Pendleton Street Advisors

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What to Expect Next Week

I must admit that anyone trying to forecast how our nation’s political process will affect the stock and bond markets during the same time is attempting a bit of a fool’s errand. So whether we’re fools, or good advisors trying to remind clients of important things, we are jumping into the fray perhaps a little early, ahead of the cacophony all of us expect in the coming days.

We do expect stock and bond market volatility to increase next week. In fact, we’ve already seen markets begin to react in anticipation of polling efforts that are taking place by the minute at this point before election day. It’s been widely reported that the S&P 500 just completed a 7 trading day (Oct 24-Nov 3) losing streak whereby the index lost—prepare yourself—2.9% over that time. I hope you can feel the facetiousness in that last sentence. Commentators nearly asphyxiated as they announced that the market hasn’t gone down in value 7 trading days in a row since 2008. Heck, most of us remember days in 2008 where a -2.9% day was considered a mild victory. But I digress.

Post-election volatility can come in a variety of scenarios that we’ll play out below. We’ll also arrange them in what we think is most likely to occur to least likely (but possible, think the “tails” of a bell curve).

  1. A clear electoral college win by either candidate: Volatility will ensue regardless of who wins. A Trump victory will cause some turbulence in the government bond market, and most of the stock market with the exception of a few sectors that could benefit from his presidency, think infrastructure stocks, and drug makers (due to the perceived lessening of prescription drug restrictions from ACA, etc.). A Clinton victory will most likely send drug stocks down, as there will be pressure from her supporters to tighten regs, and potentially control prices. Financial stocks also stand to get hit with a Clinton win. Nonetheless, a clear victory by either will send their respective shockwaves into the markets. Expect the effect to be short lived as buyers step in to these opportunities.
     
  2. An electoral win by one candidate, but with contested results from the other candidate: This is where volatility becomes more pronounced. We think this will affect the broader markets, and not be contained to specific “candidate friendly” sectors (see #1 above). Markets hate uncertainty. A contested election with accusations flying and lawyers jabbing will leave an already exhausted electorate in no mood to follow along. Markets will react with the populace. If an outcome is determined quickly, or a challenger concedes in short course, the damage should be minimal, and forgotten in days. If it’s prolonged, it won’t be good. However, the long term should not be adversely effected.
     
  3. Electoral college tie, House of Representatives decides the election: If this happens, we’ll all feel like we will receive honorary Master’s degrees in Political Science once the outcome is known. Here are links to two helpful resources to see how this would work here and here. These are both from House of Representative archival data, and not from partisan websites. Meanwhile the markets will be in quite a state of confusion. All of this relates back to uncertainty. The longer we wait for an outcome, the more we can expect markets to tantrum. It also shouldn’t be lost on anyone that politicians, central bankers, and other various policy deciders keep tabs on the markets. They all claim to not be swayed by this, but we’re all human. And most of us have assets participating in public markets. If it comes to this, expect the House rules to call a vote quickly, and hopefully an outcome is decided on the first ballot. What a way for this President’s administration to begin—a no confidence public vote, with a decision coming from folks who may not potentially be in office after the January inauguration. At least our Founders contemplated this outcome, and the process for determining a winner is known.

This begs the question; what is Pendleton Street doing about this? It’s a fair and timely question. And this is one where process trumps (bad pun, I know) prognostication. For starters, we create diversified portfolios tied to specific client objectives. Diversification may not be the most exciting strategy, but when volatility comes along, it makes a lot of difference. After diversification, our process includes portfolio rebalancing. This is where we take gains in overachievers, and buy more in investments that have not performed as well. Over time, this allows you to consistently buy lower, and sell higher. We do this several times per year. It is also a good way to harness volatility to work for you, rather than riding the wave. Cash is also something we’re a bit overweight in at the moment. This has been driven more by stock/bond valuation than the current political events. Having a cash buffer on hand during heightened volatility means you can be selective when opportunities arise due to a market tantrum that has overly punished something on factors unrelated to valuation. It’s the proverbial dry powder.

Volatility isn’t the enemy. It’s a normal part of a market. Emotions felt during volatility leading to rash actions are the enemy. Anyone remember the Brexit? In two days, the market was down 5%. 3 days later, the market had regained 90% of what it gave up the previous two days. If you sold stock on June 27th of this year, you were feeling pretty terrible by June 30th. This is on top of the bad feelings you felt that led you to sell on the 27th. When emotions are high, decision making clarity is low. Valuation discipline, diversification, rebalancing, and cash are all process driven things that we can do proactively regardless of market conditions. These activities matter for long term investors.

 

John H. Barnes, CFP®
President & CEO
 
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