Beware of Sharks...The Election is Approaching

By Dr. Robert Votruba

It’s often said that The President of the United States (POTUS) is one of the most powerful people in the world.  The President can influence tax policy, trade, government spending, and regulation, among many other consequential policies not related to the economy.  As election day approaches, candidates Harris and Trump are expected to continue highlighting their economic agendas because, as James Carville stated during the Clinton campaign, it's all about “the economy, stupid.”  While each candidate asserts that their respective plans will cure what ails us and create a brighter economic future, history tells us that even though the person sitting behind the desk in the Oval Office has the authority to give the final order to initiate a nuclear attack, he/she does not possess a secret code to control financial markets and the economy.  

Election years typically bring favorable conditions for financial markets, and this year is no exception, with most major stock indexes hovering near all-time highs.  You wouldn’t know it by listening to either candidate, but the US economy is in decent shape by most measures.  Talks of recession seem a relic of 2023, replaced by cheers of a Goldilocks economy.  Jerome Powell and the Federal Reserve Board’s (the Fed) dream of a “soft landing” might have already happened.  A soft landing is the label that describes bringing inflation down without cooling the economy so much as to trigger a recession.

On September 18th, the Fed lowered interest rates for the first time since the COVID pandemic, indicating that it feels a victory over inflation is near. The Fed stated, “The committee has gained greater confidence that inflation is moving sustainably toward 2 percent and judges that the risks to achieving its employment and inflation goals are roughly in balance.”   

So, with inflation nearing the Fed’s target, why are both candidates focused so heavily on rising prices? Because The Fed, like many others, is targeting the rate of inflation change. Over the past 12 months, The Consumer Price Index (CPI) has increased by 2.5%, not bad - in line with historical norms (if not a touch lower) and right around the Fed’s target.  However, none of this erases the 9.1% figure we saw in June 2022.  If we compare consumer prices to where they were in early 2020, we find that the cost of living has increased by over 20%. (*)  And therein lies the source of angst.  

By most measures, 2024 has been favorable for the economy and financial markets.  Both the stock and bond markets have enjoyed particularly cooperative conditions since early summer.   In September, bonds posted their fifth consecutive month of gains, while the rally in the stock market broadened beyond “The Magnificent Seven.”  With this in mind, it's interesting to observe how one’s political views affect their perception of how the economy is performing.  The following graph illustrates how people feel about the economy, given their political preferences, compared to how it is doing.   

Most voters focus on tax policy when considering economic agendas, and this year is no exception.  Although much of the current discourse may be rhetoric, once elected, our new President will champion some form of change to the tax code.  Former President Trump promises various tax cuts, while Vice President Harris advocates for increases for high earners and corporations.  However, these proposals will need to navigate Congress, making it challenging for either candidate to implement their agenda without control of both the House and Senate.  Even with complete control in Washington, a President’s wishes are not guaranteed. Just ask President Biden, whose proposed tax increases under the Build Back Better plan were shot down, even when his party controlled both chambers in 2020 – 2021.

Some worry Vice President Harris’s proposal to increase corporate taxes will harm markets.  During President Trump’s first term, corporate taxes were reduced from 35% to 21%.   He now proposes lowering them yet further.  On the other hand, Harris has proposed a plan to increase the rate to 28%.  Should she get elected, and her plan gets through the House and Senate, aside from the past few years, that would still leave corporate taxes at their lowest levels since the 1940s.

The Tax Cuts and Jobs Act of 2017 (TCJA), enacted during the first Trump administration, is set to expire at the end of 2025.  While the sunset will not impact corporate taxes, other changes include cutting the estate tax exemption in half and bringing bank personal income tax rates to the higher brackets of 2016 (including those making less than $400,000).  We will have an eye on this in the future for planning opportunities, particularly for estate taxes.  If the TCJA expires in its current form, income tax rates will revert to levels seen under President Obama, which is roughly where they were under President Clinton.   In looking at the market’s performance under the past dozen administrations, Clinton and Obama rank #1 and #2, respectively.

Correlation is not causation.  This lesson is often taught in statistics classes using the famous study of ice cream consumption and shark attacks.  Studies show that shark attacks are much higher when ice cream consumption rises, meaning the two variables are highly correlated.  Of course, even the novice statistician will catch that there is a third factor at play – summertime.  People eat more ice cream, and sharks have more beachgoers to feast on in the summer.  

Over the next few weeks, the regression modeling in the financial media will be on overdrive.  There will be talks about how the market might perform under Harris compared with Trump and how the market might perform under a unified Congress versus a divided one.  Past studies will be referenced, but they are no different from the example of the ice cream and shark attacks.   Particularly entertaining will be forecasts of the sectors that might perform well under different administrations.  Take the energy sector, for instance.  It’s common to hear projections that Republicans are more friendly to that industry, which could help their stock prices.  It seems rational.  Yet, the energy sector was the worst performing among the eleven while Donald Trump was in office and the best under Joe Biden.  The following chart outlines sector performance by President.  Note that the top three sectors were the same while both Obama and Trump were in office.  

While we don’t know what will happen in politics and financial markets over the next few weeks, we assume emotions will intensify as election day nears.  These conditions may continue beyond November 5th if the results can not be determined on election night, as has happened in the past.  Barring any changes in one’s financial circumstances, during times like this, the smartest move tends to be no move at all.  For evidence, consider the fate of the investor who invested over the long term alongside their political preferences.  A $10,000 investment made in the S&P 500 in 1961 that stayed invested only when a Republican was in the White House grew to $102,293 by the end of 2023.  Following the same strategy on the other side of the aisle was more fruitful: the same $10,000 grew to $500,476 if one stayed invested only when a Democrat was in office.   However, neither strategy compares with the $5.1 million that would have amassed had the $10,000 stayed invested regardless of who was in office.  Once again, “time in” versus “timing” the market wins out.

Robert Votruba, Ph.D.

(*) U.S Bureau of Labor Statistics

This material contains the current opinions of the author but not necessarily those of Guardian or its subsidiaries and such opinions are subject to change without notice. Data and rates used were indicative of market conditions as of the date shown. Opinions, estimates, forecasts and statements of financial market trends are based on current market conditions and are subject to change without notice. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security. All investments contain risk and may lose value. Indices are unmanaged, and one cannot invest directly in an index. Past performance is not a guarantee of future results. Past performance is not a guarantee of future results.

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