As we wait for the votes to be counted on the day after the US election, it is important for us to reflect on what drives financial asset returns. Simplistically for bonds, investors expect a return that compensates them for expected inflation, credit risk of the borrower, and the real return above inflation on a risk-free asset such as a treasury bond. Similarly for equities, investors require a return to compensate for expected inflation, real return as well as risk premiums related to investing in equities such as value, momentum, and liquidity. Long term returns in public equities can be attributed to dividends, growth in earnings, and changing valuation multiples. The factors listed above are more influenced by where we are in the economic cycle than the head of state of the largest economy in the world.
While Presidents often use stock market indices as a barometer of their management of the economy, historical data is inconsistent with the notion that Republican Presidents are better for the stock market. The following table summarizes the returns under Democratic and Republican Administrations. On an annualized basis, the stock market as measured by the S&P has annualized 5% better under a Democratic President than a Republican President.
While the result of the Presidential election in and of itself is not critical, the belief in our institutions, rule of law, and the lower uncertainty of an uncontested election are critical in reducing the potential for volatility in risk assets. The reaction of public equity markets trading up (as of mid-day November 4, 2020) without a declared winner is likely in response to the relative calm in the streets and the split in Congress with the Senate continuing under Republican control and the House led by the Democrats. This would be consistent with historical data compiled by LPL Financial which shows that beginning in 1950, the average annual stock return was 17.2% under a split Congress, 13.4% when Republicans held both chambers, and 10.7% when Democrats had control.
Where does this leave your assets that WealthCo. manages on your behalf?
The noise around events such as elections, natural disasters, acts of terrorism, and other one off events can often lead to knee jerk reactions and behavioural decisions in response to volatility is not a recipe for success. As we communicated in the Q3 quarterly update, we believe the investment philosophy of using alternatives to diversify from public markets will allow us to build diversified portfolios with the objective of compounding capital over the long term. These investment vehicles allow WealthCo. and our investment partners to make decisions with information and data that can be viewed through a long-term strategic lens. By working with the best in class asset managers across the globe, we believe we can build portfolios that are higher in quality assets, have a reason to exist, generate income, and importantly grow income over time to preserve the purchasing power of your capital.
Peter Lieu, CFA
Chief Investment Officer
WealthCo Asset Management
Download Economic Cycles PDF - WAM Market Commentary November 4, 2020.
During times of market volatility and uncertainty it is natural for investors to question the health of their portfolios. Although this year was a difficult one, it highlighted the need for investors to take an active role in the health of their investments. Canadians who engage in financial planning report significantly higher levels of financial and emotional well-being than those who don’t.
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