Stock Markets in an Election Year

Stock Markets in Election YearsElection years have traditionally been good for the markets. Since 1928, there have been 21 elections and the S&P index has had a negative return during an election year only three times. Of course, 2 of those 3 negative years were 2000 and 2008. Hence, there may not be a pattern and, even if there was, the pattern may not be relevant to the decisions we are about to make.

Business Week had a great series of graphs in December showing how correlation and causation are often erroneously linked. They suggest that creating statistics is easy: all you need is two graphs and a leading question to “prove” whatever you already believe. For example, did you know that babies named Ava caused the U.S. housing bubble? Well, if you graph the number of newborns that were named Ava each year starting in 1991 until now and compared that graph to a graph of the housing price index over the same time, there is a significant correlation. After 2006, Ava, for whatever reason, has become a significantly less used name for newborns. Of course, this significant decline was very close in percentage terms to the decline in the housing market at the same time. Here’s another one: did you know that Facebook is driving the Greek Debt Crisis? Again, if you graph the Facebook stock price since 2005 and compare them with the yield (interest rate) on Greek debt until now, you will find a very strong correlation. There may be a correlation, but there is certainly not causation.

In a similar way, the performance of the stock and other markets has little to do with an election year. Typically, when an incumbent is doing well in the polls it is because the economy is doing well, unemployment is low and companies are generating solid earnings. These causes drive the stock market higher and make Americans feel more secure. Conversely, when economic conditions are weak and unemployment is high, the stock markets don’t perform as well and challengers have a better chance of winning. 

Mr. Market doesn’t get into politics. He’s not a Republican or a Democrat. He’s more like radio and TV detective Sgt. Friday from Dragnet who reportedly wanted “Just the facts…” Current data and expectations concerning consumer spending, unemployment, corporate profits home and abroad, housing, inflation, world events and many other data points cause the markets to move. This information does two things- impact the markets and affect who may be elected.

Election year politics  have become a huge spectacle. Yet, Mr. Market really pays little attention to all the promises, conflicts, hype and media show. He, instead, stays focused on relevant facts and moves accordingly.

Some Words of Wisdom

Hopefully the Holidays were wonderful for all of you. Ours certainly were. At some Holiday events, people would ask: “Les, what will the markets do in 2012?” My response: “I honestly don’t know.” Then, I would continue: “There’s a wide range of possibilities.” And, if they were non-clients, I would ask them: “Is your portfolio ready for what may lie ahead, good and/or bad?” It always led to an interesting conversation.

2011 wasn’t very pretty for most investors. First, there was the earthquake and tsunami in Japan, then the spring  uprisings that toppled Arab dictators, next there was the toxic debate over the debt ceiling and S&P gave the U.S. its first ratings downgrade ever. In the fall, the Europe crisis took over and grabbed everyone’s attention. The S&P 500 index ended up 2.1% for 2011 and now has been basically flat for the last five years.  The cost of living continued upward, increasing 3.3 % in 2011 and is up 2.3% annually over the last five years. Many investors who need their investment portfolio to consistently beat the CPI index were disappointed, again.

What’s ahead in 2012? The Bulls are confident the stock markets are going to do well  in 2012 because corporate earnings will continue to rise, inflation will moderate, the economy will sidestep recession, housing will be less of a drag on the economy, economic data overall is improving, and most importantly, over the long term, stocks have historically outperformed all other investments. The Bears say that the U.S. GDP growth is barely positive and unlikely to produce a decrease in the unemployment rate, and our politicians haven’t found a way to deal with our huge debt and social security and Medicare costs. In addition, the Bears say, China’s growth engines may stall and a full-scale crisis in Europe would mean trouble across the world. The truth is; no one knows the future. So, except for those who own a crystal ball, we suggest you prepare for both the ups and the downs in the world and the markets in 2012. Here’s how:

First, review your investment results for the last year, the last three years and the last five years. Compare them to your goals and the CPI (Consumer Price Index). At a minimum, your portfolio should meet (and exceed) the CPI.

Next, review your risk tolerance. Generally, people are more averse to risk today than they were a few years ago. If your risk tolerance has decreased, then your asset allocation needs to be revised to reflect that.

Next, review your financial needs. How much income do you need from your portfolio? What percentage rate of return will you need from your portfolio so you don’t outlive your portfolio? You’ll probably need to update your overall financial plan to do this accurately.  

Next, review your asset allocation. What’s your percentage of stocks? Bonds? Real Estate? Other Alternatives? What percentage is liquid? How will they likely perform in Bull markets or Bear markets?

Finally, acknowledge that the world has changed and continues to do so. In the ‘80s and ‘90s the stock market seemed to produce double-digit returns year after year. Ten years ago, our government produced a balanced budget and our national debt was less than 1/3 of what it is today. Five years ago, real estate values were regularly hitting new peaks. That has all changed. It has been almost five years since the bursting of the housing bubble and four years since the onset of recession.

Even so, there are still tremendous opportunities for those of us prepared to embrace change. Today, for example, there are more investment vehicles available, such as liquid alternatives, that are designed to excel in any market environment and protect on the downside. Hence, investors need to consider all available investment vehicles, review their risk tolerance and asset allocation, and make sure that their financial adviser embraces change, as we all must do, in order to meet our financial goals.