Quarterly Letter to Clients - October 2016
What a strange election year! Clinton and Trump are the oldest presidential candidates ever; both are viewed unfavorably by a majority of likely voters; Trump is not being endorsed by a large number of past and present officeholders within his own party; and campaign rhetoric is unusually angry and personal. Feelings are so strong on both sides that many individuals are reluctant to disclose their leanings to others for fear of ruining friendships. In many ways, it will be a relief to see all this end on November 8.
Common stocks have had a positive year in spite of all the acrimony and uncertainty. Through September 30, Standard & Poor’s 500 Index was up 6.1%, and small company stocks performed even better, as evidenced by the 10.2% gain in the Russell 2000 Index. Positive results are not unusual in an election year, however. During the 13 presidential election years since 1964, when Lyndon Johnson was elected in a landslide, the S&P Index has shown gains 11 of 13 times, or an equivalent of 5.5 winning years for each that is negative. The two times stocks declined were in 2000 and 2008. In 2000, the S&P Index lost 10.1% after the dot-com bubble burst. In 2008, the Index fell 38.5% after a major financial crisis triggered a severe recession. There seems to be no compelling explanation for the high frequency of positive return years. Perhaps investors want to believe campaign promises and expect conditions to get better no matter who wins. A caveat worth noting, however: In years in which a president must be replaced, such as the current one, the S&P Index has actually averaged declines of 4.0%, though largely because of the big loss in 2008. To fit this past pattern in 2016, stocks would have to go into a real tailspin before year end, a change in course which does not seem very likely.
Pre-election stock price movements have also typically been good predictors of presidential election results. Since 1928, when stocks have been higher in the months before a vote, the sitting party has won 19 of 22 times. That historic record would seem to bode well for Clinton, with stocks showing gains and economic indicators positive as well. This has not been a typical election year, however, so, those who favor Clinton probably shouldn’t break out the champagne quite yet.
We find historical statistics on stock movements in election years both interesting and worth noting, but we also believe that past patterns such as these should not be used to change one’s basic investment strategy in any significant way. In our view, fundamentals, such as the outlook for the economy and for individual company sales, earnings and financial strength, are of much greater importance. In that regard, we are heartened by indications that the economy showed improving growth in the third quarter, buoyed by strong consumer expenditures and an upturn in business capital spending. Real gross domestic product averaged a rather anemic 1.0% annual rate of growth in the first half this year but increased to an accelerated pace since, in excess of 3.0%. Company earnings have been meeting expectations for the most part and stock price valuations, while not at historic bargain levels, do not seem excessive. In this environment, we will continue to seek quality companies, the stocks of which are reasonably priced relative to their earnings and dividend prospects.