Market Know-How 4Q 2024
Inflection Point
In 2024, roughly 4 billion people will have headed to the polls, reflecting the largest expression of political will in human history. The prevailing themes from this massive global electorate have been mixed so far, with several far-right victories across Europe while South Korea and Taiwan saw center-left parties take control of their respective legislative bodies. What does appear consistent across all voter cohorts is anti-incumbency.
The US general election on November 5th will weigh the disparate platforms of two ideologically distinct parties. The legislative differences between a Republican or Democratic sweep are stark. Each presidential candidate may also emphasize vastly different priorities via executive action. In common, the two parties face: inflation, tariffs, deficits, and roughly half a nation that will be displeased with the election.
From an investment standpoint, these political moments often serve as inflection points for optimizing portfolio design due to potential legislative and regulatory activity, such as shifting tax codes. Importantly, while elections may provide opportunities for portfolio adjustments, we don’t see them as moments to move all-in or all-out of the market, as legislative gridlock precludes drastic and immediate change. In our view, economic growth, earnings, and time tend to trump politicians.
In this edition of the Market Know-How, we evaluate the intersection of markets and politics, noting potential action investors can take that may transcend the differences between candidates, including:
- Exercising discipline reflecting the time horizon of one’s investment objectives, not that of the political or news cycle.
- Building down-in-cap equity exposure as the likely domestic beneficiaries of US-centric trade policy.
- Actively navigating the fixed income landscape given the unrelenting fiscal trajectory of both parties.
Source: Goldman Sachs Asset Management. As of September 19, 2024. “Anti-incumbency” can be referred to as the sentiment in favor of voting out incumbent politicians, for the specific reason of being incumbent politicians. “Legislative gridlock” can refer to a slowdown in lawmaking activity and legislative progress, potentially stemming from divided control across government branches.
Macro Views
US elections come at a time when the Fed begins a delicate normalization of its tight monetary policy and the government faces large fiscal deficits. In this environment, the future US administration must carefully calibrate its policy mix. While tariff hikes pose upside risks to domestic inflation and downside risks to trading partners’ growth, we see greater fiscal stimulus boosting growth under a unified government scenario.
Source: Goldman Sachs Asset Management. As of September 19, 2024. “Fed” refers to Federal Reserve. Chart Source: Bloomberg and Goldman Sachs Asset Management. As of July 31, 2024. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved.
Key Macro Insights
Taxes: Most expiring provisions of the Tax Cuts and Jobs Act would likely not be extended, while the policy’s permanent corporate tax reduction may be reversed, and higher taxes may be enacted on higher income brackets. Expansion of the Child Tax Credit may also be on the table.
Spending: A greater focus on community issues and social spending, such as expansion of education, healthcare, and other programs.
Immigration: A reduction in unauthorized immigration and tightening of border entry rules, though to a lesser extent.
Tariffs are expected to remain mostly unchanged, but more targeted towards certain industries such as semiconductors.
- Disinflation would likely persist, along with the expected FOMC rate cutting timeline.
- Corporate regulations may tighten, potentially impacting earnings and growth across US large cap companies.
- The impact of similar trade policies as the Biden administration under a Democratic sweep could also cause the US dollar to weaken, as disinflation progress enables the Federal Reserve to ease monetary policy.
Taxes: Expiring provisions of the Tax Cuts and Jobs Act would likely be extended at the individual level and potentially amplified at the corporate level.
Spending: Taxes and benefit spending would likely remain unchanged, while defense spending would likely increase.
Immigration: A reduction in unauthorized immigration and significant reduction in overall immigration flows appear most likely, in our view.
Tariffs are expected to increase, with the potential for a 10% across-the-board tariff and a higher tariff on China.
- Disinflation progress may stagnate slightly under a Republican sweep, potentially delaying the Fed’s rate cutting timeline.
- Domestic workers may gain more bargaining power under tighter immigration policies, reducing labor supply while placing greater upward wage pressure on employers.
- The impact of tariffs and tighter immigration policy could impact the positive fiscal GDP impulse, potentially resulting in a modest hit to GDP growth under a Republican sweep.
Market Views
While elections can impact markets and increase volatility in the short term, predicting election outcomes is extremely difficult. We therefore believe investors should focus on policy that may continue irrespective of outcome — like industrial protectionism and further economic decoupling from China — and on secular trends when building their portfolios.
