2020 U.S. Election: Market and Economic Implications
Tony Fisher: Welcome to the Investment Conversation. I’m Tony Fisher. As votes continue to pour in across the U.S., We're doing a special election edition of the podcast today. without further ado, here's Will Andrews.
Will Andrews: Hi, I’m Will Andrews, Digital Editor for Lord Abbett. So we're concluding one of the most remarkable US election seasons in history. Well, not just yet. As of 7:00 am New York time on November 4, there was no clear winner in the contest between Donald Trump and Joe Biden. Ahead of the vote, we sat down with Lord Abbett partner and director of strategic asset allocation Giulio Martini to get a sense of the implications of this momentous vote, from both a historical perspective and the economic and market environment leading up to the election.
Giulio, in our prep for this podcast, we spoke about some of the underlying pluses and minuses in the macro environment. Can you go through them with us?
Giulio Martini: Well I think there are three major unknowns that we're struggling with right now. And the first of course is COVID-19, and the presence of the virus, and whether we're going to have a vaccine available any time soon. There're a number of vaccines in phase three clinical trials.
We're waiting for readouts on data to-- try and understand whether they have a sufficient degree of efficacy. But you know, I think there's just a lot of uncertainty related to that, to therapeutic solutions, and to public health measures that could be implemented to deal with the virus.
And that's the biggest unknown. The second I think is an unknown with regard to fiscal policy. We had a very strong policy response early in March and April from both the Fed [U.S. Federal Reserve] and from the federal government in providing support for the economy. But those programs have now basically come to an end.
And we need renewed fiscal support to keep the economy on its feet until we get a health care solution. So that's the second unknown. And the third of course is the election itself, but that's another thing the economy and the markets have been struggling with.
Now counterbalancing that, you know, I think there are some positives for investors that are meaningful. The biggest one is that, you know, U.S. corporate earnings performance has been spectacular.
In the second quarter, the magnitude of positive earnings surprises and the breadth of positive earnings surprises set records for the time period in which we have data for those things. Going back into the early 1990s. The third quarter as the data are rolling in looks almost as good--not quite, but it could it's the second-best quarter ever for positive earnings surprises and for breadth of earnings surprises. So, U.S. companies have really demonstrated a resiliency to the underlying economic situation that is very surprisingly positive.
And I think what that's really demonstrating is that large companies have managed to cope with this environment much, much better than smaller companies and independently owned businesses have. And that's of course a benefit to shareholders and something that business owners are struggling with.
Another thing that I think is meaningful is that the Chinese economy has made a full recovery. GDP in China is higher than it was before they shut down to deal with the virus. That bounce-back has been what you would have hoped for in a v-shaped recovery.
And China is the second largest economy in the world. So when the second largest economy in the world and the largest trading nation in the world bounces back so strongly, it spills over to other parts of the global economy very forcefully. And in contrast to the first half of this year when all economies were spiraling downward simultaneously, at least now with have a significant part of the global economy which is pushing very strongly in the other direction and offsetting some of the weakness that we may be seeing elsewhere.
And lastly, I would just say that in this environment of tremendous unknowns and tremendous uncertainty, it's not surprising that investors have taken a very cautious stance with regard to the positioning of their portfolios. Stock allocations are below average, both for retail investors and for institutional investors.
And of course that's something that really is quite good for the market because the outlook going forward for returns is much better when investors are positioned conservatively than when they're expecting the best.
And we certainly from what we're able to tell, are seeing conservative positioning. So, you know, there're significant unknowns. But there're also some positives in the environment that I think are very meaningful and that we have to weigh into our decisions as we go about making them.
Andrews: Giulio, of course we'll be digging into the implications of the 2020 results in the days to come. But first, it might be useful to have a bit of basic history on the performance of U.S. equities in the run-up to, and the aftermath of, presidential elections.
Martini: I'm going to address presidential elections but also, I want to talk about the larger data-set that we have of all [U.S.] federal elections. Of course, those happen every two years since the end of World War II. Because I think we can get some additional information by looking at those as well.
And what you see in that history-- and there're about 35 of those elections that we can examine-- is that the market pretty systematically tends to be weaker before elections, and stronger after elections. And that's sort of consistent with the idea that the election itself creates uncertainty because there could be meaningful political and policy changes afterwards. And then after the election has happened and that uncertainty is resolved, then the market does better once it knows what it's working with going forward. And that pattern of better performance after elections than before, holds whether the result of the election is unitary government by Republicans, unitary government by Democrats.
Those are basically the same with respect to the outcomes that the market has delivered. What's a little bit better is when you get divided government, meaning that when one of the parties holds at least one of the three out of the presidency and one of the houses of Congress and the other party controls the other two. So the market has tended to do a little bit better in divided government than in unitary government situations. But, you know, what's quite interesting is to look at some recent examples where that hasn't held, where the market has not done better after an election.
We had one of those in 2000—Bush versus Gore, which was an election where election day did not decide the outcome. In fact, we had heightened uncertainty after the election because we had that problem with vote counting in Florida and nobody really knew who had won until that was resolved. And in that case, the market continued to weaken until mid-December which is when we got the resolution of electoral uncertainty. And then of course in 2008 after Barack Obama was elected for the first time, the market did badly because the election took place right after the worst financial crisis that we had had since the 1930s.
