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Economy

What Comes Next?

The question I’ve been wrestling with since Thanksgiving (when it became fairly certain that 2024 would end up being another stellar year for stocks) is: “What comes next?”

To recap recent history: large company US stocks, as measured by the S&P 500 index, gained nearly 25% in 2024, which followed a 26% gain in 2023. Back-to-back stock market gains of such magnitude are unusual.

Researcher Michael Cembalest at JP Morgan Asset Management looked at US stock returns going back to 1879. In the past 145 years, there have been ten instances where stocks have climbed more than 20% for two consecutive years.

The table below shows what came after two years of 20%+ returns in the past.

Underneath each year, the corresponding return of the stock market for that year is shown. The two consecutive “20%+ return years” are shown on the left in the regular font, and what happened in the subsequent two years follows on the right in bold font.

Source: JP Morgan

What does history tell us about what comes after two fabulous years of 20%+ consecutive returns?

  • In eight of the nine historical instances, cumulative returns in the following two years were lower
  • In five instances, cumulative returns, while lower, were still positive
  • The three instances where cumulative returns were negative coincided with either recession (1957) or the Great Depression (1929-30 and 1937-38)
  • In one instance (1995-1998) returns following the two years of 20%+ consecutive returns were higher

This data suggests that if the US economy avoids recession for the next two years, then there is a good chance that US stock returns will be positive in the 2025-2026 period.

The JP Morgan researcher Michael Cembalest (who compiled the data) has this to say about 2025:

  • Expect a 10% – 15% correction at some point in 2025
  • In 60 of the past 100 years there has been at least a 10% correction
  • In 40 of the past 100 years there has been at least a 15% correction
  • US equity markets should end the year higher than they began
  • Be sure to have plenty of liquidity to take advantage of what might be a volatile year

Other Voices: four researchers that I respect and follow closely from three firms have made the following comments in their 2025 outlooks:

  • Torsten Slok, Chief Economist at Apollo: “Incomes are high, stock prices are high, home prices are high, debt levels are low, interest rate sensitivity is low, and banks are more willing to lend to households. There is significant upside risk to US growth, inflation, and interest rates.”
  • Howard Marks, co-founder of Oaktree Capital: “The markets, while high-priced and perhaps frothy, don’t seem nutty to me.”
  • Nick Colas & Jessica Rabe co-founders of DataTrek: “We’re sure 2025 will have its share of concerns, but, in the end, we see little that could derail the ongoing move to higher stock prices.”

As we move into the next year, my take on 2025 is:

  • Stocks continue to be an important part of the investment portfolio and a good bet for long-term investors
  • Return prospects for intermediate-term bond funds have improved as Treasury bond yields have moved up toward 5%
  • Inflation resurgence and surprise economic policies from the incoming Trump administration pose the biggest potential risks for financial markets
  • While we’re likely to see episodes of stock selling and lower prices in 2025, conditions are not present for the onset of the next bear market
  • Portfolio returns are likely to be satisfactory for many investors this year, though probably not as strong as in 2023 and 2024

-RK

 

The Red Sweep and Taxes

The incoming Republican Administration has floated a range of ideas related to taxes – some are more likely to be implemented, others less so.

Changes to tax law must go through the legislative process, and since Republicans will control both houses in the 119th Congress, substantive change to tax law is likely in 2025.

Also, there are several adjustments to the tax law relating to retirement plans that will go into effect on January 1, 2025.

Possible changes to tax law, and upcoming tax-related changes for retirement plans are discussed below.

Tax Policy Under a New Administration

Many of the provisions from the 2017 Tax Cuts & Jobs Act which lowered taxes for individuals are set to expire at the end of 2025, including: lower individual income tax rates, a larger child credit, higher standard deductions, and the bigger lifetime estate and gift tax exemption.

Tax policy ideas floated by Republicans during the presidential campaign include:

  • Make the 2017 tax cuts permanent
  • Raise the child tax credit
  • Drop the corporate tax rate
  • Impose across-the-board tariffs
  • End green energy breaks
  • Tax-free overtime pay
  • Exempt Social Security from taxes

The tax experts at The Kiplinger Tax Letter believe that the last two bullet points (tax free overtime pay and exempting Social Security from taxes) are unlikely to gain enough support to pass Congress.

Current expectations are that Congress will pass a big tax bill in the fall or winter of 2025, with most tax changes starting in 2026.

