Weekly Investment Strategy

Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

  • Politics aren’t a key driver of the markets
  • Volatility from a government shutdown is often short lived
  • The Fed may end its streak of 75 basis points rate hikes

As we celebrate Veterans Day, we acknowledge and express our gratitude for the service and sacrifice made by the members of the U.S. Armed Forces and their families. Thank you for being always ready, always there! While nothing will rival defending our country, there were plenty of defensive operations and tactics impacting the markets this week. First, Democrats and Republicans had to defend their views in the midterm elections. Second, the October CPI report served as the latest update in the Fed’s fight against inflation.* With Election Day (almost) behind us and with potential for a less hawkish Fed, the S&P 500 is on pace for its best week since June. But how do these two market moving events impact our outlook for the economy and markets moving forward? Here are our insights.

  • This We’ll Defend: Politics Aren’t A Key Driver Of The Markets | The polarization of our political environment naturally leads to debates over which composition of government the economy and equity market favor most. Given that the midterm elections just took place, it is easy for market participants to try to extrapolate what the election results will mean to market performance. But as we detailed in last week’s Weekly Headings, there are incidents of both strongly positive and negative economic and equity market performance amongst different periods of both unified and divided government. Why? Because fundamentals drive market performance, not the power structure of Washington D.C. In our view, the macroeconomic backdrop matters most when determining the trajectory of the equity market. Now, one may be thinking, isn’t government spending a critical component of growth? The short answer is yes, but it only accounts for ~17% of GDP—a far cry from the 40% that it contributed during the mid-1950s and far less than the ~70% contribution from consumer spending. Therefore, to figure out the strength of the economy, we start with the fundamentals of the consumer, which are driven by the health of the labor market, wage growth, and sentiment rather than who controls Congress. When assessing the equity market, in addition to the economy, we look to factors such as earnings growth, Fed policy, valuations, and corporate activity as they have greater predictive power than politics.

    Looking Ahead | The outcome of the midterm elections will not be confirmed until the results in Arizona, Nevada, and Georgia are known, but as it stands the Republicans are projected to have a slight majority in the House and the Democrats are projected to keep control of the Senate. If this projected result proves accurate, few major legislative items are likely to be passed. Therefore, perhaps the most impactful outcome could be an elevated risk of a government shutdown. The good news is that in most cases, downward equity volatility is often short-lived, with equities quickly rebounding. In fact, history shows that since 1976 (20 shutdowns) in the one year following a shutdown, the S&P 500 has been up ~13% on average and been positive 85% of the time.