Positioning Portfolios for Election Uncertainty

As another presidential election approaches, many investors have already turned to the post-election landscape. How might the ultimate outcome impact their portfolios? While every election cycle is unique, history has shown that materially changing your asset allocation in advance seldom pays off.

Yet we’re increasingly asked by clients what they should do as the election draws near. We suggest the following:

First, maintain perspective. For all the focus devoted to elections, history shows that they rarely alter the course of the overall economy and the broad markets. For those with a plan in place, stick with it. For those with new funds to invest, develop a plan and then stick to that.

Second, diversification still matters. While yields sit at historically low levels, bonds still play an important role in offsetting equity risk—as evidenced by their positive September performance amid a declining global equity market. International equity exposure also provides valuable diversification benefits. For instance, some election scenarios which pose heightened risks to US stocks may be offset by strength in European or Asian markets. In addition, for qualified clients who are comfortable with additional complexity and less liquidity, alternative investments may prove effective in combating market volatility.

Finally, as we’ll detail below, portfolio managers have the ability to actively respond to evolving market conditions. To that end, we asked our equity and bond portfolio managers how they’re preparing for the potential uncertainty ahead. While each team’s strategy reflects their individual exposures and objectives, some common themes emerged.

Corporate Tax Hikes: Many of our investment professionals acknowledge the potential for an increase in corporate taxes, directly reducing the earnings underlying both stocks and corporate bonds. To neutralize this exposure, some teams favor sectors or companies whose tax rates may not rise as much. Others are positioning in a less conventional way, utilizing the fact that tax increases would likely accompany an infrastructure package—which could potentially benefit firms in the industrial and utilities sectors. Building or maintaining a position in sectors that would benefit from infrastructure spending (as an offset to higher corporate tax rates) reduces the need to mitigate that risk in less optimal ways.

Easy Monetary Policy: A prolonged period of accommodative US monetary policy appears both widely expected and largely priced in by the markets. That said, the news flow we’re watching most closely for signs of a shift includes:

• Potential fiscal stimulus during the period before the election
• Polling data, including the election results for both the White House and the Senate
• Changes in corporate guidance for 2021 as companies begin reporting earnings this month
• Significant new policy announcements in the period leading up to the election or refinements of previously announced policies

Sector Implications

We can say in advance that stronger performance by Vice President Biden and the Democrats would likely benefit the future earnings of industrials, utilities, and renewable energy companies while hurting fossil fuel players. Yet even if that outcome transpires, any changes to our positions will reflect those fundamentals—as well as the extent to which the market incorporates them.

Likewise, stronger performance by President Trump and the Republicans may benefit certain companies in the healthcare and defense industries.

Recently, an emerging focus has garnered more attention: Antitrust Regulation of Big Tech. While Congressional hearings continue, will there actually be increased regulation? Implementation is more difficult and nuanced than commonly perceived. First, passing policies may be challenging. Second, regulations may accidentally entrench the advantages of the big tech companies. And third, some tech companies’ shareholders might benefit if they’re forced to split up.

When we think about election implications, we’re watching the balance of power in the Senate just as much as the Oval Office. While the historical returns for unified governments are lower than divided governments, we think it’s different this time. One concern across our teams is the prospect for further stimulus to offset the negative shock of the pandemic. The inability to reach an agreement on stimulus spending this fall, just ahead of an election, highlights how difficult it could be to negotiate a deal in a divided post-election government. Likewise, the degree of unified control could affect policy priorities, such as the form an infrastructure plan takes or the extent to which regulations are rolled back or reintroduced.

 

To be clear, we believe the economy needs stimulus. While many jobs are coming back, the labor market continues to bleed a staggering number of jobs each week. Congress and the Fed took swift action to keep poor cash flows from turning into a solvency crisis for small businesses, but amid a prolonged pandemic recession, many remain too close to the cliff’s edge. If these businesses go over, it will make the eventual recovery that much tougher. The prospects for the economy and the market—both in the short and long run—are much better with stimulus. We’re watching that very closely.

In the municipal bond space, we continue to see large amounts of newly issued bonds, capitalizing on low interest rates and preempting election uncertainty. Our municipal bond team delved into election outcomes in their recent blog, How Tax Policy May Impact Municipal Bonds. Regardless of the election results, though, municipal bond allocations remain quite safe and our teams can also allocate to Treasury bonds to offset volatility.

Across the board, our goal is to create portfolios that can safely navigate whatever the news brings and take advantage of any opportunities turbulence presents. That starts with strategic asset allocation—making sure you have a balance of stocks, bonds, geographies, and other drivers of investment returns that can weather temporary storms and allow you to reach your long-term financial goals. That’s the most important pillar of your investments. Finally, all our investors in actively managed strategies benefit from diligent research and risk management. As the news changes, so will our positioning. And through all of this, we’ll keep our clients informed.