One potential hurdle to enacting all the proposed tax breaks is cost: if all the changes are implemented, the revenue loss for the federal government is estimated to be about $9 trillion, according to financial magazine Barron’s.

We expect to be sifting through a lot of new information in the months ahead and reporting back to you as we get clarity on changes to the tax situation – especially changes related to individual income taxes and exemptions.

Retirement Plans: Upcoming Changes for 2025

The following key dollar limits on retirement plans are set to increase in 2025.

401(k) Plans

  • Contribution limit rises to $23,500
  • People aged 50 and older can contribute an extra $7,500
  • People aged 60 – 63 can contribute a larger “catch up” of $11,250

SIMPLE IRAs

  • Contribution cap rises to $16,500
  • People aged 50 and older can contribute an extra $3,500
  • People aged 60 – 63 can contribute a larger “catch up” of $5,250

Traditional IRAs

  • Contribution cap remains $7,000
  • Catch-up for people aged 50 and older is an additional $1,000
  • Couples deduction phaseout: Adjusted Gross Income (AGI) of $126-000 – $146,000
  • Singles deduction phaseout: AGI of $79,000 – $89,000
  • Note that phaseouts apply to people covered by a workplace retirement plan
  • If only one spouse is covered by a plan, phaseout for the uncovered spouse is: AGI of $236,000 – $246,000

Roth IRAs

  • Contribution cap remains $7,000
  • Catch-up for people aged 50 and older is an additional $1,000
  • Couples contributions phase out at AGI of $236,000 – $246,000
  • Singles contributions phase out at AGI of $150,000 – $165,000

Qualified Charitable Distributions (QCDs)

  • People aged 70.5 and older can transfer up to $108,000 from an IRA directly to charity
  • QCDs can count as Required Minimum Distributions (RMDs), but they are not taxable and are not added to AGI

-RK

Reflection on the US Election

The conclusion of the 2024 election cycle delivered a red sweep, with Republicans set to take control of the White House and the Senate in 2025, while maintaining control of the House of Representatives.

For slightly more than half of American voters, this was the desired outcome.

For many other Americans, though, the election result was unwelcome.

And for those who are philosophically at odds with the people soon to be in power and the policies they promote, it may be deeply troubling.

Susan, Donna, and I understand the anxieties that can come with change, and we share many of the concerns that have been vocalized since the election.

We recognize that there will be periods of time where staying invested in the financial markets might be psychologically challenging.

Also, there likely will be stretches in the months and years ahead where asset prices decline, and portfolio values drop.

These events – policy enactment and market direction – may be causal, or they may be coincidental, and I suspect at times it will be hard for investors to keep clear heads as the situation unfolds.

Remaining unemotional when it comes to your money is always a challenge.

It might help to remember that nearly all individuals are prone to confirmation bias, which is the tendency to interpret new information as confirming one’s existing beliefs.

As investors, we must be extra vigilant to avoid the confirmation bias trap. Taking action in your portfolio that might hurt the probability of your financial plan succeeding over the long term isn’t a recipe worth cooking.

It can be uncomfortable to climb a wall of worry holding a portfolio that contains risky assetseven when we know this is a sound long-term financial decision for most people, under most circumstances.

As fiduciaries, Susan, Donna and I are legally bound to put the best interests of our clients first.

As advisors who care deeply about our clients, we are professionally oriented to work in a collaborative and compassionate manner.

We pledge to continue to approach the financial environment with objectivity, to deliver personalized and accurate financial advice to our clients, and to promote your financial well-being at all times, whatever circumstances may arise.

As we move toward 2025, we hope that the current state of the nation doesn’t weigh too heavily on your overall well-being.

It has been helpful for me personally to remember that there have been times in the past when our country has been starkly divided, and to an even greater degree than it is today.

I have found some comfort in reading Abraham Lincoln’s first Inaugural Address, and especially the following passage, taken from the last few lines:

 “Though passion may have strained it must not break our bonds of affection. The mystic chords of memory… will yet swell the chorus of the Union, when again touched, as surely they will be, by the better angels of our nature.”

One Helluva Horse Race

Horse racing by actual horses in America may be on its last legs. Aside from big events like the Kentucky Derby, attendance at racetracks is abysmal.

Crowds at Belmont in New York, for example, are down by nearly 90% from four decades ago, according to the End Horse Racing Coalition; tracks are closing; and races are in fewer and farther in between.

