Election Blues (And Reds)

Given the market volatility around the 2016 election results and election day tomorrow, I thought it would be a good idea to do a Q&A-style post about the election and its potential impacts.

Q: Who’s going to win the presidential election?

A: There’s no way to know for sure at this point, and it’s pretty likely that we won’t know tomorrow night either. But, if you believe the polls and the work of statisticians such as Nate Silver (fivethirtyeight), Biden has about a 90% chance of winning. If you believe the betting markets, Biden has about a 60% chance of winning. These are two very different ways of analyzing the election probabilities. Analyzing the polls is essentially using the estimated margin of error in each poll and weighting the polls by their likely accuracy to determine the mathematical chance of the overall margin of error being big enough for Biden to lose and Trump to win despite the polling averages showing a lead for Biden on average. The betting markets on the other hand are showing the odds that a bettor on Biden would be willing to take (betting $3 for a chance to win $2 more) vs. what a Trump better would be willing to take (betting $2 for a chance to win $3 more). The betting is purely opinion-based and is an average of what all bettors think is going to happen in aggregate. It’s possible that both are somewhat skewed. I don’t really believe the hype around Trump supporters lying to polls, but it’s possible that they’re harder to reach to poll. It’s also well known that the betting markets are male-dominated and that Biden’s lead over Trump is much lower among men than women. Since people often bet in a way that favors what they’d like to see happen, that could skew the odds toward Trump’s side. If I had to guess, I would go somewhere in between and say that Trump has about a 30% chance of winning. That means I’d be willing to bet $3 to win at least $7 on him, or be willing to bet no more than $7 to win at least $3 on Biden. 30% is not zero. The favorite doesn’t always win, as we saw in 2016. A good baseball hitter gets a hit about 30% of the time. There are lots of hits in baseball. There are more outs though.

Q: What about the Senate?

A: 538 gives the Democrats about a 75% chance of taking control of the Senate (including a 50-50 split with a Democratic president), with the most likely scenario being 51-49. Betting markets. again, have the race closer with Democrats having a 60-65% chance of winning. The closest races are in GA (2), NC, IA, ME, and MT. Interestingly, the second GA senate seat is a special election to fill a vacant seat and has multiple candidates from both parties. If a majority isn’t reached, a runoff will take place on January 5, 2021. That could be the seat that decides control of the Senate and a runoff has a decent chance of happening at this point.

Q: What impact will the election results have on the stock market?

A: I don’t think that answer would be clear even if we knew today exactly how every race would turn out. That’s because there are so many potentially offsetting impacts. Here are some of the possible scenarios:

  • Biden wins, the Democrats take control of the Senate by several seats, and the Democrats keep decisive control of the House – corporate tax rates likely increase (clearly bad for stocks), taxes on higher income individuals likely increase (probably bad for stocks, at least short-term), higher regulation (probably bad for stocks, at least short-term), large stimulus package gets passed (probably good for stocks, at least short-term), more certainty (probably good for stocks), less pressure on global trade (probably good for stocks) less political angst (impeachment, oversight inquiries, etc… probably good for stocks).
  • Biden wins and the Democrats control the Senate and the House by a small margin – tax picture a little more blurry, regulation still likely to increase, still likely to get a large stimulus package, but allocation to state/local may be a bit smaller, still a boost to global trade, a little less certainty, still less political angst.
  • Biden wins and the Dems & Republicans each control one chamber – tax changes are unlikely (probably good for stocks as a relief to the alternative), smaller stimulus likely (probably bad or less good for stocks at least short-term), still a boost to global trade, more political angst.
  • Trump wins and the Dems control both chambers – tax changes very unlikely, large stimulus likely, much more political angst, and global trade challenges continue (worsen?).
  • Trump wins, the Republicans hold the Senate, and Democrats hold the House (status quo) – tax changes unlikely, stimulus likely smaller with less support for state/local and maybe a big battle to get it done at all, political angst steady, and global trade challenges continue (worsen?).