Source: Goldman Sachs Asset Management. As of September 19, 2024. Chart Source: Bloomberg and Goldman Sachs Asset Management. As of September 5, 2024. Chart shows annual S&P 500 performance from 1933 through 2023, broken down first by which party was in control of the US Presidency, then by the composition of US Congress. The left three bars show performance under a Democratic President across different congressional control and the right three bars show performance under a Republican President across different congressional control. For the composition of US Congress, “Democratic” refers to a unified Congress where both chambers are controlled in majority by Democrats, “Divided” refers to a situation where no one party controls both chambers of Congress, and “Republican” refers to a unified Congress where both houses are controlled in majority by Republicans. “Low/High Range” refers to the difference between the worst performing year and the best performing year historically under each of the six different potential regimes. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Past performance does not guarantee future results, which may vary.
Given both candidates’ focus on fiscal expansion, US equities are likely to do well under both a Harris and a Trump presidency, but different pockets of the market might benefit to a different degree. Tariffs would create a headwind to the performance of stocks with high international revenue exposure. The big tech companies are the most vulnerable on this metric. By contrast, small caps would probably do better given that they are more domestically- orientated. Other DM equities, especially in Europe, look vulnerable to the threat of tariffs, in our view.
The equities of many emerging markets may be sensitive to tariffs given US revenue exposure, their supply chain linkages to China, and their historical beta to China equities during past episodes of tariff announcements. Equities in China, Korea, Taiwan, Mexico and Brazil are the most exposed, while equities in India appear the most insulated against potential US tariff risks.
Recent bouts of market volatility have been driven by macro data surprises, market illiquidity and systematic trading, however fundamentals remain intact. We believe episodes of volatility tend to cluster and may remain elevated through the election, but should subside once election results are finalized. Nevertheless, volatility also begets investment opportunities, and at the very least, investors looking to navigate through political uncertainty may be better served by staying invested.
The impact on rates of forthcoming elections will largely depend on the magnitude and nature of the fiscal plans. That said, in both a Democratic and a Republican sweep scenario we would expect higher long-term Treasury yields and a steeper yield curve due to fiscal expansion. However, under a Republican presidency, tariffs may flatten the curve if they were viewed as a negative shock to productivity and growth.
Deferred issuance and issuers desiring to get ahead of election-related volatility have grown municipal bond supply this year, providing opportunity for investors seeking to reallocate cash. We believe that demand for municipal securities may increase as a result of healthy State and Local fiscal balances, supportive technicals, and the potential for tax code revision.
Three factors are likely to influence the outlook for credit markets: targeted fiscal spending, corporate tax policy and regulation, in our view. In a Republican sweep, spreads could widen if eased anti-trust policies lead to an increase in debt-financed M&A. However, the endorsement of anti-trust measures by J.D. Vance, could moderate the impact. In a Democratic sweep, corporate tax increases could weigh on credit, but sectors like infrastructure and healthcare could benefit from increased spending.
Implementation Solutions
Staying Invested
Countering Complacency: Election years tend to make for difficult investment environments, as potential policies and the consequences of those policies are unclear. This uncertainty, alongside elevated equity market volatility during election years, may bias investors toward less risky asset classes such as cash-equivalents. Indeed, the flow of assets in the last seven US presidential election years has exhibited this bias, as flows into money market funds have been roughly five times greater than those into equity funds, on average. We believe cash allocations should be a reflection of investment objectives and their associated liquidity needs, rather than the political cycle.
Source: Morningstar and Goldman Sachs Asset Management.
Staying Invested: By defensively posturing portfolios in the months surrounding elections, we believe investors may be leaving strong equity performance on the table. For example, the S&P 500 has provided an average return of 14.4% in the month leading up to and eleven months after past elections since 1992, while short-dated Treasury Bills have delivered an average return of just 2.1%. Investors seeking to prudently position equity allocations may find value in covered-call writing strategies, which may provide downside protection and potentially generate attractive income streams when option premiums are expensive. This strategy has delivered an average return of 10.3% surrounding past elections while capturing only 70% of the maximum drawdown experienced by the S&P 500 since index inception.
