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Don't Let the Vote Rock You
ELECTIONS OFTEN INFLUENCE MARKET BEHAVIOR, BUT NOT FOR LONG
If it seems to you that the market acts a little erratic in election years, it's only because you've been paying attention.
The reasons behind this historical trend are pretty simple. First, the market doesn't like uncertainty. And the people running for office often have very different ideas about taxes, trade, fiscal policy and other things that affect our economy. Second, regardless of who the incumbent is, campaign rhetoric is designed to make the stakes seem even higher. Incumbents will argue the status quo is delicately balanced and will fall apart if their opposition takes power. Meanwhile challengers will insist that things should be much better and will only get worse under current leadership.
Despite a particularly active news cycle this time around, the basic dynamic is pretty much what we would expect in any election year – volatility in the run-up generally subsides once the outcome is known. Seasonal trends, while currently bearish, are just one factor in the "Weight of the Evidence" approach we take to market and economic analysis.
ABOUT THE ECONOMY After slightly missing expectations for Q1, economic growth surged to 4.2% in Q2 and appears to be on pace to match or exceed that pace in Q3. There are some factors that warrant watching as we approach year end — including general heightening of expectations and the still largely unknown implications of global trade disputes — but we rate economic fundamentals as bullish overall.
DON'T FIGHT THE FED The Federal Reserve continues to normalize policy through small, incremental rate increases. Given the strength of the economy, we would expect another soon. But it's important to remember that even with the increases still planned for this year, the Fed isn't yet in historically normal territory. So we rate monetary policy as neutral for now.
FEW BARGAINS TO BE FOUND Despite the return of more historically normal volatility, stock prices have remained high overall in 2018, even relative to earnings that have exceeded elevated expectations and a strengthening economy. Seasonal factors could bring prices and earnings back into a more comfortable ratio as election season revs up, but we currently rate valuations as bearish. We're also keeping an eye on market breadth. We like to see more and different kinds of companies participating in rallies, but some consolidation of "winners" isn't necessarily a bearish sign. Our breadth rating remains neutral.
THE BRIGHT SIDE OF PESSIMISM Historically, when people feel the most optimistic about investing is often when you can expect a dip in market performance. Despite a trend toward optimism this year, we haven't seen levels we consider excessive yet (possibly due to increased volatility and seasonal election uncertainty). So for now we rate sentiment neutral, but we'll keep watching.
THE BOTTOM LINE Although the outcome of the election shouldn't dramatically change the economic or market landscape, we do anticipate volatility will cool down once it's over – regardless of the balance of power in Washington. Your Baird Financial Advisor can help you determine if other aspects of our outlook or new developments in your own financial life have near-term implications for your investment strategy.
Weight of the Evidence:
EVIDENCE ARGUES FOR CAUTION
The Fed continues to move short-term rates higher, with the next hike likely coming in September.
Economic momentum continues to build at home even as growth overseas stalls.
Robust earnings growth has valuations heading in the right direction, but they still remain historically elevated.
Optimism is again becoming excessive. A test of sentiment could come if price volatility picks up.
SEASONAL PATTERNS AND TRENDS
Stocks tend to weaken ahead of midterm elections, especially in periods of global uncertainty.
Rally participation continues to lack robustness, particularly when viewed from a global perspective.
For the latest Weight of the Evidence summary and other timely market insights, visit our Markets & The Economy page.
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