Election Expectations: Matt Palazzolo on Whether Investors Should Make Moves Ahead of November

Stacie Jacobsen: Thanks for joining us on The Pulse by Bernstein, where we bring you insights on the economy, global markets, and all the complexities of wealth management. I’m your host, Stacie Jacobsen. Today we’re talking about the U. S. presidential election. Now with all the noise, we’re here to focus on one main question, and that is, how will the election affect the economy and the financial markets?

Historically, stock market returns have not been materially impacted based on who wins the White House. But can we count on that same consistency in today’s political climate? Here to help us answer that question is Matt Palazzolo, Bernstein Senior National Director of Investment Insights. Matt, welcome back to The Pulse.

Matt Palazzolo: It’s great to be with you, Stacie, and happy to be here. 

Stacie Jacobsen: All right. Let’s jump right into the impact of the election on the market. So historically, market returns have been indifferent to which party sits in the White House. Yet it seems before every election, there is a bit of angst as investors contemplate the impact.

So, will you give us a little bit of background on how the markets have behaved depending on who is sitting in the White House? 

Matt Palazzolo: Yeah, so look, it’s a great question. It’s a question that we get every four years around any election cycle. Investors are prone to ask, you know, what does this mean if this candidate wins or if this candidate wins?

Look, if you go back and you look at the totality of the data on average, whether it’s a Republican president, if we’re dealing with the United States or Democratic presidents, the average return is almost the same. It’s about 7 percent for both parties. So, I would say investors should focus less so on whether it’s, it’s their candidate that wins or their party that wins and not the other, but the policy certainly matters, but more important than all of that to the market returns is whether or not the companies that they own in their portfolio are growing their earnings and executing their plan less.

So, what happens on Capitol Hill? 

Stacie Jacobsen: Got it. And do you think that will hold true for this election season? 

Matt Palazzolo: I think in general it will hold true. Again, there’s a lot of evidence that suggests that what matters to markets is profitability, right? Take your average company. For the most part, the vast majority of their earnings are driven by whether or not they’re executing their strategic business plans and whether or not they’re driving top line growth and bottom-line growth.

Of course, now there are some sectors that are more or less influenced by policy that can come out of Washington, D. C. I’m thinking utility sectors, energy, banking and so forth. But even them, the most amount of their stock price movements over time is going to be driven by the execution of their strategy and top and bottom-line growth.

So, if we’re looking at the 2024 election cycle, we’ve got two candidates that are on many policies. That being said, there are some areas that the market is focused on. These are the areas that tend to impact top and bottom-line growth, things like corporate tax rates. 

Stacie Jacobsen: So, what areas are of the market are more impacted by policy and who’s in the Oval Office?

Matt Palazzolo: You know, if you would look at the areas that the market tends to focus on, these are the business-friendly policies that are either implemented or not in place during an administration. Corporate tax rates matter a lot. You might remember several years ago, the corporate tax rate was cut from 35 percent down to 21 percent.

The market really applauded that regulation. How easy or hard is it for businesses to get things done? That matters a lot. So those are two areas that I would say the market is certainly focused on this time around at whether or not there’s any change to where we stand on those issues remains to be seen, but it’s important to not conflate our own personal views about what this candidate or that candidate means for the country and focus more on what it means for business and the economy.

Stacie Jacobsen: All right, Matt. So, you made it clear that although markets are relatively indifferent to who wins an election under divided governments versus unified governments, markets do behave differently. 

Matt Palazzolo: Yeah. So, this is a great point and a little bit of a nuance. And I mentioned a moment ago that no matter if you’re looking at a Democrat president or Republican president, the average return is about 7 percent for both.

But if you dig a little bit deeper and you look at the makeup of Congress, to your question, when Capitol Hill is divided, meaning Congress is split between the House and the Senate, that has generated on average an 8 percent return over time. Whereas if you have a unified Congress, the average return is 5 percent.

Now look, that could be just coincidence. I tend to think that it’s not, and here’s why. The market tends to like gridlock because then they don’t have to analyze and try and forecast and predict what’s going to happen and come out of Capitol Hill. But when you have gridlock, not a lot happens, not a lot comes from a divided government.

And so, analysts like our team can just focus on what’s happening from the company’s perspective, less so what’s happening on Capitol Hill. So that’s a big enough difference that I think we need to pay attention to it. And certainly, for the 2024 election cycle. 

Stacie Jacobsen: All right. Now you had mentioned sectors early on that might be impacted differently based off of the presidency.

So, are there times when the market does pay closer attention to what happens in DC? 

Matt Palazzolo: Yeah, well, certainly around election cycles for sectors like energy, like banking, like utilities, they’re always watching policy that these are heavily regulated industries. And so, what happens either at the local level or at a national level matters a lot.