However, the horse race for US president is in full stride with record participation likely at the polls.

Terms like neck and neck and down to the wire (relating to equine contests) come to mind when considering the election on November 5th.

Below are three different methods for forecasting the outcome of the 2024 Presidential campaign: traditional polling; the betting markets; and campaign fundraising.

The Economist forecast, constructed from traditional polling data, which had been giving the leg up to Harris after she entered the race in July, reset to even on October 30, and as of November 3 had moved slightly in favor of Trump (51% to 49%), but essentially shows a statistical dead heat.

Source: The Economist

The Economist forecast lines up with the last New York Times / Sienna College poll conducted from October 20 – 23, which asked the question: If the 2024 presidential election were held today, who would you vote for? The results were: 48% for Trump, 48% for Harris.

However, alternative indicators point strongly in different directions.

The betting markets have been consistently forecasting a Trump win. The website RealClear Polling (RCP) aggregates odds data from betting sites like BetOnline, Betfair, and Bwin, and the November 3 “average” from RCP put the odds of Trump winning at 53.9% versus 44.9% for Harris.

Betting sites are an interesting way to measure sentiment, because their signals are derived from people willing to put their money where their mouths are. Polymarket claims a total of $1.8 billion has been wagered on the 2024 US Presidential election on its platform.

But it is also possible that some big fish are skewing outcomes. In a recent MarketWatch article by Brett Arends (who has covered sports and political betting for decades) the columnist warns: “the betting markets have their own flaws as a forecasting tool and need to be taken with a grain of salt.”

The betting markets also have been quite volatile. As recently as mid last week, Polymarket gave Trump a 67% chance of winning. That’s now down to 52%.

Another money-where-your-mouth-is measure is fundraising, and Harris leads by a sizable margin in campaign fundraising.

The Harris campaign fundraising efforts have outpaced Trump’s efforts by 3:1, according to Federal Election Commission Filings, as reported by Forbes on Oct 25.

And Harris’s campaign set a political fundraising record in the third quarter, bringing in $1 billion in the three-month period that ended September 30.

The majority of both campaign committees’ spending has been on advertising.

Given her cash advantage, Harris has been able to spend more of her time campaigning during the weeks prior to the election in swing states, while Trump has had to allocate time raising money in places where his popularity is high.

We will need to wait until election day (or, if not, hopefully sometime soon thereafter) to see how the money advantage plays out in the polls.

I’ll share a closing thought on the elections related to investing from the folks at independent research firm DataTrek:

“We see the US presidential election as a toss-up and we’re entirely OK with remaining long (owners of) US large company stocks regardless of the outcome. Our mental model is that America is a business as much as it is a country…

No matter which party occupies the White House or controls the chambers of Congress, companies always adapt and continue to innovate and grow.”

In my view, the DataTrek opinion (above) is sound long-term financial thinking and is strong “case for” sticking to a portfolio that supports your long-term financial goals.

-RK

Presidential Polls & Policy Update

We are now one month away from the next Presidential election, and the race continues to look like it will be very close.

What the Polls Say

The Economist forecasting model, which we’ve been following, has shown no change during the past month. The projection as of October 4 shows Harris leading by 274 electoral votes to 264, with 270 electoral votes required to win.

Source: The Economist

The Economist also keeps a running average of national head-to-head polls, which gives a sense of how the race is progressing. In early September, Harris was ahead 49% to 47%. This margin has expanded slightly in favor of the Democrat, and as of early October was 50% to 46%.

Interestingly, during his previous two presidential campaigns, Trump never led in general-election polling averages. In 2016, he trailed Clinton by four percentage points on election day. In 2020, Trump’s deficit was eight percentage points.

The seven swing states, where the race likely will be decided, remain highly competitive according to the latest forecast from The Economist.

Currently, Democrats seem to have a slight edge in Michigan, Nevada and Wisconsin. Republicans have the lead in North Carolina, Georgia, and Arizona. And Pennsylvania appears to be a virtual dead heat.

Policy Points

While it’s unclear who will be sitting in the Oval Office in mid-January 2025, we can take a closer look at the two parties’ tax and spend proposals to get a better understanding of candidate and party priorities, and the future impact on Federal finances.

The bottom line is that both candidates’ proposals are out of balance (in terms of dollars and cents) and will continue the trend of running large deficits and push the US further into debt.

From what has been revealed so far, the impact on the deficit and debt looks to be less bad under Harris.

