Benefits of the campaign trail (Archivé)
By John Bailer, The Boston Company Asset Management¹
A year of political uncertainty lies ahead for the US, creating winners and losers among industries and companies. Here we look at a few of the industries likely to be affected and discuss the challenge of investing in today’s political and economic environment.
The outcome of the November 2016 US presidential election is impossible to forecast but some analysts will tell you there is nothing unpredictable about the outlook for markets in this key political year.
They will assure you that history shows that in the fourth year of a presidential cycle stock markets rise. Pepperdine University’s economic professor Marshall Nickles articulated this theory in his 2004 paper “Presidential Elections and Stock Market Cycles,” which revealed that between1941 and 2000 all the major stock market declines occurred during the first two years of the four-year presidential cycle. No major falls occurred during the fourth year.2
In the past 20 years, elections have been very close and could have swung either way. Therefore, it has been difficult to predict winners and losers as it depends on the political make-up of Washington and, importantly, whether one party will be in control of the presidency and Congress.
But there are a few areas of the market we believe will benefit no matter who gets elected, especially given the focus on middle classes voters. In our view, this means infrastructure spending, health care, financial companies and defence spending could be all hot topics. Media companies are also likely to be impacted as a huge media spend will support the negative and positive rhetoric of candidates as they appeal to middle-class voters.
People like the idea that things are going to be fixed, and a key point of Nickles’ study is that governments have every incentive to stimulate the economy in the run up to the election as the incumbent party seeks to stimulate the electorate and perpetuate its time in office.
As we approach the latest presidential ballot, there has been considerable talk of a Highway Spending Bill aimed at addressing the country’s crumbling infrastructure, by funding roads, bridges and mass transit. This would establish a six-year plan for development, bringing an end to the repeated passing of temporary stopgap measures.3 These stopgap measures have only kicked the can down the road instead of forcing Congress to make some hard funding decisions. If Congress manages to push this bill through before the election it would be a boon to the economy and especially to aggregate producers, residential and non-residential construction companies.
As the race to win over voters intensifies there is a good chance we will see other promises of increased spending. Defence spending looks to be a beneficiary of the debt ceiling debate, for example. However, given the propensity for Republicans and Democrats to disagree, we believe any increased spending measures outside of defence and infrastructure will be limited.
One thing we can be sure of as the race gathers pace is a lot of negative rhetoric on Wall Street banks from both Democrats and Republicans. For example, there is already discussion around reducing the dividends member banks receive from the Federal Reserve System to pay for the highway bill. These banks are easy targets as a significant part of the electorate still views them as having caused the financial crisis.
Also, the Democrats will probably have a negative message on the ability of pharmaceuticals to raise prices. We have already seen the impact this talk can have: biotech shares fell sharply on 21 September, 2015, after candidate Hillary Clinton tweeted she would cap prescription drug bills for chronically ill patients. Her comments knocked more than US$38bn off the value of biotech stocks.4
There are other things we can forecast with some conviction. The media sector has historically benefited from presidential elections and we anticipate it will be another record year for political ad spending.
Candidates and campaign groups are expected to lay out US$11.4bn this year, a 20% increase from the last presidential election year of 2012, according to the media tracking firm Borrell Associates.5 Broadcast TV is set to get US$6bn of that pot, while digital media is also gaining in importance and is expected to break the US$1bn barrier for this first time this year.6
Ad spending is going to be big but its impact on the economy will still be small: media spending is more affected by the economy than the economy is affected by media spending. The real effects of the 2009 US$700bn stimulus on the US$16 trillion economy are still being debated. US$11.4bn sounds like a big number but seen in the wider perspective the net effect on GDP could be small.
We are bullish on the US economy and the equity market longer term – although we do believe the election and the Fed’s ultimate normalisation of interest rates are likely to lead to considerable volatility over the next year.
Equity strategies that emphasise dividends look likely to offer advantages in this environment. The 2.2% yield of the S&P 500 is attractive relative to fixed income yields globally and dividends typically grow over time. With higher-yielding equities, the incremental yield is a cushion to returns in a flat or weaker market, while dividends are also a powerful driver of returns. With ageing populations in many developed economies, we believe demand for income will remain strong and that companies will respond with a growing stream of dividends.
However, not all dividend strategies are created equal, and valuation matters. Some high-yielding sectors that behave like bonds, such as utilities, are expensive, have limited earnings growth potential, and are susceptible to rising interest rates. If you go back and look at history, it is clear that the stock market as a whole does not do badly when rates rise. It is the bond proxies, like utilities, that frequently do not fare well.
On the other hand, we believe financials could offer good value. There is real scepticism about financial stocks (even those that do not have risk from negative political rhetoric), but they are in better shape than they have been for many years.
Since the financial crisis, for example, banks have been making some of their best loans and have very strong capital levels. As the year progresses, we believe they will benefit from rising interest rates and may be positioned to raise dividends over time.
What to watch
- The presidential election will add to uncertainty until November
- Negative rhetoric on Wall Street banks and pharmaceuticals could be reflected in share prices
- We expect more divergence in stock valuations and increasing volatility
3.Bloomberg: ‘Senate Sends Latest Stopgap U.S. Highway Funding Bill to Obama’,30 July 2015
4.Financial Times: ‘Biotech stocks fall further as Hilary Clinton unveils drug policy’, 22 September 2015
5.Borrell Associates: ‘2015 to 2016 Political Advertising Outlook', August 2015