And with the economy in a very deep recession. So that even though that election did resolve uncertainty about who was going to be governing and what the lineup would be in Congress-- the market continued to fall until early February , because what was unknown was how deep the recession would be. And I think in the present environment, we do have the potential that the election won't be decided the day after the votes are taken or the night ofand we also are having this election in an atmosphere of tremendous uncertainty where the economy has rebounded very well, but in the absence of support that might help it continue to do well going forward.
So I think this is a very interesting case where it's not as simple as pre-election uncertainty gets resolved and then we move on in a normal economic situation. This is clearly an abnormal situation. And we'll have to see whether the election does in fact resolve the uncertainty that we're dealing with going into it.
Andrews: You told us that there were some misconceptions about what presidential victories for Democrats or Republicans might mean for the market. What might investors be getting wrong about this?
Martini: Well, you know, everybody campaigns on the basis of a wish-list. And then they have to confront the reality of governing once they step into the presidency or control of Congress or what have you. And the reality of governing is very different from the wish-list that you talk about on a campaign.
So for instance, you know, President Trump was talking about a big infrastructure program if he became president. And, you know, that's something that never happened among, you know, the many things that did and did not happen. So there's always an incomplete fulfillment of the goals and the promises that a president has when they come into office. And so, you know, what we're hearing, is a very long list of things that [a] potential Biden administration would do if Joe Biden in fact wins the presidency.
I think the reality that they're going to face when they come into office is that they're inheriting, you know, the worst health care crisis that we've had in the United States since 1918.
And that has to be dealt with forcefully--immediately. Or it's going to really create an untenably weak situation in the economy. And it's going to perpetuate a tragedy on the health care front that is becoming overwhelming. And really overwhelming every aspect of American life.
And so that's going to have to be priority number one. And I think that's going to take a lot of attention and energy both on the part of the president and Congress. The second thing is the economy needs assistance. You know, we have a small business sector that's suffering seriously.
It's going to continue to suffer. We know that things like restaurants that employ 10 or 12 million people in country are doing very badly. The entertainment industry, the leisure industry, the travel industry, [are] doing very, very badly.
And they'll continue to do so until people feel safe enough to go out and behave normally again. Which depends on control of the virus. And so, you know, there has to be a bridge built to the other side for these businesses. Or we're just going to have a massive amount of failures and of unemployment that results from that. And it really is fiscal policy that has to take over in the form of grants, in the form of loans, in the form of unemployment insurance for workers who are suffering-- in the form of payments to households so they can spend as much as possible.
There's a large variety of things that could be done. But they do need to be done. And that's another big problem that the Congress has to tackle. Now after doing those two things, what could be next on the list is, you know, some kind of beginning of green infrastructure.
I think, you know, something like voting rights is something that has to be tackled. Tax reform is something that will be tackled. But broadly, this administration is also going to find itself with a really-- unsustainable budget situation.
Because right now given the size of the federal budget deficit, given the growth rate of the economy, and given the level of interest rates, we're on a path where the debt to GDP ratio in the United States is just going to continue rising indefinitely and fairly rapidly.
And at some point, you know, that will really create a threatening situation with regard to the willingness of investors to continue holding debt of a country whose fiscal fundamentals are, you know, just worsening without limit.
And that needs to be dealt with. And, you know, the last two Democratic administrations, Bill Clinton's and Barack Obama's had to deal with unsustainable fiscal debts and deficit, and were forced into a set of policies that they didn't want to implement that had to do with accepting the need for fiscal restraint. And they did so. They reorganized budget priorities. But they lived within a budget constraint that was much tighter than they would have liked to. Or that then they campaigned on.
And, you know, I think the Biden administration, if there is a Biden administration, will find itself in the same situation. I'm assuming that if President Trump is reelected and we have the same political configuration that we have right now, that there will be a continuation of the status quo.
And we'll have another four years of very significant budget deficits. And essentially the same set of programs which the administration has pursued to date without any major changes. There's certainly hasn't been anything talked about on the campaign trail that would give us a strong hint of changes to come.
Andrews: In light of the election, what should investors be thinking about in the days ahead?
Martini: What I would say is that you definitely don't want to make investment decisions in an emotional post-election environment, right? Regardless of whether things have turned out the way you hoped they would, or they haven't turned out that way, that's not a good basis to make an investment decision on.
Because what we've seen is that, you know, elections whether they favor one party or the other, or result in divided government, are typically followed by favorable market environments. And so you might think in a gut instinct that the Republican party's pro-business and so it's been better for the markets. Or the Democratic party is kind of pro-union or pro-worker and so it's going to be worse for the markets. History shows that the market does not respond that way. And so don't make decisions based on the outcome of an election.
Even when there's uncertainty, even when the election is in the middle of a bad economic period, what we've seen is market bottom shortly afterwards. And so, this is a time to just have good portfolio management hygiene. So if your portfolios are out of balance, re-balance them to what they should be in terms of long term asset allocation.
But don't make decisions about that underlying asset allocation itself now. This is not a good time to make those kinds of decisions. You should do that over a longer period where you can think about it, evaluate alternatives, and decide what's best for you-- in a calmer environment.
Andrews: Thanks to Giulio Martini for his insights today. We’ll stay in touch with Giulio as things develop over the coming weeks. In the meantime, be sure to visit lordabbett.com/2020Election for further coverage of the election and its impact on the market.
Tony Fisher: Stay tuned and stay up to date at lordabbett.com. Subscribe and rate us on Apple Podcasts, Spotify, or your favorite streaming app of choice. Thanks for listening.________________________________________
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