Keeping Portfolio Balance in Election-Driven Market Volatility
Electoral surprises spur stock and bond market turbulence, but sensibly diversified and balanced portfolios don’t depend on political outcomes.
As markets were whipsawed by the changing fortunes in the U.S. general elections, re-pricing assets from a risk-on “Blue Wave” to a thicker-than-expected “Red Mirage” and the prospect of a continuing split in the two chambers of Congress, the merits of bottom-up, all-weather portfolios stood clear.
“Honestly, we’re not doing much,” said Jeff Klingelhofer, Thornburg’s co-Head of Investments and portfolio manager on several global fixed income strategies. “We don’t have to reposition the portfolios because we’re not positioned for a particular outcome.”
Those who structure risk exposures around singular events often run the risk of “availability bias,” which in behavioral economics usually refers to the tendency to assess risk or likely outcomes based on information readily available and reflective of consensus views. Polling organizations and betting markets clearly missed the underlying currents of support for President Donald Trump and Republican candidates for the Senate and Lower House of Congress. Most mainstream media outlets and social networks amplified forecasts that proved widely inaccurate, much like in the 2016 general elections.
Portfolios tilted toward a Blue Wave effectively bet on a new tsunami of fiscal stimulus poised to lift small- and mid-cap stocks as well as large-cap value stocks, all of which outperformed large-cap growth stocks in the two months to the election. At the same time, the expected gusher of new government bond sales sent the 10-year U.S. Treasury yield up 25 basis points to 0.9%, only to collapse 15bps in the wake of the vote as the market had to pare back its forecasts of Treasury issuance. All that anticipated issuance was supposed to gin up inflation, pressuring rates upward, boosting cyclicals, undercutting growth stocks and sinking the dollar to the benefit of overseas risk assets.
Red Mirage Melts U.S. 10-Year Treasury Yield
Portfolio Balance with a Longer-term View
Risk assets will likely get repriced again, as the definitive election results in key swing states become known. “The markets want certainty,” Klingelhofer points out. But that could take a while, especially given the Trump campaign’s lawsuits challenging ballot handling in those states, he adds. Rather than speculate about vote counts, legal outcomes and ultimate policy implications, it makes more sense to focus on portfolios populated with diverse securities exhibiting solid fundamentals, acquired at attractive valuations, and able to balance each other within a turbulent market environment.
To be sure, keeping an eye on political and macro risks is one of many aspects of risk management. We’re aware that, at this point, the likely scenario of a Biden Administration and Republican Senate suggests no revamp of Trump’s 2017 tax reform, which would be positive for corporate earnings. While we may finally get some infrastructure spending, it won’t be Biden’s version of a “Green New Deal,” if the post-election weakness in clean energy stocks after a great run is any indicator. A “skinny” new fiscal stimulus means less liquidity pumped into the economy and that much less of a growth rebound near-term. But it also means a lighter public debt load weighs less on the economy down the road.
Health care stocks outperformed strongly after the preliminary election results, likely reflecting the view that a “public option,” “Medicare for All” or a similar expansion of government-mandated benefits will be restrained. Will a Biden Administration try to reverse the Trump Administration’s deregulation campaign and restore more labor-friendly policies by doing end-runs around a Republican Senate with executive orders? Will a more conservative judiciary after Trump’s many judicial appointments brake a renewed expansion of the regulatory state? Will there be cooperation on China and other thorny international issues? Will both parties seek to more closely regulate the dominate tech companies?
“While Democrats and Republicans generally have differing opinions regarding energy and healthcare, Biden and Senate Majority Leader Mitch McConnell may agree on the regulation of Big Tech and China trade policy,” says Thornburg President, CEO and Portfolio Manager Jason Brady. “A Biden win means a changed regulatory agenda, not because of a change in the administration, necessarily, but because Biden can perhaps more easily align with the Senate majority leader.”
Investors tend to focus on the outcome of the election as it relates to policies, and they should, Brady says. “But we’re really trying to balance our portfolios relative to what’s happening in the markets and economy with a longer-term view. So, we don’t put all our chips in one basket. Rather we want to create portfolios that perform well in all environments.”