The two charts below, courtesy of Michael Cembalest of JP Morgan Asset Management, show the fiscal impact of the tax and spend policies of each candidate.

Harris’ fiscal policies take a standard redistributionist approach, where there are an additional $1.3 trillion of taxes on the wealthy and $2.8 trillion of taxes on corporations over a 10-year period.

This revenue would be used to extend tax cuts for people earning less than $400,000 in income and for a variety of entitlements for families and home buyers.

The Harris tax and spend plans will have about a $1.5 trillion net negative impact on the deficit, compared to the baseline forecast of the Congressional Budget Office.

Source: JP Morgan Asset Management

The fiscal impact under Trump would likely be two to three times worse than under Harris and translate to a $4 trillion net negative impact on the deficit, compared to the baseline forecast of the Congressional Budget Office.

Trump is proposing large tax cuts, including extending all the individual and business tax cuts initiated in 2017 that are set to expire in 2026; eliminating taxation on Social Security benefits; and repealing the cap on the State and Local Tax (SALT) deduction.

Also, further cuts to the corporate income tax rate have been floated. The cuts are to be partially offset by revenue raised from tariffs and a repeal of clean energy subsidies.

Source: JP Morgan Asset Management

Jason Furman, Harvard professor and former chair of the White House Council of Economic Advisors, recently noted that “the first modern presidential race between two candidates with undergraduate degrees in economics hasn’t thrilled economists”.

Both candidates’ plans pose longer-term risks to the US economy by further expanding the Federal deficit, but regarding this measure of risk, the scales are currently tipped toward Trump.

Apart from a widening budget deficit, a major risk under the Harris proposal is that higher corporate tax rates could push businesses to relocate headquarters out of the US to save on taxes.

This activity, known as “corporate inversion”, has slowed meaningfully since the Federal corporate tax rate dropped to 21% from 35% in 2017.

A major risk under the Trump proposal is the re-ignition of inflation from higher prices that are likely to result from tariffs on imports and potential retaliation from other countries.

It is worth noting that estimates of the fiscal impact of the Democrat and Republican policy proposals vary widely.

For example, the Committee for a Responsible Federal Budget, a nonpartisan group that favors lower deficits, estimates an even larger negative fiscal impact from both red and blue party policy proposals than what the JP Morgan analysis shows.

A Republican sweep or a Democratic sweep of the executive and legislative branches would probably result in more caution in the markets, as investors wait to see the scope and speed of enactment of new policies.

But the most likely outcome in the coming election is some kind of split government.

If this were to happen, neither candidate’s proposals likely would be passed into law as currently articulated. And divided government tends to have fewer negative implications for investors.

-RK

The “Shake It Off” Economy

Taylor Swift’s mega hit Shake It Off is a decade old this year. Over the course of ten years, the songwriter-musician-performer has gone from sensation to superstar. Her net worth, too, has gone from sensational to off the charts.

In addition to the financial benefits that have accrued to her personally, the demand created by The Eras Tour (149 concerts over 20 months spanning 5 continents) has had a meaningful economic impact. Swiftonomics refers to Taylor’s economic influence.

For example (according to Investopedia) ahead of her six concerts in Los Angeles, the California Center for Jobs & the Economy estimated the tour would result in a $320 million increase to the LA County GDP.

The Center also expected The Eras Tour would increase area employment by 3,300 and local earnings by $160 million.

Despite (or more likely because of) her success, there are haters. Imagine!

Like Taylor Swift, the US economy has been creating jobs and facilitating profits for companies since the last downturn in 2020.

The most recent jobs report, released by the Labor Department on October 4, showed US employers added more than a quarter million jobs in September, “blowing past expectations” according to the Wall Street Journal.

Nonetheless, the US economy still has its “haters”, too.

Bill Dudley, a well-respected economist and former head of the Federal Reserve Bank of New York, had been one of the haters, but has recently shaken off his negative outlook.

Dudley wrote an editorial published by Bloomberg on October 3, where he stated: “I’ve been too pessimistic about the risks of a so-called hard landing (recession) for the US economy” and “a recession remains very much in doubt.”