Longer-term, I really don’t think it matters who wins. Take a look at the chart below from Capital Group:

Sure, there are some dips in that chart, but for the most part it’s a steady upsloping line for 87 years regardless of party. By the way, I don’t think one can make any conclusions about which party is better for the market from that chart because the market prices in election results prior to the election and certainly prices in likely policy changes between election and inauguration. The takeaway should be that from a purely stock market perspective, if you zoom out far enough, it doesn’t really matter who wins a single presidential election.

Q: You said that we probably won’t know the result of the election tomorrow. Why not? When will we know?

A: Each state has their own method of counting ballots. The NY Times recently attempted to summarize those methods. The battleground states have some significant differences. Florida, for example, has already counted many ballots received by mail and will release those counts along with in-person early voting by 8:30pm eastern. Election Day ballots will be counted through the night, but no additional mail-in ballots are allowed after 11/3. So we’ll know who won FL by 11/4 morning barring a 2000-like “hanging-chad” incident. Ohio also plans to release pre-election day votes 11/3 evening (by 8pm) and will count election day votes through the night. But, in stark contrast to FL, they will allow ballots postmarked by 11/3 and received by 11/13 to count, and then won’t provide updated results as those ballots come in. As of 11/2, officials say that full statewide results may not be known until the election is certified by the state on 11/28. Since the state knows how many mail-in ballots were sent out, it will know the maximum that could be received, but if neither candidate leads by enough to make it statistically impossible for the mail-in ballots to swing the results, it sounds like Ohio can’t be called until 11/28! 538 recently published a graphic with their opinion of the state-by-state portion of the vote that should be counted on election night:

There is a chance that one of the candidates will have enough of a lead in battleground states, that that ballots received and counted after 11/3 won’t matter and the election results could be known on 11/3 or 11/4. Again, we can rely somewhat on betting markets to gauge opinion of the probability. PredictIt has a wager on when the election will be “called” by both CNN and Fox News. That wager shows the odds of being called on:

  • Election Day = ~23%
  • November 4th = ~31%
  • November 5th = ~7%
  • November 6th or 7th = ~6%
  • Later in November = ~18%
  • December or later = ~15%

Personally, if I were a betting man, I like the combination of after 11/4 for better than even odds. Maybe that’s more of an emotional hedge though. I certainly hope for a result by the 4th!

Q: What’s the market going to do if we don’t know who won or if the election is contested?

A: We know the stock market didn’t like the 2000 election result process (the FL “hanging chad” election), but it wasn’t exactly catastrophic, as the chart of the S&P 500 shows. It also wasn’t long-lasting.

A contested election that results in not only recounts, but lawsuits that potential swing a result from one candidate to another, etc., could be temporarily much worse. But it’s unlikely that an election with a large margin of victory would be contested and even lower chance that it would reverse the result. So, a very close election with no clear result, that leads to social unrest could certainly hurt financial markets temporarily. Some unrest is likely no matter what the result given current political polarization. The less clear the result is and the more it seems to change, the higher the risk of extreme volatility. I have a high degree of confidence that the next president will be inaugurated on January 20th, regardless of how the election goes. With all of that said, the stock market does a very good job of factoring-in event probabilities and their impacts (including support by the Federal Reserve if things really go off the rails). That means the market is likely to respond very positively, all else being equal, to a clear winner. There’s no way to game the system without a crystal ball or time machine.

Q: Give it to me straight, all-in-all is tomorrow night going to be a mess for the stock market?

A: If you define mess as volatile (bouncing sharply in either/both directions), I’d say that’s much more likely than on an average night. If you define mess as the market falling sharply, I don’t think anyone knows in advance. The better question though is whether what happens tomorrow night matters. I made this short post at about 11pm on election night 2016. Stock futures were down 4.5% at the time and got slightly worse as the result became clear. By 8am, futures were barely down. By the close on 11/9, stocks closed up a little over 1% from the election day close, completely reversing the overnight pullback. By the end of 2016, they were up almost 10% from the day of the election and even now, mid-pandemic, they’re still up over 50% (S&P500) from that election. People are on edge over the election for reasons that far outweigh finance. I get it. The moral of the story here is that there’s little/no reason to let predictions of, or even actual, stock market volatility add to your anxiety.

