point to maintain accommodative monetary policies given where inflation is trending, right around 2%. The markets certainly like that number, and not just equities, but when you think about other asset classes like bonds and real estate, all asset classes have benefited. But as we got a taste of it in 2018, the Fed’s hand is forced to react to rising inflation. This could change the trajectory of the market in my opinion.
My views expressed today are my current opinion and not an indication of the fund’s intention to trade or hold a position. I would also like to highlight that my opinion may change in the future and it should not be viewed as investment advice.