Dudley went on to highlight the following positives:

  • The economy retains considerable forward momentum: “Growth in the second quarter was revised up to a 3.0% annualized rate, and the Federal Reserve Bank of Atlanta’s GDPNow estimate for the third quarter is currently 2.5%”
  • The labor market is holding together quite well: “Although the unemployment rate has risen above 4% from a low of 3.4% in 2023, the increase has mainly been driven by rapid growth in the labor force rather than permanent job layoffs”
  • Financial conditions have improved: “Although monetary policy remains tight by almost anyone’s standard (interest rates are high), financial conditions have eased massively over the past year (stock prices have soared and bond yields have declined)”

Dudley concludes with the following: “What does this mean for financial asset prices? As I see it, a soft-landing scenario (lower growth but no recession) implies a buoyant stock market.”

I concur with Dudley: a strong US jobs market and declining interest rates are supporting economic expansion and higher stock prices.

Absent a nationwide catastrophe, or an about-face on key government policies, it’s reasonable to expect more of the same in the coming months: more economic growth, more US profit growth, and satisfactory returns from the financial markets.

For those concerned about the potential impact of the presidential election on the economy and financial markets, it may be helpful to consider the following chart that shows the direction of the stock market during US presidential administrations from Roosevelt to Biden, courtesy of Clearnomics.

Source: Clearnomics

The stock market, like the US economy, has experienced long-term growth under both major political parties, and has the propensity to “shake it off” when it comes to dealing with adverse conditions.

It is not the case that the market or economy turns down when a particular political party is in office This is because the underlying drivers of market performance – including economic cycles and company earnings – are far more important than who occupies the White House.

-RK

Presidential Polls & Tax Policy Points

We are now a little more than two months away from the next US Presidential election. Many of our clients are interested in following the contest, and the Presidential race currently looks like it will be close.

In their US Election 2024 section, The Economist magazine publishes a daily update on the Presidential polls. I like following this format because it’s assembled by a respected organization domiciled outside of the US.

Based on The Economist model, the latest projection, from August 30, shows Harris winning by 274 electoral votes to 264, with 270 electoral votes required to win.

Source: The Economist

From the perspective of the possible impact on personal finances, tax policy marks one of the bigger gaps between Democrats and Republicans.

Many provisions in the 2017 tax law, which reduced taxes, are scheduled to expire in 2026 if Congress takes no action.

Candidate Trump wants the 2017 law made permanent, while Candidate Harris has pledged no tax hikes on those making less than $400,000.

Below are other tax ideas that Harris supports (source is The Kiplinger Tax Letter):

Tax ideas for individuals, supported by Harris:

  • Bring back the top 39.6% income tax rate for people making $400,000 or more (currently the top tax bracket is 37%)
  • Hike the 3.8% net investment income surtax to 5% for $400,000 earners
  • For taxpayers filing Jointly with incomes over $1,000,000, long-term capital gains tax would be imposed at ordinary tax rates up to 39.6% (44.6% with the 5% Net Investment Income tax added in); for separate filers, the income breakpoint is $500,000
  • Tax unrealized gains upon death, with capital gains and losses reported on the decedent’s final income tax return, with a $5 million lifetime gain exclusion
  • Apply a 25% minimum income tax on the ultrarich (those with $100 million in wealth); this tax would apply to unrealized capital gains
  • Bring back expansions to the child credit: boost to $3,600 per child (from current $2,000), with monthly payments and full refundability
  • A new one-time credit of $6,000 per child claimed in the first year of the child’s life
  • Give first-time home buyers a credit of up to $10,000
  • Allow more people to get credits for buying health insurance through the Health Insurance Marketplace
  • Make tipped income tax free

Tax ideas for businesses, supported by Harris:

  • Raise the 21% corporate tax rate to 28%
  • Increase the 15% alternative minimum tax on large corporations to 21%
  • Quadruple the 1% excise tax on stock buybacks by publicly held firms

It’s likely that additional tax ideas will be floated by both campaigns in the weeks ahead.

It’s also important to recognize that, regardless of who becomes 47th US President, the composition of the House and Senate will be critical in determining which policy proposals actually become law.

-RK

Interest Rate Showdown

In poker, the “showdown” is a situation where, if more than one player remains after the last betting round, remaining players expose and compare their hands to determine the winner.

The showdown for interest rates occurred on August 23 in Wyoming – absent horses, cowboy hats, pistols, and booze.

The Jackson Hole Economic Symposium is an annual three-day international conference hosted by the Federal Reserve Bank of Kansas City at Jackson Hole, Wyoming.

The keynote speaker is the Chair of the Federal Reserve Board of Governors (the leader of the Fed), whose comments typically focus on the US economy and monetary policy.

