Tom Yeung here with today’s Smart Money.
The presidential election is less than a week away… and with it, the potential for postelection chaos.
If the election is as close as it looks now, we all know that this havoc could span the days and months till Election Day.
But you may not realize that this chaos has the potential to last years after this election ends.
That’s because both candidates are promising voters the moon… and will need to empty the coffers in order to pay for the moon.
In this cycle, we have pledges from both sides to…
- Extend the 2017 Tax Cuts and Jobs Act
- Eliminate taxes on tipped wages
- Maintain Social Security spending at current levels
- Reduce taxes on the middle class
Now, most of that’s great news in the short term.
Investors salivate over the potential “goodies” consumers and corporations will receive and bid up stocks as a result. Since 1928, markets have returned 11.3% during presidential election years, according to data from Morgan Stanley, with 19 out of 23 election years providing positive performance.
But the long-term outcome is not so pretty.
According to T. Rowe Price, shares of the S&P 500 have underperformed the median by -4.3% in the year after the election. In fact, more than half of postelection years (54%) overlapped a recessionary period.
However, we still believe that markets tend to be overoptimistic going into elections… only to be disappointed when campaign promises turn out to cost far more than expected and take far more time to materialize.
Here’s what this means for the next 6 to 12 months…
The Election on Steroids
The 2024 election has been a caricature of past cycles. The S&P 500 already is up 23% so far this year – its best 10-month performance in the 21st century. The tech-heavy Nasdaq-100 index is up 26%.
Much of this has to do with the unusually generous stimulus packages both sides are promising for the economy. In addition to the assurances mentioned above, there are pledges to expand the child tax credit… bring back manufacturing with tax incentives… cut the prices of groceries and fuel… and so on.
In fact, the nonpartisan Tax Foundation believes that both Donald Trump’s and Kamala Harris’s plans will send the national debt to more than 200% over 10 years. If this happens, it will mark the largest deficit spending by the U.S. government in a non-war period.
Hyper-partisanship is also playing a major role. Both sides have run this race on “vibes,” leaving investors hearing only the good parts of both candidates’ plans without any details on how things will run. There is little incentive for either side to give any details on their plans.
The result has been a surge in average valuations. The Shiller PE Ratio, which averages earnings over a 10-year business cycle, now sits at 37.0, its highest level since the heady days of 2021.
AI stocks are particularly pricey, with companies like Amazon.com.com Inc. (AMZN) trading at 40 times forward earnings.
Of course, this unusually large preelection boost will likely be met with an equally significant postelection hangover. When the Shiller PE Ratio was last at this level in December 2021, stocks tumbled 19% over the following year.
And as for all the campaign promises that could push the debt-to-GDP ratio to those seen by Japan? That also puts the U.S. government on track to spending a quarter of all tax revenues on debt servicing.
Where to Hide Your Money
Each election tends to create its own mini-bubbles. The 2004 cycle saw a burst of buying in telecom stocks after President George W. Bush laid out a plan for universal broadband availability by 2007. The state of New Jersey went as far as to call 2004 “The Year of Telecommunications.” The industry – as measured by iShares Communication Services ETF (IXP) – rose 16% in 2004 before plummeting -9.1% the following year.
The 2008 cycle saw a similar rush into defensive stocks by investors who expected a drawn-out recession. Consumer staples, a defensive segment, went from being the best-performing sector in 2008 to the third-worst-performing one in 2009.
Today’s high market valuations include even higher prices in real estate, clean energy, and AI. Data center REIT Digital Realty Trust (DLR) trades at a miserly 2.7% yield, while Tesla Inc. (TSLA) is valued at 90X earnings. History tells us that these pricey stocks tend to go higher in the short term before disappointing investors with mediocre returns over longer periods.
As always, our recommendation is to avoid these companies at tippy-top valuations and invest in high-quality growth companies trading at reasonable prices instead.
To further arm yourself against election-cycle volatility, my InvestorPlace colleague Louis Navellier introduced a quantitative tool that that thrives in chaos during his “Day-After Summit” earlier this week.
According to back-testing, his system has outperformed the market by a 6-to-1 ratio since 1990… and we believe that it will help you navigate volatile markets ahead.
You’ll want to be sure to get ahead while you still can. You can click here to access the special broadcast.
Regards,
Thomas Yeung
Markets Analyst, InvestorPlace