So, I’d say it’s not sometimes more than other times. It’s more, you know, the industry versus other industries, which are less impacted by consumer staples. If you’re just making just regular consumer products, less so. But, but these heavily regulated industries are always paying attention and trying to have conversations with policymakers in order to tip the scales more in their favor.

Stacie Jacobsen: All right. Now, in the last election of 2020, you know, it was very clearly top of mind for most voters was COVID, right? We were in the depths of it. When you look at this election in 2024, what is it that voters are most concerned with? 

Matt Palazzolo: You know, it’s the economy, right? To go back to that old saying, and I won’t say it fully, but it is the economy that matters in 2024.

Think about the last couple of years from your average consumer’s perspective, what they’ve been contending with very strong inflation since the beginning of 2022 gasoline prices have moved around a lot, but more importantly, food prices. Goods prices, services, prices are all up meaningfully from the beginning of that year.

And that’s part of the conversation when, when the two candidates are out on the campaign trail. So, the economy and specifically inflation, housing affordability is another issue that is being talked about a lot. If you watch any of these debates, it’s front and center for the candidates. So, the economy, roughly around 40 to 50 percent of what the individual voter is focused on of all the different areas that they can focus on tends to be the economy these days and so that’s why that’s taking up a lot of airtime in the media and debates and so forth.

Stacie Jacobsen: in our last episode we just discussed the impacts and the influences on consumer spending and how there’s a shift in the way that consumers are spending based off of the topics that you just hit on. 

Matt Palazzolo: And I would mention Stacie, you can talk to folks like myself about the economy and we’ll say something.

And I might say inflation is at a tame level, whereas the average consumer would say inflation is still a problem. It’s because we’re speaking different languages. I’m talking about the rate of change over the last year. They’re talking about the absolute level of a carton of milk or eggs or so forth.

So, you know, it’s important for the candidates to focus on not just the as much what, what I’m focused on as an investor, but to focus on what the average consumer is feeling when they go to the grocery store or when they go to their average store to buy apparel or anything else. 

Stacie Jacobsen: Okay, Matt. So, if the candidates are concerned about the voters and the consumer and the absolute level of inflation, um, and given that you had just said that what’s top of mind for voters is the economy.

What can the candidates do about it?

Matt Palazzolo: From an economic perspective, just a purely economic perspective as investors, I would say we’re not in favor of government intervention into controlling prices or having an impact on prices. We’d rather supply and demand and monetary policy have an impact there and try and bring inflation down to a comfortable level, which again, I’m speaking a different language than the average consumer is.

Inflation today is at a very reasonable, comfortable level. They’re not where they were back in 2021 or 2019, but the rate of change year over year is almost squarely where the federal reserve wants it to be. 

Stacie Jacobsen: So that does lead me to the debt and deficit because look with both the candidates, the one thing that would really be consistent is that the deficit is likely to grow under either one of them.

So, what does that mean for the economy and the markets? 

Matt Palazzolo: You’re absolutely right. You know, if there’s any consistency across these two candidates is that the, the level of debt that we have in the United States, federal debt that is, and, and the size of the deficit is likely to grow. They’re going to get there in different ways.

Candidate Harris would likely be through more spending, candidate Trump would be through lower taxes. There’s a whole host of other factors that would lead to these higher deficit levels. But from our perspective again, purely economic, you know, we would say that higher deficit levels, higher debt levels ultimately weigh on future growth, right?

Think about a country or a household that has more debt than they would if they didn’t have as much debt. They’re needing to take more of their income and pay down interest expense or pay down the debt over time, as opposed to investing it into projects and programs that help to facilitate growth in the out years.

So, you know, when this ultimately comes to a head and the market or the economy or consumers throw up their hands and say, look, enough is enough. The deficit is too large. The amount of debt that we’re holding in this country is too large. I don’t know if it’s 2025 or 2055. We’ve been complaining in this country about the amount of debt and the size of the deficit periodically for decades, but at some point it comes to a head and it’s going to get dealt with.

And again, from an economic perspective, we hope that we have a positive resolution to where we stand today and where we’re likely to grow to over the next handful of years. 

Stacie Jacobsen: You mentioned the corporate tax rate change from 35 percent to 21 percent. I want to tie that together with the earnings growth. So, the market is anticipating earnings growth to accelerate in 2025.

However, if corporate taxes go up, earnings will likely take a hit. 

Matt Palazzolo: It’s always difficult when you get to these milestones, you know, where DC and policy is interacting with market assumptions. But yes, if corporate tax rates were to revert back up to 35 percent or to go maybe somewhere in between 27 or 28 percent, which has been kicked around, that would be a one-time hit to profitability.

The market admittedly hasn’t really focused on that just yet. So, you haven’t seen a movement lower in stock prices as analysts start to put that into their models. But that certainly would be the case. You mentioned the earnings growth for 2025. The consensus expectations at the moment are for 10 percent earnings growth for S&P 500 companies on average.