Source: Bloomberg and Goldman Sachs Asset Management.
As of August 9, 2024. Top Right Section Notes: Chart shows the average net flow of funds into categories defined as US equity, international, equity, and money market funds according to Morningstar in all US presidential election years and the first year of presidential terms since 1996. Bottom Right Section Notes: Chart shows the average performance of the S&P 500, CBOE S&P 500 Buy-Write Index, and the ICE BofA 1-3 Month US Treasury Bill index in the twelve months surrounding all elections since 1992, indexed to 100. Please see additional disclosures at the end of this document. There is no guarantee that objectives will be met. Past performance does not predict future returns and does not guarantee future results, which may vary.
Small Caps
Back In Action: As this current election cycle concludes and we shift from campaign promises to policy execution, newly elected officials will likely begin implementing their proposals, leading to increased fiscal spending and investment in domestic industries. Investors looking to capitalize on these new fiscal initiatives might find opportunities in small-cap companies, as their domestically-focused business models may allow them to quickly monetize on these new developments, especially in a monetary easing environment given their greater share of floating rate debt. Historically, small caps have outperformed their large cap counterparts by an average of 3% in the 12 months following US presidential elections, reflecting their sensitivity to economic growth, which is typically supported by increased government expenditure.
Source: Bloomberg and Goldman Sachs Asset Management.
Poised For Protectionism: A key driver of small-cap outperformance following US presidential elections is their higher domestic sales exposure. For instance, Russell 2000 companies generate 77% of their sales revenue from the US, compared to just 59% for S&P 500 companies. While this domestic focus may increase risk during US recessions, it also offers significant upside potential during periods of expansionary and protectionist policy, both of which are possible outcomes of the upcoming presidential election. If tariffs rise, fiscal spending increases or domestic-focused policies are implemented, small caps could experience notable outperformance in the upcoming post-election period, in our view.
Source: FactSet and Goldman Sachs Asset Management.
As of September 18, 2024. Top Right Section Notes: Chart shows Russell 2000 and S&P 500 performance in the 12 months after each of the past 10 US presidential elections. Bottom Right Section Notes: Chart shows the average proportion of revenues that firms in the two respective indices derive from domestic sales versus foreign sales. There is no guarantee that objectives will be met. Past performance does not predict future returns and does not guarantee future results, which may vary. For illustrative purposes only.
Treasury Markets
An Uncertain Fiscal Future: The US is notorious for its large primary deficit, the future of which is both unsettling and unsustainable. The rising cost of interest payments that the US must make on its debt is another growing concern with no solution in sight. Given neither political party has demonstrated a clear commitment towards improving the deficit problem, markets may begin pricing in the burden of this debt and its interest expense. As a result, investors may seek a higher premium for the longer end of the curve or an increased appetite for intermediate duration profiles. While US Treasuries remain a key component of portfolios, investors may find enhanced compensation from taking an active approach.
Source: United States Congressional Budget Office and Goldman Sachs Asset Management.
Finding a Footing: A wide range of fiscal outcomes may still occur depending on growth, rates, and policy. We believe strong GDP growth, an AI productivity boost, and demographic expansion are all factors that may limit the degree of rising debt over the next 15 years. As for borrowing costs, although a -1pp deviation from the CBO’s baseline projection would slow the growth of debt over the next 15 years, this would not be meaningful enough to improve the US’ fiscal standing. The next political administration would need to also responsibly manage public finances in tandem with US economic strengths to mitigate the risks of high debt. Although the US is continuing down what may be an unsustainable path, we believe its resilient growth, the dollar’s standing as a world reserve currency, and its leadership in innovation may support future efforts to grow in a financially sustainable manner.
Source: United States Congressional Budget Office and Goldman Sachs Asset Management.
Source: Congressional Budget Office and Goldman Sachs Asset Management. As of September 5, 2024. Top Right Section Notes: As of September 4, 2024. “GDP” refers to Gross Domestic Product. “CBO” refers to Congressional Budget Office. Bottom Section Notes: Chart shows the potential impact to Federal debt held by the public as a percentage of GDP from a 1pp increase or decrease in borrowing costs from the CBO’s baseline projection until 2040. “pp” refers to percentage point. “AI” refers to Artificial Intelligence. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this document. For Illustrative Purposes only.