This year, Fed Chair Powell played the interest rate showdown during his Jackson Hole speech, when he said:

  • “my confidence has grown that inflation is on a sustainable path back to 2%”
  • “we (the Fed) do not seek or welcome further cooling in the labor market”
  • “the time has come for (interest rate) policy to adjust”

What gives the Fed Chair such confidence? Pandemic-driven inflation peaked at 9% in 2022, but has declined since, and recent readings show inflation has dropped below 3%.

The chart below shows the Consumer Price Index since 1965. According to this data series, inflation had ticked down to 2.9% in July.

Source: New York Times

Along with inflation, the jobs market has cooled, too – meaning jobs are still available, but harder to find now than a year ago.

Borrowing costs at their current level may be unnecessarily high, pressing down too much on the economy and inflation. Concerns about the possibility of an economic slowdown are likely behind the Fed’s signaling of future interest rate reductions.

So, the parlor game played by Wall Street people, where prognosticators pontificated and professionals speculated on the direction of interest rates, ended with the Jackson Hole speech.

What’s important to bear in mind is that the Fed has direct control over the overnight cost of funding for big banks (the Fed Funds rate) which is a very short-term interest rate.

The Fed Funds rate then affects other interest rates, such as the Prime Rate, which sets the cost of borrowing for consumers.

Currently, the Fed Funds target rate is 5.25% – 5.5%, and the Prime rate, which is usually about 3 percentage points higher than the Fed Funds target rate, is 8.5%.

The decline in short-term interest rates will begin soon, and most likely on September 18, when the Federal Reserve concludes its next board meeting.

Fed Funds futures contracts are financial instruments which allow Wall Street traders to speculate on what the Fed Funds target rate will be next month, or next year.

Fed Fund futures now anticipate a steady decline in short-term interest rates during the next 15 months.

These contracts currently anticipate Fed Funds declining in September, continuing to fall during the next sixteen months, and dropping by 2 percentage points from today’s level, to around 3.5% by the end of 2025.

What does this mean for Main Street people?

  1. It will get cheaper to borrow money (mortgage rates have already started to drop)
  2. “Safe” returns from CDs and High Yield savings accounts will start to come down
  3. Lower interest rates should provide a tailwind for stocks

Fixed rate mortgages have already begun to decline. The average 30-year mortgage was over 8% in late 2023. Today the mortgage rate sits at 6.5%. As short-term rates and the Prime Rate fall, it’s reasonable to expect that mortgage rates will continue to decline, too.

For savers, there is likely limited time to earn 5%+ yields on CDs, High Yield savings, and Money Market accounts. If you’re counting on that income to meet expenses, you should expect to receive less of it in the months ahead.

Since short-term rate declines should proceed at a measured pace, short-term yields above 4% should be around for a bit longer. But expect those yields to fall below 4% by the end of 2025.

For stockholders, the impending interest rate declines should be beneficial. Typically, a Fed easing cycle is a tailwind for stocks when the economy is growing (no recession, like today’s environment) at the time of the first rate cut.

The chart below shows that on average, stocks have significant gains during the year after the Federal Reserve reduces interest rates.

Source: Edward Jones

The chart measures time along the horizontal axis in weeks prior to and following the first “Fed cut”, or reduction in short-term interest rates by the Federal Reserve.

Stock market performance has been much less satisfactory when interest rates are declining during recessionary times.

-RK

Geopolitics & Stocks

With hostilities raging in the Middle East and Eastern Europe, the resultant humanitarian tragedies weigh heavily on caring individuals, even for those of us fortunate enough not to have loved ones directly affected by the strife.

As investors, our minds may also turn to the potential financial market impact of the conflicts.

I participated in a conference call recently on geopolitics hosted by Goldman Sachs. The guest speaker was Retired General Sir Nick Carter, whose last assignment was chief of the Defense Staff for the United Kingdom (the US analog is the Chair of the Joint Chiefs of Staff).

The first message for investors: geopolitical tensions are rising, and with higher tension comes higher risk.

General Clark examined the situations in Gaza / Israel / Iran; Ukraine / Russia; China / Taiwan; and North Korea – through the lens of current or potential future military engagement.

The flashpoint that concerned Clark most was Iran’s recent drone and missile attack on Israel, following the Israeli attack on the Iranian consulate in Damascus on April 1.

