GW&K Investment Review 3Q 2024
ECONOMIC COMMENTARY
As we enter the final weeks of the presidential election season, pundits will inevitably prognosticate on how any number of events will unfold depending on which candidate wins. This is a mistake. Any attempt to predict what might happen is a fool’s errand.
Below I have included excerpts from GW&K’s most recent Global Perspectives, “Keeping Your Portfolio Above the Political Fray,” by Global Strategist, Bill Sterling, which offers three examples that emphasize this point.
Sector Surprises: When Conventional Wisdom Fails
Even those who correctly predict election results can find their company- or sector-specific bets going awry. Consider three recent examples that defied conventional wisdom:
- Apple under Trump: Despite escalating US-China trade tensions during the Trump administration, shares of the heavily China-exposed Apple gained 351%, handily outpacing the S&P’s 81% gain over the same period.
- Clean energy under Trump: Despite Trump being viewed as no friend to the clean energy industry, the iShares Clean Energy ETF soared by 309% during the Trump administration, outpacing the S&P 500 while the traditional S&P 500 Energy sector lost 30%.
- Energy under Biden: Contrary to fears of an anti- fossil fuel agenda, the S&P 500 Energy Sector Index surged 148% under President Biden, outpacing the tech sector and more than doubling the broader market’s 53% Ironically, the iShares Clean Energy ETF lost half of its value, while oil and gas production rise to record highs.
In this same piece, Bill also notes stock market performance since 1928 under all US presidents; with the exceptions of Presidents Hoover, Nixon, and Bush 43, the stock market rose under every administration, and each time by double digits (see below).
Obviously, the list reflects very different policy makers over those 96 years. And yet, the intrinsic strength of the US economy has provided wonderful consistency throughout. While there will always be hiccups, a private sector geared to adjust and thrive ensures that those are few and far between. As I discussed last quarter, the Artificial Intelligence (AI) revolution could be as impactful as the Industrial Revolution, taking the recent advances in the technology revolution to a whole new level. I just read Walter Isaacson’s book, Steve Jobs, a biography of the Apple co-founder, which included a beautiful summary of the relentless push toward innovation over his 30 years with the company.
Knowing our limitation in predicting economic outcomes, how should we approach the present moment? Let’s take the easy stuff first. With the Fed’s 50 basis point reduction already enacted, we can be fairly certain that short-term rates are trending down; how quickly and by how much are not critical questions. What is important to understand is that the markets are forward-discounting mechanisms and companies will begin to adjust to this new paradigm. The prior cycle’s high short-term rates succeeded in cooling inflation, but they also caused major dislocations in the economy, both for businesses and individuals. With the pivot in monetary policy, business activity will accelerate, and investment opportunities will broaden.
While it’s true that the Federal Reserve Board establishes the direction of short-term rates, it has no such control over long-term interest rates, which are determined by the markets. These will instead be driven by the future rate of inflation and the complicated intersection of supply and demand. Turning back to the election, it seems clear that neither presidential candidate has any interest in contain- ing deficits. In fact, we haven’t had a balanced budget since President Clinton’s first term. The deficit is now $1.9 trillion, up twofold from five years ago, while government debt stands at $35.5 trillion, nearly doubling over the last decade. It sounds like both candidates will be comfortable with deficit spending for different reasons, the Democrats providing funds for the disadvantaged, the Republicans reducing taxes. Both argue that their policies will result in faster economic growth and higher revenues. Practically speaking, deficits will likely continue to grow, as will the cost of servicing the debt.
We are left with an economy that will benefit from the reduction of short-term interest rates, but will be held back by a federal government increasingly comfortable with deficit spending. As short-term rates decline, money market and other short-term debt instruments will lose buying power. Intermediate and longer-term bonds should provide more nominal income, but real rates of return may not look as good.
One solution is to lean on a diversified equity portfolio, even with multiples currently sitting at 20-22x this year’s earnings. With the AI revolution supplying a critical tailwind and corporate decision makers prudently deploying capital, profit growth could easily surprise to the upside over these next few years. Fortunately, neither consumers nor companies are over-leveraged and with nearly $7 trillion in money markets waiting for investment opportunities, there seems to be reasonable hope that the markets will continue to improve.
As we look to the next four years, we all realize that there are many areas of government that need a fresh look and creative restructuring. While a business-as-usual attitude from our politicians will not be sufficient to bring our country together, a business-as-usual approach from our private sector should continue to create value and drive investment returns. We only can hope that the new administration finds the courage and creativity to heal social divisions. But even in these complicated times, please know we believe in the resilience of the markets and will maintain our discipline regardless of the outcome in November.
Harold G. Kotler, CFA
Founder-Chairman, Chief Investment Officer