Opportunity From Hyperbole
October 2016
Election season is roaring (in every sense of the word) toward the finish line, with candidates
of every stripe suggesting that their ascension to office is the only thing standing between
the nation and veritable extinction. Chief among the candidates’ concerns is the US
economy, which despite seven consecutive years of expansion, is due to plunge into the
abyss should their opponents’ well-meaning but foolish hands be allowed to grip the
controls.
In our view, the probability of recession in the US over the next six to nine months is low.
That is not to say that growth is booming – far from it – but several economic indicators
suggest the modest expansion of the last several years is likely to continue.
For example, the consensus for S&P 500 earnings in the
just-completed third quarter increased last week, from
$115.10 to $116.40, a significant improvement. Similarly,
bank loan activity has been strong of late, rising 8%
(year/year) in October, while unemployment claims
recently fell to a 42-year low.
One interesting anecdote – last
week Wal-Mart Stores raised the
salaries of its managers by 8%,
after raising them 18% just ten
months ago. This is a clear
indication that labor markets are
tightening, which is leading to
higher
wages
across
the
economy. Higher wages should
add fuel to the recent increase in
consumer spending. Since the
consumer makes up approximately 70% of the US economy, this growth should create
further economic expansion.
While the economy appears capable of sustaining its gradual advance, stock market
momentum may be waning. The accompanying chart shows the price movement of several
major market indices over the last ~10 years.
Analysts at Ned Davis Research, a highly respected research house, judge the S&P 500 Index
as still in an uptrend, but conclude that the other averages have regressed to a neutral
reading. This is well-short of a sell signal for the stock market, but it does suggest to us that
further caution is warranted. Our best estimation is that the current low interest rate
environment will continue to serve as a tailwind for the stock market, while relatively high
valuations will act as a headwind. This moderately-positive environment suggests to us that
a combination of dividend-paying stocks and smaller companies, which are less dependent
on economic momentum, is prudent.
Returning to the elections at hand, understandably, the Presidential race receives the bulk of
the attention. However, when it comes to the economy, Congressional outcomes have
proven to have a significant impact as well. The colorful chart on the next page illustrates
stock market performance based on various combinations of presidential and congressional
leadership.
At present, the vast majority of polls suggest a Democratic president and a Republican
congress. Historically, this has led to a stock market gain per annum of 8.46%, the second
highest return among the potential combinations. This is far from an exact science, but the
chart does provide interesting food for thought as we project winners and losers in the
weeks to come.
We discussed the hyperbole of election language in the opening paragraph of this letter,
but dramatic statements and grand visions are important, as they set the tone of a
campaign and establish a central message for the candidate. Our job is to try to distill the
rhetoric and determine the likely impact of political change, both on the overall economy
and the financial markets. Historically, our system of checks and balances has led to more
evolutionary rather than revolutionary change, so when passionate calls to action roil the
markets opportunities for patient investors like Cornerstone Capital are often created.
Brad Dinsmore