That’s pretty robust compared to history, and in our opinion, slightly optimistic compared to our expectations. We’ve got penciled in something closer to six or 7 percent earnings growth. So, you know, we’ll probably be somewhere in the middle by the time, you know, 12 months from now, when we look back on all of this, but it does matter to market returns because the market is trading on a valuation, which is at the upper end of its historical range. And if you were to have earnings growth, that’s not 10, but it’s six or it’s five, and that’s going to impact the returns over the next 12 months. 

Stacie Jacobsen: All right, Matt, that leads me to tariffs. Now tariffs have been used to different degrees by presidents in the past.

This time around, there’s been a significant amount of debate around him. So, if we do see new or higher tariffs implemented, how might the markets react to that? 

Matt Palazzolo: Yeah, look, it comes down to the devil always being in the details and the magnitude of any tariffs, a 60 percent tariff on Chinese goods and a 10 percent tariff on all goods coming to this country would be inflationary.

That would push up the price of those goods, and so, I just think that at a time when we’re all of us worried about inflation resurging, and many of us were saying that inflation is still here, implementing some kind of economic policy that would further that concern I think is wrong from an economic and profitability standpoint.

So, we have to watch this very, very closely. I would expect that if that becomes more of a reality, that would cause some volatility in the markets as analysts start to figure out on a company by company basis, based on the products that they import. What does that mean for their profitability? Are their margins going to get shrunk?

Stacie Jacobsen: All right, Matt. So, for now, I want to ask, once we get past the election, what is it that you are looking forward to in 2025? 

Matt Palazzolo: So, look, our base case is that the economy continues to slow modestly through the balance of this year and into next year. I want to be clear here. Nothing cataclysmic, nothing that would cause any alarm.

From our perspective, the economy is slowing, but from a pace that was fairly robust in 2000 and ‘23. Our base case is that the Federal Reserve, then with the economy slowing the labor market, likely the cause of a lot of that slowing and inflation coming down towards target, as I mentioned earlier, that that would allow them to continue to cut rates to a level that is more neutral than restrictive, which is where they are today.

So, we’ve got penciled in three cuts in this year. They’ve already done one. They’ll probably take out another 50 or 75 basis points out of fed funds, and then a full percentage point out of Fed funds in 2025. Five, overall, you get an economy that is running at a decent pace, not great, but not weak.

Interest rates that have come down and are less restrictive companies that can grow their earnings mid-single digits and a stock market in a bond market that are likely to generate returns somewhere in that mid-single digit area as well. And after a great 2024 from an investor’s perspective and the great 2023 from an investor’s perspective, mid-single digit returns would be just fine.

Stacie Jacobsen: I am sure I would not be the first one to ask you this question, but how do you respond to clients who ask what action they should be taking either before or after the election based off of the results? 

Matt Palazzolo: Well, I would say, first of all, you know, let’s make sure that you’re at the right long term strategic asset allocation and assuming that they are.

My next thing that I would say was let’s not conflate our joy or concern about who won the 2024 election with what we should do with our portfolio and what we think that means for our portfolio. We started off the podcast talking about how there’s really no good correlation between who sits in the Oval Office and what market returns are.

That holds true, I believe, for the next four years. I would encourage that client very strongly to not make any meaningful adjustments to their portfolio. That being said, they want to make an adjustment at the margin just to allow them to sleep better at night, that’s fine. That’s not going to be disruptive.

It’s not imprudent to do so. But again, in all likelihood, the impact that D.C. would have on a long-term investor’s portfolio returns. The histories would suggest, and I think looking at this one, this election in particular, would suggest it’s not going to be meaningful, if at all. 

Stacie Jacobsen: Okay, thanks for that. Do you have any final thoughts or comments that you would like to leave our listeners with?

Matt Palazzolo: You know, again, as individuals, we focus on the president, and even the makeup of Congress, as important to the country, and it absolutely is. But our portfolios are different. Geopolitical risk is also weighing on a lot of these conversations and these concerns that investors have. But at the end of the day, what matters to our portfolios is the level of interest rates, which would suggest a more important person is not the president of the US but the head of the Federal Reserve.

So, let’s watch who that is over the coming years and, and the actions that they take. And then also on the equity side, the profitability of the companies that we’ve chosen or our managers, like ourselves have chosen to invest in the CEOs of all those organizations. They’re too likely more important than the gentleman or the woman sitting in the Oval Office.

Stacie Jacobsen: All right, Matt, thank you so much for your time today. I love having you back. 

Matt Palazzolo: My pleasure. Thanks for having me. 

Stacie Jacobsen: As always. Thanks to everyone for listening. We’ll be back in two weeks with another episode. I’m your host, Stacie Jacobsen, wishing you a great rest of the week.