To summarize:

  • For the markets, the election is all about probabilities. While Biden is favored to win and the Democrats are favored to narrowly take the Senate, neither is anywhere near a sure thing.
  • There are dramatic, offsetting impacts to the economy and financial markets, at least short-term, in every possible scenario. Each is currently priced in, probability-weighted.
  • It may take a while for election results to unfold with certainty.
  • It may be chaotic in the markets for a while and that could include big down or up moves as a clearer picture of the future arrives.
  • Long-term, the 2020 election barely matters from a financial point of view. If you’re feeling anxious, try to zoom out for perspective. Stick to your plan. Things are going to be ok.

Note: Many of the links in this post are being updated periodically with new information as election information evolves (538, NY Times, etc.).

Market Update – 8/24/2015

Most of you know by now that when you see a “Market Update” post from me, something ugly is happening in the financial markets. This time, it’s the classic fear of a global growth slowdown, with China at the center of the action. There’s plenty of literature out there pointing to all of China’s problems, so I won’t bore you with a recap. Growth there is slowing, dramatically, and there’s little debate about that. For a long time, emerging market growth was thought to be enough to overcome the stagnation that has happened through much of the developed world. Slowing growth (maybe even a real recession?) in Asia, eastern Europe, the Middle East, and Latin America has left financial markets wondering what can drive global growth. Without it, it’s hard to imagine that corporate profits can continue to grow, hiring will increase, spending will rise, and the virtuous cycle will continue. Oil prices have plunged, partially due to the increase in supply led by the US shale revolution, but lately, I suspect it’s again due to demand slowdown fears led by China. While lower commodity prices are beneficial for consumers, it puts a halt on the growth of one of the sources of job gains in the US and provides even more basis for worrying about global growth. Add in fears of the Fed starting to raise rates soon (which almost certainly isn’t going to happen in September now thanks to the recent stock rout), and we have the makings of a meltdown.

[As I write this at 9:30am, the US stock market just opened and the market itself is not functioning properly. There are stocks and funds that opened down 20%+, were halted, and bounced back sharply. It looks a lot like the flash crash of a few years ago. I’d venture to guess that many of those trades will be cancelled by the end of the day. Many stocks did not open on time. Don’t believe what you’re seeing for quotes until that’s all resolved. I suspect the Dow was never really down the 1000+ points that were indicated shortly after the open.]

I don’t know how bad China will get. I don’t know how much fear will beget fear and cause stocks to fall. I don’t know how long it will take for everything to stabilize. What I do know is that China won’t be wiped off the map and that a billion people have a massive amount of productivity to deliver to the world as skills, technology, and resources move from other parts of the world to China. There is a massive portion of the developing world that is living in or on the edge of poverty. Technology is moving so quickly, making the world smaller and smaller and it seems impossible that the disparity in standard of living between the developing and developed worlds can continue forever. Emerging markets will drive growth eventually… It just make take a while to get through some of the policy mistakes their governments have made and to normalize some of the capital flows that have probably put too much of the developed world’s central bank provided liquidity into emerging markets in search of yield. While the media may try to convince you otherwise on a day like today, the world is not ending.

