May 2018 Comments: Political Conflict and its Impact on Financial Market Prices

Victor Levinson Comments

In our July 2017 Comments, we wrote that….”following Donald Trump’s surprising presidential election victory, the major US stock market indices have registered their own surprising gains, with the S&P 500 increasing from 2,140 on election eve 2016 to 2,470 as of the end of July 2017, a gain of 15.4 %. Without taking any position on the current political situation in the US (other than noting its extremely adversarial nature), many financial observers and investors are wondering how/why stock prices remain at or near all-time highs.”

In these May 2018 Comments, we revisit this same question of why stock prices have remained well above their post-election levels (from 2,140 to 2,705 as of May 31, 2018, a gain of 26%, even with a decline of 6% from the January 2018 all-time high of 2,873), although political dysfunction over serious domestic and global issues seems to be rising. The Economist Magazine makes an effort to explain what is happening:

“Most American elites believe that the Trump presidency is hurting their country. Foreign policy mandarins are terrified that security alliances are being wrecked.  Fiscal experts warn that borrowing is spiraling out of control. Scientists deplore the rejection of climate change. And some legal experts warn of a looming constitutional crisis. Amid the tumult there is a striking exception.  The people who run companies have made their calculations about the Age of Trump. On balance they like it. Bosses reckon that the value of tax cuts, deregulation and potential trade concessions from China outweigh the hazy costs of weaker institutions and trade wars. And they are willing to play along with President Trump’s home-brewed economic vision, in which firms are freed from the state and unfair competition, and profits, investments and, eventually, wages soar. The financial fireworks on display in the first quarter of this year suggest that this vision is coming true.  The earnings of listed firms rose by 22% compared with a year earlier; investment was up by 19%. But as our briefing explains, the investment surge is unlike any before – it is skewed towards tech giants, not firms with factories.  When it comes to gauging the full costs of Mr. Trump, America Inc. is being short sighted and sloppy.”

Note that our purpose in citing the Economist article is to provide some of the current rationales for stock prices remaining at favorable levels in spite of all the political turmoil. We are not presenting the remainder of what becomes a critical article on many of the Trump policies, because this would be beyond the scope of these Comments.

Note also that as these Comments are being written, governmental shifts in Italy and Spain, and the imposition of various tariffs by the US, have given rise to further concerns. These concerns have cited as reasons for one-day stock price declines, but generally they have been followed by one-day recoveries of similar amounts.

Returning to our July 2017 Comments, which quoted Jeff Sommer’s article in the Sunday NY Times Business section  headlined “Political Strife is High, but the Market Doesn’t Care”: “The US is so sharply divided that political consensus appears to fray almost daily. Yet two truths about politics can be demonstrated with hard numbers. The first is that partisan conflict doesn’t just seem to have become more intense this year: It has actually reached new levels of nastiness. The second is that the stock market doesn’t care. In fact, the rising acrimony has been a fine environment for stocks, though possibly detrimental to the economy itself.”  The article concludes that “even in the era of Big Data, some mysteries have not been unraveled with numbers. Right now, the sublime indifference of the stock market (to partisan political conflict) is one of them.”

The July 2017 Comments also presented historical information of troubled presidencies and the levels of the S&P 500 index during those periods. These figures come from a June 2017 “Clients’ Corner” article by Nick Murray, a well-known commentator on investments and advocate for investing in stocks for the long term:

  1. Nixon fires Watergate Special Prosecutor, October 20, 1973; S&P 500 closed at 109
  2. Carter’s 100th day in office, end of April 1977; S&P 500 closed at 100 (the Carter presidency “encompassed the second of two huge oil shocks, runaway inflation, and a deep recession.”)
  3. Vote on Clinton’s impeachment, December 19, 1998; S&P 500 closed at 1,203
  4. US government shutdown during Obama administration, October 1, 2013; S&P 500 closed at 1,695
  5. Trump election, November 8, 2016; S&P 500 closed at 2,140; July 31, 2017 close at 2,470

Murray also points out the following record of stock and economic results:  “Over this almost 71 year period (1946 to the 2016 election), the S&P 500 stock index has increased from 15 to 2,140, not including dividends, which have increased from 71 cents to $45, while US GDP has increased from $2 trillion to nearly $17 trillion.”

Murray concludes with the following statement: “If history is any guide, rational capital ultimately outlasts irrational presidencies. And that fleeing capital markets in reaction to distressing political events has in the past never proved to be a lastingly successful investment policy.”

Murray seems to be advocating ignoring the political turmoil, since the historical record shows recoveries over lengthy time periods. We would repeat our comments from July 2017: (1) the 44 years from Nixon’s S&P 500 level of 109 to the current 2,470 comes to an annualized gain of 7.35% (excluding dividends), a reasonable but not extraordinary return; and (2) stock price increases do not occur in a steady, straight line. For instance, in March 2009, at the low point of the stock market after the financial crisis and Great Recession of 2008, the S&P 500 index fell to 677. This decline, from the then previous all-time high of 1,527 during the first quarter of 2000, represented a 56% decline in stock prices, and also reduced the annualized return from 1973 to 2009 (36 years) to 5.2%

It is this potential for significant declines that creates concern for many investors, and which leads us to advocate prudent asset allocations, so our clients can maintain their investment portfolios through the inevitable periods of stock price declines.