Americans voted and decided that the “status quo” will remain for at least two years until the next mid-term elections. Now, with less than 40 trading days left in the year, investors must determine what the US election results mean to their portfolios. Here are some facts that may be counterintuitive, but are supported by history.
1. Presidential elections have historically had little impact on market direction or volatility.
2. Since World War II, there have only been five two-year periods where a single party has controlled the House of Representatives, Senate and White House. Therefore, it is inaccurate to say “Wall Street likes gridlock”; although it may be true, there is not enough historical evidence to support this thesis.
3. Academic research shows that monetary and fiscal policy, mainly interest rate levels and directionality, impact equity market performance.
So, what should investors expect from these election results?
Rule No. 1: Act and react to market data, not market rumors or expectations.
Looking ahead over the next two months, it is not unreasonable to expect investors’ fears of potentially higher taxes on capital gains, dividends, and investment income to trigger a short-term sell-off in equities. However, I do not expect a pronounced market sell-off.
Should a sell-off occur, I expect high-beta sectors such as financials and technology shares to sell off the most, while consumer discretionary, industrial, and telecom shares should outperform the broader market through the end of the year.
On the interest rate side, market participants seem to have concluded that President Obama’s reelection increases the risk of the US going off the fiscal cliff. This also appears to be impacting today’s equity trading on the argument that emboldened Democrats will insist on higher taxes for the wealthy, something a stronger Republican House of Representatives will not easily or quickly agree to.
The partisan debate and resulting increased risk of falling off the fiscal cliff will likely result in the 10-year Treasury (INDEXCBOE:TNX) yield falling below 1.5%.
Looking Ahead to 2013
After the initial market volatility passes, expect markets to focus their attention on corporate earnings growth rates and the overall fiscal direction of the country. Therein lies the problem. I expect earnings forecasts for 2013 to be revised lower and do not foresee a quick resolution to the political stalemate and partisanship that has divided the country so far. Investors are likely to place greater emphasis on revenue growth rather than earnings growth in 2013.
Based on these hypotheses, I see companies that are able to grow revenues and maintain or increase their profit margins performing best. Historically, these companies have been in the technology, industrial, energy, and materials sectors.
