Buckle Up: A Rocky Six Months Ahead

The US equities markets continue to graze all-time highs as companies from a wide range of industries consistently beat earnings forecasts. While FED interest rates remain near zero, and inflation persists at a nominal level, businesses are posting better-than-expected growth considering the favorable lending conditions. However, when the market hits an all-time high, I will always be skeptical…

The markets are headed for a 10-20% correction, and the catalyzing event will be the Fall’s US Presidential election, regardless of who wins the presidential race.

The markets react more positively to a Republican than a Democrat taking office, because conservative government generally opposes regulation, and enables businesses to proceed more on their own terms. A deregulated environment increases the potential for greater profit margins, but also increases the possibility for an economic collapse exemplified in 2008. Regardless of the risks, investors lust for the opportunity to generate more profit. To be clear, I am not arguing that the economy performs better under a Republican, but rather that the markets get exited about a more deregulated economic environment.

In contrast, a Democratic administration will be more inclined to impose regulation, sometimes limiting the potential for businesses (particularly financials) to make exorbitant profits. These are simply different degrees of managing risk in a capitalist system.

If Hillary Clinton wins the Presidential race in the Fall, the markets will fall into a 10-15% correctional phase in the following months. Thereafter, I anticipate that the FED will begin its gradual interest rate increase in Q1 ‘17, and economic conditions will continue to improve nearly a decade after the most devastating financial collapse that was the Great Recession. Clinton promises more stringent regulations than those of Trump, and the market will react somewhat negatively at first, but should subsequently enter a long-term growth phase.

If Donald Trump claims the oval office, the markets will undergo a similar dip at first. Although Trump has promised the removal of numerous trade deals that would supposedly facilitate international commerce under more favorable terms, the greater economic philosophy of his administration is vague, and the markets sour when confronted with an unclear future. The financial industry could directly benefit from a deregulating Trump administration, but overall market sentiment would be disturbed by an uncertain future. A smaller correction is plausible at the beginning of a Trump administration, but the uncertainty associated with a Trump presidency bodes poorly for the equity markets.

All else equal, history shows that the stock market performs below average in the first year of a Democratic administration, but above average in the following three years. On the contrary: the market performs well when a Republican takes office at first, but underperforms over the following three years. I interpret this phenomenon as the market overlooking the positive impact that Democratic regulation has on our economy. While the market sours at the news of new regulation and thus temporary slowdown, history proves that the long-term implications generally contribute to the economy and foster sustainable growth.

Public equities are positioned for a correction this Fall regardless of November’s election result, but could subsequently enter another great bullish era in American history.

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One Comment Add yours

  1. Byron McCann says:

    Good overview of potential outcomes of the election. Sounds like the long term investor should sit tight and maybe increase positions when the correction hits.

    Like

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