Take this as a gut check. After years without a major fall, there is a tendency to think that stocks go up in good times, and do nothing in bad times. We’ve forgotten that stocks also go down and they tend to go down much faster than they go up. This causes stress when portfolios have not been set up appropriately for your goals. Ask yourself this question: “If the stock market loses half its value as it did twice in the last 15 years, will I still be able to achieve my goals?” The answer to that question is dependent on what your goals are, how soon you need your money, and how much of your portfolio is in the stock market. If your goal is retirement in 20 years, then you’re going to have most of your money in the stock market and downturns are going to be painful, but you (and your portfolio) won’t even remember that this downturn occurred by the time your retire. If you’re looking to buy a house with most of your money in the next couple of years, then most of your money is in bonds, which actually do fairly well when stocks move lower allowing them to offset some of the stock fall and mute the impact on your portfolio. The real concern for investors should be whether or not you’ve really evaluated your goals and communicated them to your advisor. As long as we’re on the same page, your portfolio is allocated in a way that the stock market falling 10%, 20%, or even more isn’t going to ruin you. That doesn’t mean your portfolio won’t go down… I assure you it will and that’s a necessary risk in order for it to go up in the good times. It means that you should still be able to achieve your goals even if stocks fall sharply over the short term. As I posted on Twitter on Friday, “If it matters to you that stocks fell today / this week, you’re gambling, not investing.” If you feel like you’re gambling and you’re worried, please contact me. It means you’re letting your emotions get the best of you (and I’m happy to talk you off the ledge) or that your portfolio isn’t in line with your goals (which means we really need to talk).

I’ll conclude with something no one wants to hear while the market is falling, but everyone realizes is true eventually. Investing at lower prices actually increases long-term wealth and the probability of achieving your goals. In my most rational moments (which are admittedly hard when the entire world’s stock markets are down 10%+ over two days), I cheer when the market falls and get more nervous when it rises because I know your long-term goals (and mine) have a better chance of success when prices are lower and we can invest more money at those lower prices (see The Value Of Volatility post from 2013). Would you rather your next 401k contribution get invested at last week’s higher prices or this week’s lower prices? Buyers should always want prices to be lower, even if it doesn’t feel good at the time. On days like today, which definitely don’t feel good, please keep that in mind.

Misleading Markets

While the Dow and S&P 500 have done fairly well this year and have held up decently so far this quarter, other asset classes that aren’t in the headlines, but are part of a well-diversified portfolio, have fared far worse. Some classes, like Commodities and Microcap Stocks have even fallen enough to be considered in a “correction” by its classical definition (10% down from highs). The table below shows (through 9/22) year-to-date and quarter-to-date returns for a select group of ETFs that represent major asset classes, along with their decline from their high over the last 52 weeks.

There’s no way to know whether this divergence in returns is predictive of poor returns to come, or if a reversion to the mean is more likely which would have underperforming asset classes begin to outperform. I just wanted to quickly point out that while the perception is that the market is at all-time-highs, this is really only true if you’re looking at US Large Cap Stocks in isolation.

All-Time Highs – A Historical Perspective

If you watch business news TV, read the business section of the newspaper, or follow business/investing websites, you’ve undoubtedly heard a lot of “due for a pullback”, “too much too fast”, “need a correction” and “not safe to invest at all-time highs” lately. Mind you, many of these predictions started when the stock market was 10-20% lower than it is today. While I continue to believe predicting the short-term direction of the market is a fool’s game, and I’m definitely not saying it’s going to happen this way again, it’s worth looking at the last time in history that the stock market moved essentially sideways for 13-14 years and then broke out to new highs. The first chart below shows the S&P 500 from 1966 to mid-1980. Essentially no gains for over a decade, two massive drops (one near 50%). This was the period of the infamous Businesweek cover that claimed “The Death Of Equities”. The second chart shows the same S&P 500 index starting from the same point, but extending to 2000. If investors were too scared in 1980 to invest in the stock market, or were waiting for a correction to invest because it was breaking to new highs, they may have missed the run from 120 to 1500 on the S&P 500 (1150% return).

The moral of the story is not that you should invest now because the stock market is going to go up for the week, month, year, or decade. It’s that trying to use the recent past (or even 14 years of past) to determine the value of the stock market today is useless. It may even be worse than useless… it could lead you to feel that the market it overvalued, right before it increases 1150% over the longest bull market in history.