Editor’s note: We firmly believe that politics and portfolios must remain separate. As we will show below, decades of evidence show that mixing politics and portfolios is a toxic decision. By investing to accomplish personalized goals, we work past pessimism and the perception of challenging environments for long-term success.
Each election cycle is unique with its candidates, platforms, and campaign issues. These dynamics give the markets opportunities to react differently. This election season is no different with the media and markets in a constant discussion around the 2020 Presidential Election.
We’ve previously discussed whether a president has an effect on the market and economy, and we’ve also looked at what lessons investors can learn from the last election. Understanding these building blocks, we can look for the differences between the past and current election.
Compared to the 2016 Presidential Election, how are markets responding differently, and what can investors do to take advantage of these differences?
Who Do Markets Think Will Win?
Polling is a notoriously fickle inexact science. Between sampling errors and inconsistent polling methods, it is difficult to determine who and how much an advantage one candidate can have at any point in time. (Remember: Regarding “margin of error” referenced in every poll, this term means there is a 68% chance the candidate’s actual polling number is +/- the “margin of error”. Multiply by 2 to get the 95% likelihood range.)
With this margin of error, it’s difficult to definitively identify the likely winner according to national and state polls. Without a prohibitive favorite in the polls, we must look at other platforms to identify real-time likelihood of winners.
Since it is illegal to bet on the winner in Vegas, we can review British and offshore betting platforms to aggregate expectations.
Two items stand out in this aggregation of betting sites:
President Trump’s early lead has see-sawed into a current deficit. This same deficit has been significantly reduced into a current 53% - 47% status.
At today’s levels, betters are not strongly expecting one presidency over another. This lack of clarity is partly due to President Trump’s ability to quickly oscillate between lows and highs.
Lacking a clear leader in the betting markets, it would be difficult to assume the financial markets are positioned any differently.
Moreover, many financial prognosticators have learned their lesson from the 2016 Presidential Election when famed investors saw their political views lead to portfolio losses.
It’s important to remember that many investors have learned the repeated head fakes from Washington around shutdowns, budgets, infrastructure spending and other initiatives that never came to fruition. Regardless of what a President may hope to pass, the funding has to come from Congress, thus serving as a check and balance on proposed projects.
Given these facts, there remains one glaring anomaly in the US stock market.
What’s Different Between 2016 and 2020 Elections?
The VIX is a commonly tracked index that measures the expected volatility in stock prices over the coming 30 days. It is often referred to as the “Fear Index” because investors associate large volatility with big losses.
It’s critical to remember that volatility refers to big swings down and up. A heightened VIX reading doesn’t mean consistent big down days are expected for the next 30 days. Instead it means that investors should be prepared for significant up and down movements in the stock market.
So how does the 2020 Presidential election VIX compare to prior years?
Starting at above 30, the VIX is already in uncommon territory because of COVID-19 and its impact on the global economy. At this 30 level, this indicator is essentially predicting price movements of +/- 1% each day of trading.
In comparison to prior election year VIX charts, it’s clear to see the abnormalities around this 2020 election. Whereas there was an upward slope to the 2012 and 2016 VIX futures, the 2020 VIX spikes before the election before decreasing afterwards. There is clearly a unique spike around the 2020 election, compared to 2008, 2012 and 2016 elections. The future declines can be attributed to the economy strengthening and greater political certainty.
In an article about the election volatility, the FT writes, “ ‘ Despite the fact that elections, even for president, have not been a reliable catalyst for volatility in the past, a wide range of asset classes are already pricing historically high ‘event risk’ into options markets,’ Joshua Young, a JPMorgan analyst.”
‘Despite the fact that elections, even for president, have not been a reliable catalyst for volatility in the past, a wide range of asset classes are already pricing historically high "event risk" into options markets,’ Joshua Young, a JPMorgan analyst.
Is it possible that this “Fear Index” is merely a result of 2020 and the recession? To answer this question, we can compare the US “Fear Index” to global equivalents.
US markets are heightened compared to not only their historical averages but also international markets. These international markets are not free of political risks, with Hong Kong demonstrations, Brexit and international trade wars. Even with their own political tensions, international stocks have less expected volatility than US stocks. As a result, investors focused on US stocks can expect to see increased volatility and price swings as the election nears.
Understanding these details, we can see that investors are particularly more concerned with this year’s election and the potential impact on markets.
So What Does This Mean for Investors?
As the days tick toward year-end, we enter the phase when many people begin prepping for fall and ultimately winter. Water lines are drained. Lawns are aerated. And winter coats are placed into closets. We know cooler temperatures are headed our way.
The markets are indicating that volatile prices and big daily swings are to be expected as well.
Being prepared mentally for these big swings is paramount for investors. Just like you know that a brisk morning air is to be expected, so should you expect a temporary period of volatile markets.
Why not simply do the equivalent of be a snowbird and return in May? Because if 2020 has taught us nothing else, markets are erratic and cannot be predicted. The S&P 500 has previously rebounded from temporary losses; it’s historically been a matter of when and how long it would take. Whether or not an investor regains their money is dependent upon them not selling prematurely and locking losses.
It’s not timing the markets. It’s time in the markets.
Additionally, this coming volatility serves as a reminder of the importance of owning stocks outside of the S&P 500. Be they smaller US companies or international firms, these stocks help insulate the portfolio against wild swings.
For retirees, the focus must remain on expected dividends and interest payments during the day-to-day prices vacillate. It’s also good to remember that bond prices are typically less risky during these heightened volatile moments.
2020 is a year to remember, and according to the markets, it will end with even more excitement. Understanding that portfolios are built for the long-term and market timing is not an option, entrepreneurs should prepare themselves for the coming market volatility.