Clark stated that this was the first time since the founding of the Islamic Republic of Iran in 1979 that Iran has mounted a direct attack on Israel. In Clark’s words, “we’ve reached another level in terms of escalation.”

Additionally, Clark sees the Israeli / Hamas situation as near unsolvable; the Russia / Ukraine war as intractable; China’s objective of gaining control of Taiwan unmovable; and North Korea’s desire for nuclear weapons insatiable.

Clark concluded by wondering if the system of rules-based international order, put in place after World War II, will survive; and if not, what might replace it.

This was clearly a heavy report with a discouraging prognosis.

The second message for investors: bad geopolitical outcomes infrequently bring about extended stock market declines.

While far from uplifting, past experiences may serve to allay the worst fears related to the potential market impact of escalating geopolitical risk.

The table below from Goldman Sachs presents twelve hostile geopolitical events and stock market performance over three subsequent periods: the next day, 30 days later, and low point in the market following the event (which may have occurred before or after the 30-day mark).

The key take-away from this chart: adjusting portfolio positions in anticipation of a bad geopolitical outcome is a hit-or-miss strategy. In six of the twelve instances, stocks were in positive territory one month after the event.

Stock market drops concurrent with negative geopolitical events are often significant, as the low point in the chart above depicts, but the duration of the impact is impossible to know, and other influences and countervailing events can affect stock prices, too.

Also, the negative stock market impact of geopolitical events tends to be in line with normal stock market declines experienced in years that did not include a hostile geopolitical event.

Since 1980, the average intra-year stock market drop has been 14.2% (see the first chart in the previous section of this letter).

It is understandable if you are troubled by geopolitical risk and worry about how it might affect your investments. Recent events have been distressing, violent, and cause a strong emotional response for many of us.

However, from an investment perspective, remaining dispassionate is recommended. Sticking to your investment approach and your financial plan will serve you well in the long term.

-RK

 

Polls, Politics, and the 2024 Election

The race to win the White House in November 2024 is now in full gear. For anyone who’s accustomed to reading the news, watching TV, or engaging with social media platforms, the font of information on this topic will overflow as we approach November.

At this point, the Presidential election seems to be headed toward a 2020 rematch. The outcome likely will be consequential in many areas, including for the tax and investment environment for individuals and businesses.

Recently, I had the opportunity to participate in a conference call hosted by Goldman Sachs, which featured a leader in the bank’s Office of Government Affairs.

Key takeaways on the current political situation ahead of the November elections:

  • The race for the Republican nomination will continue if Nikki Haley wins a plurality of the votes in the New Hampshire primary on 1/23; otherwise the race is “pretty much over”
  • In a Biden-Trump rematch, the third-party element is important; currently Robert F. Kennedy Jr, Jill Stein, and Cornell West cumulatively are polling in the mid-teens to low-twenties in the percentage of the popular vote
  • Third party candidate support tends to pivot toward the established candidates as election day approaches
  • In 2016, third-party candidates accounted for 3-6% of voters in battleground states; in 2020, support for third-party candidates collapsed to about 1.5% of the vote in battleground states
  • Third-party voters who pivot have tended to favor Democrats, so if third-party support stays strong, Republicans will likely be the beneficiaries
  • In the electoral college, Biden will start with 226 “highly likely” votes and Trump with 219, with 270 required to take office
  • There are seven states in the “up for grabs” category: Arizona, Georgia, Michigan, Nevada, North Carolina, Pennsylvania, and Wisconsin
  • In 2016, Trump won all seven of these swing states
  • In 2020, Biden won 6 of the 7, losing only in North Carolina
  • States which had the tightest margins in 2020 were Arizona, Georgia, and Wisconsin, where the cumulative margin of victory was 44,000 votes
  • The House of Representatives is down to a 2-seat Republican majority due to recent departures
  • Congressional districts are being redrawn in some areas as a result of court challenges from 2020-21, which will likely favor Democrats
  • Three Senate seats in “super-red territory” are coming up for re-election which are currently held by Democrats: in Montana, Ohio, and West Virginia
  • It seems possible that Democrats could win a majority of seats in the House, and probable that Republicans will win a majority of seats in the Senate
  • With a Trump victory, a sweep of the House and Senate is possible, which would put Republicans in control of both houses of Congress and the Presidency
  • With a Biden victory, divided government is the likely outcome
  • Presidential election years typically correspond with weaker stock market returns

RK