5 min read
Performance
Stocks endured a choppy ride over the quarter, with domestic and international indices recovering from a mid-summer dip to ultimately end substantially higher. Bonds rallied as well, pushed higher by the prospects of a declining interest rate regime, which came to fruition via the ½% short-term rate cut from the Federal Reserve in late September. The pace and magnitude of Fed rate cuts over the next three months will help determine the market’s direction leading into 2025.
Stocks
U.S. stocks (Russell 3000) experienced ample volatility during the quarter, overcoming a hiccup in August before rebounding to finish the quarter in record-high territory. Increasing stress on the labor market helped cause the mid-quarter nervousness in markets, as did the intrigue surrounding what the Fed would do with interest rates. International stocks (MSCI All Country World Index ex-U.S.) performed strongly to overtake their U.S counterparts for quarterly leadership, and emerging markets (MSCI EM) companies once again bested developed markets (MSCI EAFE) stocks. The change in Fed rate policy towards lower rates helped lead small-sized (S&P SmallCap 600) companies to a decisive advantage over large-sized (S&P 500) and mid-sized (S&P MidCap 400) stocks. Lower rates could provide a boost for smaller companies, as they can typically benefit from lower financing costs as rates decline.
Bonds
Expectations for rate cuts drove bond (Bloomberg US Aggregate Bond Index) prices higher over the course of the quarter, a position cemented with the announcement of the first Fed reduction. (Reminder: Bond prices typically move in the opposite direction of interest rates.) With an additional 2% or more of rate cuts priced in by the end of 2025, bonds seemingly are positioned to perform well whether the economy experiences a recession or “soft landing.”
Alternatives
Alternative assets posted a gain during the quarter, led by a significant increase in global real estate (FTSE EPRA/NAREIT Developed). Commodities (Bloomberg Commodity) and natural resources stocks (S&P Global Natural Resources) also posted positive contributions to boost the overall asset class performance.
Perspective
“Politics is far more complicated than physics.”
– Albert Einstein
“If elected I shall be thankful; if not, it will be all the same.”
– Abraham Lincoln
If you live in a swing state like Michigan, no matter the election outcome on November 5, you might mimic Honest Abe’s gratitude in celebrating the end of political ads. Although some of us might feel like Einstein trying to make sense of politics, this quarter’s Thrive investment commentary will attempt to make sense of election season. Through a discussion of potential outcomes, economic policy possibilities, and helpful investment strategies, we’ll seek to help you deal with election season.
The U.S. has lived through close elections in the past two presidential cycles, and 2024 is setting up to be no different. In fact, recent polling in the seven states that will likely decide the presidency in the Electoral College – Michigan, Wisconsin, Pennsylvania, Nevada, Arizona, Georgia, and North Carolina – indicates that the presidential margin of victory may be even closer than either 2016 or 2020. The race for control of Congress seems to also be balanced on a knife’s edge. The House is likely headed for another very slight majority – whichever party is in control. While the election map slightly favors an outcome of Republican control of the Senate, it is far from certain.
Factoring in a highly competitive presidential race, there is a reasonable chance of political gridlock in Washington for at least the next two years. If neither party achieves control of both the legislative and executive branches, the more ambitious economic proposals from each side will almost certainly be shelved in favor of implementing more incremental changes which has marked the recent period of divided government.
Focusing on economic policy, the scheduled sunset of the provisions in the Tax Cuts and Jobs Act (TCJA) at the end of 2025 will necessitate some interesting discussions in Washington on the future of tax policy. Personal and corporate tax rates, child tax credits, standard deduction amounts, and estate tax exemptions are just a few of the TCJA pieces that would need to be revisited and either amended or extended. In such a closely divided political culture, the 2025 legislative battle over economic policy promises to be a contentious battle regardless of the election outcome this fall. Keep in mind that divided government is not necessarily a recipe for stock market strife; while returns of unified government have been historically higher than other scenarios, performance has been strong in any environment (see chart below).
Another thorny issue, of course, is the ever-expanding national debt, a problem that has metastasized over presidencies of both parties. Neither party has exhibited great fiscal discipline since the financial crisis of 2008 (see chart below), and the policy proposals from both parties does not engender much faith that the mounting debt will be addressed anytime soon. If anything, the debt problem is likely to increase in scope, due to projected continued deficit spending during the next several years.
Chart Source: columbiathreadneedle.com
On the positive side, stocks thus far in 2024 have shaken off geopolitical strife and a mid-summer bout of volatility to post strong year-to-date gains. While the magnitude of gains this year is larger than historical norms (see below), the trend in 2024 is not dissimilar from prior election years. On average, since 1932, stocks have seen larger gains in the immediate six months following Election Day compared to non-election years. Whether or not that trend continues in the aftermath of this year’s voting remains to be seen. There are still real concerns about a slowdown in the labor market eventually sparking a recession, even though other economic indicators remain mostly positive.
Positioning
What should investors do amid all the uncertainty regarding which presidential candidate will emerge victorious, or which party will control Congress? First, try as best you can to remove emotion from your investment playbook and resist the temptation to base allocation decisions on political factors. Second, recognize that “True Wealth” is not predicated on the outcome of a single election. While we certainly recognize that specific policy proposals can affect your financial plan, True Wealth – however you define the term – results from cherishing the things that are most meaningful in our lives, no matter the political climate.
We also reiterate our typical admonition against making rash “all-in” or “all-out” decisions based on electoral results. As the below chart of S&P 500 Index performance since the inauguration of Franklin Roosevelt shows, stocks have performed well over the long run (albeit with occasional blips along the way) regardless of who has won the presidency.
Basing an allocation decision solely on the heightened emotions of an election season often lead to outcomes that substantially reduce your chances of achieving your financial goals. Instead, concentrate on the key tenets of asset allocation, global diversification, cost sensitivity, and marrying your investment strategy to your financial plan. We’re always available to review your plan and discuss how well you’re tracking towards goals. Often, a simple conversation to check in with your advisory team can provide the reassurance and perspective you need to feel comfortable navigating the election landscape.
When it comes to the state of the economy, we still see a dichotomy between positive signs and potential roadblocks. On one hand, economic growth, corporate profits and consumer spending all remain constructive for the near-term future of stock prices. However, some slight fissures within the labor market, the increasing level of credit card debt and declining consumer savings could pose challenges on the horizon. As a result of the conflicting information, we are content to remain in our slightly defensive positioning – which translates into a slight underweight to stocks relative to benchmark weighting. At the same time, we are on the lookout for a pullback in stock prices to provide a good buying opportunity to return to neutral weighting.
We are also comfortable with our dedicated small-cap U.S. stock allocation, as well as with our ex-China emerging markets index fund. Small-cap stocks, with a significantly higher proportion of their outstanding debt tied to floating interest rates compared to larger companies, are poised to benefit from falling financing costs (barring a recession). Regardless of who wins the U.S. presidency, it seems likely that a reasonably tough stance against China will persist within the next administration. Coupled with the property market, economic growth, and demographic troubles presently facing China, we are taking a wait-and-see approach to future dedicated exposure to the Chinese stock market.
As the end of the campaign season approaches, the team at Planning Alternatives is ready to assist you in this moment of election uncertainty. Whether it’s carefully reviewing your financial plan, adjusting your level of portfolio risk, or helping identify what constitutes True Wealth for you – rely on the collective experience of our team to help navigate you through the current environment.
Please contact us with questions, or just to chat!