A client-friendly version of this article can be downloaded here.
Politicians and the media do a lot of talking about the economic implications for each political platform during major elections, which mostly creates a lot of noise.
In turn, much of this noise creates market volatility. However, noise and volatility become less relevant over appropriately longer time horizons for equity market investors.
History suggests to us that what happens within the Washington, D.C. beltway has little relationship with the broader U.S. economy and long-term financial market fundamentals. It is the fundamentals that really matter for investors.
PERFORMANCE BY ADMINISTRATION
Consider the price change in the large cap U.S. stocks for every administration since President Hoover. The only relationship between political party and stock market returns is that the market has seemingly performed better under Democratic administrations, but even that is a spurious relationship. Two republican presidents, Herbert Hoover and George W. Bush, had the bad luck of beginning their terms after the stock market had huge runs in the 1920s and the 1990s. Certainly, it could be said that the Hoover bubble burst was brought on by the Great Depression, and the Bush presidency ended with the 2008 financial crisis. However, in both cases, markets were set to fall from lofty price levels. If one were to adjust the results for this bad timing, the stock market returns under both party’s administrations becomes much closer over time.
IMPORTANT ECONOMIC FACTORS
We think that economic fundamentals, such as Gross Domestic Product (GDP) growth rates, and market fundamentals, such as valuations, matter over time. Clearly, history shows that earnings drive stock prices in the long-term. There are periods where prices deviate from earnings, and valuations compress or stretch, but the relationship over the long-term is telling.
Earnings growth drives stock prices, and earnings are heavily dependent on revenue. Revenue growth, in turn, is closely related to the nominal growth in economic activity, or NGDP, as the following graph demonstrates. When thinking about economic and stock market fundamentals, it is important to think about what drives NGDP growth.
Nominal GDP (NGDP) is real GDP, plus inflation. We care more about nominal GDP because revenues and earnings growth includes inflation. In generating its long-term forecast for real GDP (not including inflation), the Bureau of Labor Statistics (BLS) combines a forecast for labor market growth and productivity growth. Labor market growth is based on demographic trends, which move slowly and are relatively easy to measure. Productivity is more difficult to forecast because it is based largely on new technologies and innovation. The BLS forecasts annual growth of roughly 0.5% for the labor force, and approximately 1.8% for productivity growth, for a 2.2% real GDP forecast. To create a forecast for NGDP, we include an inflation factor using market-based inflation expectations as a proxy for what to expect going forward. We like to use the relationship between Treasury bonds and Treasury Inflation Protected Securities (TIPS) of the same maturity, known as the TIPS breakeven spread, to derive what the market thinks inflation will be over the next several years. The market expects inflation of roughly 1.5% over the next 10 years. As a result, we think that 3.7% (2.2% + 1.5%) is a good estimate for NGDP on average over the next several years.
By creating this nominal GDP forecast, we think that it is possible to create reliable expectations for U.S. economic activity, revenues, and earnings over the long-term. Obviously, short-term events can derail the economy’s near-term potential or accelerate revenue and earnings growth, but we think longer-term economic growth is rooted in these factors. Importantly, these factors suggest a positive environment for slow, but steady growth ahead.
None of these inputs to economic growth (labor force and productivity growth rates, along with inflation), corporate revenues, and earnings in aggregate are directly and significantly impacted by a presidential administration. Granted, an administration may have significant influence on specific industries through various policy measures (e.g. regulations or subsidies), but, in aggregate, what drives the U.S. economy is the stable growth rate of our labor force and productivity of the private sector. It is these factors that should be the areas of focus for broad equity market investors.
Unlike a centrally planned economy, such as China, these factors are not driven by the president. Through the wisdom of our forefathers, our system of checks and balances prevents any president from wielding too much power. The upward bias to our economy and our markets are a result of our democracy and capitalism. This has held true despite many different administrations, both republican and democratic, with very divergent economic and political policies.
Is it different this time? Yes, the candidates are different. Still, the dominant factors that drive our economy and markets are unchanged regardless of presidential administration. The demographic, productivity, and inflationary trends that drive our economy and financial markets are well entrenched. These trends indicate slow, but steady growth ahead and a positive environment for equity market investors with appropriate time horizons.
Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not be taken as an advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted.
The S&P 500 Index is an unmanaged index of 500 stocks used to measure large-cap U.S. stock market performance. Investors cannot invest directly in an index. Index returns do not reflect any fees, expenses, or sales charges. Returns are based on price only and do not include dividends or other sources of income. Past performance is not a guarantee of future results.
The securities identified and described may not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. Data is provided by various sources and prepared by Stringer Asset Management LLC and has not been verified or audited by an independent accountant.