Portfolio positioning for 4 November and beyond
Sal Bruno, CIO, IndexIQ, has bravely waded into our ongoing comment column on the forthcoming US Presidential election.
It was an October Surprise that really was a surprise. In a tweet that went out at 12:54 AM on October 2, President Trump wrote that he and his wife, Melania, had tested positive for Covid-19 further upending what had already been a highly unpredictable election.
This came on the heels of the first presidential debate, an event that generated a lot of heat but not too much light and one that appears to have done little to change the dynamics of the race. With barely a month before voters go to the polls, former Vice President Biden continues to lead. How President Trump’s diagnosis impacts this remains to be seen.
One thing we do know is that the polls have often proven unreliable, as the last election cycle demonstrated so clearly, and Trump voters continue to believe they are undercounted. For our part, we think it’s most useful to view the Presidential race as up for grabs. October still looms ahead and the prospect of some kind of ‘October Surprise’ can’t be counted out.
In down-ballot elections it seems likely that the Democrats will continue to control the House of Representatives while the Senate has moved from leaning Republican to being a much closer call. The pending hearings on the nomination of Amy Coney Barrett to replace the late Ruth Bader Ginsberg on the Supreme Court have further energised those on both the left and the right and added another level of uncertainty to the debate.
A Democratic White House
There are three broad policy areas of policy to consider in examining the impact of the election on investors and the economy: taxes, regulation, and fiscal stimulus.
Should the Democrats sweep, we expect to see major shifts on all fronts, with taxes likely to rise across multiple areas including income, estate, and corporate. New taxes may be introduced on wealth and financial transactions, while the so-called ‘carried interest’ deduction will probably be a thing of the past. Less obvious but equally important, the regulatory environment may become more restrictive.
While these initiatives, if realised, will probably weigh on economic growth, at least in the short term, they are likely to be counter-balanced by more aggressive Democratic fiscal policy. This could include more and longer support for the economy, new social spending, a higher minimum wage, relief for cities and states, and some form of student loan forgiveness. Collectively, this could add trillions of dollars in new stimulus and put substantial new disposable income in the pockets of consumers, a major boon for the economy.
And of course, there’s healthcare, which has again come to the fore thanks to the pandemic, the reconfiguration of the Supreme Court and the challenge to the Affordable Care Act that is currently pending on the Court’s docket. This complex, emotionally charged segment of our economy has historically been resistant to quick fixes. Should the Democrats prevail – and especially if they capture all three branches of government – we would expect to see movement towards a single-payer system, with enthusiastic support from the Bernie Sanders’ wing of the party.
Should President Trump rally to win, he is likely to view the election as a mandate to continue the policies of the last four years. This would probably mean more pressure on China and trade, more deregulation, a continuation of the ‘America first’ approach to international relations, modest healthcare reform, and another round of tax cuts. We would expect a smaller contribution on the fiscal side.
Positioning for 4 November
The coronavirus pandemic has dominated investor thinking for much of the year, but now the focus is turning squarely on the election. President Trump has continued to question the validity of a result in which mail-in voting is likely to play a disproportionately large role. Regardless of the merits of the argument, the idea that the election results won’t be finalised for weeks after the polls close – and that they may be actively disputed – is beginning to unsettle Wall Street and contributing to increased volatility.
For investors considering how to position for this changed world there are a few things to consider. First, fiscal policy will have an impact regardless of who wins, at least in the short term. A more aggressive policy should be more supportive of growth; one targeted to lower income people should underwrite additional consumer spending and potentially boost related sectors of the market – consumer cyclicals, for example. Forgiving student debt, or some part of it, would also be stimulative, if it happens, as would increased deregulation.
Trump’s election in 2016 initially shocked the markets, but things settled down pretty quickly and stocks moved on to record highs. The economic crosswinds are more complex this time around, as global economies continue to grapple with the impact of coronavirus. Still, over the longer haul the U.S. has demonstrated extraordinary resilience, and we have seen stocks perform well under both Democrats and Republicans.
Building a resilient portfolio
If the polls are right and Biden wins, investors could be looking at a significant portfolio repositioning. Higher tax rates may drive demand for municipal bonds, as individuals seek to generate tax-advantaged income. The bonds themselves may be easier to come by, as states and municipalities raise debt to spend on infrastructure projects. This is a space where we clearly see the value of experienced active management, where a professional can not only understand the fragmented and inefficient nature of this market, but use it to investors’ advantage.
Another possible beneficiary: Environmental, Social & Governance (ESG) strategies. These have been gaining assets for some time and may see further demand should the Democrats prevail as more money flows to ‘green’ industries like solar and wind power.
No matter the election outcome, the Fed is committed to keeping rates low so investors will want to keep a close eye out for opportunities to add income while mitigating volatility. High yield bonds are one possibility where there are opportunities to identify high yield bonds with lower volatility than the broader category.
An aggressive fiscal policy puts pressure on the dollar making international investments more attractive. That movement could be further supported by a less confrontational foreign policy likely to be pursued by a Biden Administration. When looking internationally, however, investors cannot forget the impact that currency movements can have on returns. The US dollar has been declining, but there is no guarantee that trend will continue. The US dollar remains the world’s base currency and is often thought of as a ‘safe haven’ asset. So we recommend looking internationally, but putting on a 50 per cent currency hedge, something we’ve long termed ‘the hedge of least regret’.
Finally, liquid alts, many of which are designed to provide exposure to the markets while reducing volatility, are worth considering.
While conflict has defined this election cycle, the two parties do have a few ideas in common. Both favour infrastructure investment, which could be good for real assets like real estate. Both have targeted high consumer drug prices, putting pressure on big pharma and biotechs. Offsetting this is investment in coronavirus research, also likely to be a priority of both administrations, and support for the repatriation of parts of the pharmaceutical manufacturing chain.
Unpredictable and unprecedented are two words we may need to retire as 2020 finally draws to a close, but not until we’ve made our way through the upcoming election. Yet for all the unpredictability, opportunities remain. With that in mind, we recommend that investors vote for resiliency as they consider their options for the rest of this year and beyond.