'Profit Over Politics'

• Riverfront believes the results of this election will have less long-term stock market impact than commonly believed.
• Under US ‘Economic Exceptionalism,’ economic and earnings growth tends to shine through, regardless of political regime.
• We believe markets dislike the unknown…but tend to recover quickly after political uncertainty clears up.

From now until November 5 — and perhaps for some time after — good luck having a conversation about any topic other than the US Presidential election. By most admissions, the race is too close to call. As of publication time, Real Clear Politics pre-election polling puts the lead for former President Donald Trump in swing states at well under the 3.4% threshold that CNN estimates as polling error ‘noise.’ Congressional races — which generally have fewer polls from which to draw conclusions — appear just as close and thus next to impossible to call. The good news is Riverfront believes the results of this election will have less long-term market impact than the news would lead you to believe.

Elections tend to bring out the strongest of emotions in citizens…particularly in an uncertain and politically polarized environment. While this is understandable, we urge investors to check their personal emotions concerning politics at the door when it comes to making portfolio decisions. In our opinion, Presidential politics rarely has the effect on stock market outcomes that many expect. Instead, in our view, corporate earnings trends and interest rate direction predominantly drive intermediate-term stock prices. US corporations have a history of successfully adapting to changing environments.

While new administration policies can be disruptive at first, US companies typically figure them out. This is at the heart of US ‘Economic Exceptionalism’ — Corporate America’s unique, world-class combination of innovation, dynamism, and flexibility that "we have written about here.":https://www.riverfrontig.com/insights/american-economic-exceptionalism/

US Economic Exceptionalism is ‘bipartisan,’ in the sense that economic and earnings growth tends to shine through, regardless of political regime. This is borne out in the historical record. Since the start of the S&P 500 in the mid-1950s, only two Presidents have presided over negative index returns (see Chart 1, below). In both instances, external factors (the Arab oil crisis, tech’s collapse and a historic financial crisis) played a significant role. More recently, stocks fared exceptionally well under both the Trump and Biden/Harris presidencies, confounding critics of both political regimes. Given our positive current views of both "the US economy and corporate earnings trends,":https://www.riverfrontig.com/insights/riverfront-quarterly-chart-pack-oct-2024/ we expect this recent uptrend in US markets to continue — regardless of what happens on November 5.

We have the US Constitution to thank for limiting the power of any individual or political party through our three-branch government system and Presidential term limits. This is not to say that politics does not matter… political policy that meaningfully impacts economic policy can affect markets. However, a President rarely has the mandate from Congress to enact the full extent of their intended policies, even with a legislative majority. Regardless of the composition of the government, the market’s exceptional earnings engine tends to take center stage — ‘profits over politics,’ we might say. But since a full sweep by either party cannot be ruled out, we think a fair, non-partisan method of handicapping the potential market impact might be to highlight the most likely effects of such a sweep.

As we wrote about in our ‘Trumponomics’ series earlier this year, our best guess is that Trump’s economic policies, if enacted in full, would likely cause both US nominal GDP growth and inflation to rise, along with the value of the US dollar and long-term interest rates, in our view. At this time, we do not see a repeat of 1970s-style inflation as a result, as the current Fed is more vigilant and US energy supply is in a much stronger position than in the seventies. Thus, we think a GOP sweep scenario can support positive gains in stock markets, particularly in the U.S.

• What We Would Worry About Most in a Red Wave: Broad use of tariffs could create higher inflation and uncertainty…potentially harming valuation multiples. We will also watch Presidential rhetoric surrounding the Fed; we believe the Fed’s assumed political independence is an important component of the US market’s premium valuation.

• Possible thematic beneficiaries: Small-capitalization US companies which disproportionately benefit from corporate tax cuts, financials, US energy, US-centric companies, gold, value sectors.
• Sectors that may be disadvantaged: International stocks, China assets, multinationals reliant on offshoring and/or with large international revenue exposure, US longer-maturity government bonds.

Under a Vice-President Kamala Harris win, along with Democrats gaining control of both houses of Congress, the biggest changes we would expect to see relative to President Biden’s current platform would revolve around increases to taxes for corporations, wealthy individuals, and investors. All else equal, we feel increases to corporate taxes tend to have a direct, negative effect on earnings. However, with an easy monetary and fiscal backdrop to support business investment and consumer spending, we expect US stocks would continue their winning ways over the next few years under Harris.

• What We Would Worry About Most in a Blue Wave: Increased regulation and higher corporate tax regimes could damage corporate earnings and business sentiment; investment-related taxes could hurt after-tax returns and wealth transfer.
• Possible thematic beneficiaries: Infrastructure spend beneficiaries, renewables, and green energy.
• Sectors that may be disadvantaged: Highly taxed utilities and consumer stocks which benefited disproportionately from the 2017 tax cuts, US oil and gas, pharma due to potential regulation.

With a race this close, we should expect that we may not know the results as soon as we would like. There could be a challenge to the results by the losing party in either political scenario. Congressional results may take an especially long time to tally — for instance, even in a ‘normal’ election, we may not know the House of Representatives’ results for weeks.

In general, we believe markets dislike uncertainty, but also tend to recover quickly after political uncertainty is cleared up, regardless of who wins. But what about the potential for social unrest to follow a contested election? It is worth noting that during and after the 2020 election, the S&P 500 rose fairly consistently from Election Day to Inauguration Day the following January, despite significant political turmoil surrounding election results.

Elections tend to bring out the strongest of emotions in citizens. What can be lost in the noise is our view that, generally speaking, the structural advantages that the US enjoys — what we have termed as US ‘Economic Exceptionalism’ — will likely persist regardless (and often in spite of) who holds political office. In uncertain times like these, it is also worth noting that our investment team’s motto is ‘Process Over Prediction.’ Our process is to reassess our views as new information comes in and act accordingly, if necessary. Should our internal view of risks related to the election outcome increase significantly, our risk management process allows us to be nimble with regard to portfolio construction.

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Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.