Stock indexes lost value in September, although it may not feel like it as you’re reading this because most of the loss occurred in the first 20 days, while the remaining 10 days saw big leaps back upward. The S&P 500 finished the month negative by 3.8%. This is a big decline in any month, but it was not surprising.  The markets have run strongly not only during the third quarter but since the end of March. The S&P 500 notched an 8.93% gain in the third quarter and is positive for the year by 5.6%. It’s important to remember, though, that the S&P 500 isn’t the whole stock market. All of the other main categories of stocks are still struggling mightily this year. Mid and small sized stocks in the U.S. are still negative for the year, -9% and -15.25%, respectively. International stocks are also still negative for the year. Because of this wide dispersion—between the S&P 500 and everything else—investors with diversified portfolios are likely still flat to negative for the year. Tempting as it may be to cash out your diversified equity and go all in with the S&P 500, this would leave you exposed to only one corner of the market which is increasingly dominated by the growth stocks like Amazon, Apple, Facebook, Microsoft and Alphabet as we have discussed in prior newsletters. These five companies now make up more than 22% of the S&P 500. 

As we enter October, all of the risks we’ve recently discussed are still on the table. Rather than rehash the impact of COVID-19, the role of the Fed and the stretched valuations of tech companies, the rest of this newsletter will dive deeper on the impact of politics: the upcoming election and the decreasing likelihood of additional stimulus from Congress. These are fraught times in America’s political consciousness, and we expect some readers may seek to de-risk their investment portfolios because of that. We’d like to convince you not to do that by offering our perspective and some historical context.

First, we grant that there is a high chance of volatility due to politics between now and the end of the year. The biggest risk does not appear to stem from fear of either a Trump or Biden presidency, but rather from the prospect of a contested election. With COVID-19’s impact on voting—mail-in ballots, early voting, complications from voting in person—it is virtually guaranteed we won’t know who wins on election night. It could get ugly, with accusations of voting irregularities and fraud, leading to lawsuits and dramatic court rulings. It is hard to imagine markets taking this well. The only comparison in recent history is the 2000 election, where the S&P 500 declined by 8.4% between election night and when Al Gore conceded on December 15^th. That’s probably not even worth comparing things to, though, since there’s no reason to think events will unfold in the same way.

Second, markets have been counting on another stimulus bill from Congress to provide relief from COVID-19 disruptions. The political incentives for this seem to be low right now and getting lower as we get closer to November 3. And what happens to a stimulus after Election Day is anyone’s guess, dependent on the multitude of possible outcomes we could be dealing with. If markets don’t get the stimulus bill they’re looking for (especially if it comes in tandem with COVID-19 increases and renewed business shutdowns) the impact will be negative. 

Having stated all of that, we will explain why it is important to stick to the investment plan you’ve developed instead of panicking. First, even if the election is contested, it will be settled within a matter of months. The courts, including potentially the US Supreme Court, will be compelled to move swiftly on judgments pertaining to the election. The uncertainty will not exist in the market for some indefinite period of time. Second, the main reason Congress can afford to drag its feet right now is that things seem a lot better than they did back in March when they passed the first stimulus. If COVID-19 developments do take a turn for the worse, especially if this leads to big declines in the market, you should expect a lot more willingness for bipartisan cooperation to provide additional relief.

As dire as these political threats are in the near term, it’s tough to imagine these threats still impacting the equity markets by the time we get to April or May of next year. If you have short term needs from your portfolio, you should already be in a lower risk investment strategy to prepare for any type of bear market, including but not limited to ones caused by politics. Politics is personal for many of us, but that doesn’t mean we should prepare for political-related volatility any differently than volatility caused by other factors.

Lastly, in case you think the biggest risk is that your candidate doesn’t win, history doesn’t really back up your thesis. Markets have historically performed well regardless of which party is in the White House, and regardless of whether that party also controls Congress. Here is a quick piece of trivia: Between 1926 and 2019, what has been the average annual return of the S&P 500 during years of a Unified Republican administration versus a Unified Democrat administration? 14.52% and 14.52%.

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