POLLS, POLICIES & PORTFOLIOS

Politics and international events can influence returns, especially near-term, and volatility. In fact, in times of heightened policy uncertainty, economic growth has been slower. Stock market volatility has tended to correlate with policy uncertainty as well. However, once political events have been digested, markets have tended to perform well. Certain policies and international events can affect corporate fundamentals, and those are ones we want to pay attention to. For instance, the Tax Cuts and Jobs Act resulted in higher corporate profits, which helps support stock prices. The Russian invasion of Ukraine disrupted global commodity chains, pushing inflation and eventually central bank policy rates higher than they otherwise might have been.

Successful long-term investing acknowledges the near-term risks but leans into the long-term risk premium embedded in owning stocks for the long-term. Market timing based on policy and global events is a nearly impossible task because investors process and adjust to new information almost immediately. There may be themes that develop in which one would want to make small portfolio adjustments but major strategic decisions should be implemented only when your financial design calls for it.

Historically the stock market has performed well throughout most easing cycles. Lower rates have tended to spur increased economic activity. Additionally, a lower discount rate is supportive of higher valuations. And the corporate cost of capital eases, allowing companies to borrow in order to fund potentially productive projects. However, there have been instances of bear markets despite the easing campaign and those have lined up with economic recessions. At the end of the day, corporate fundamentals are the main driver of stock prices.

The relationship with Fed policy and interest rates is complex as longer-term rates tend to discount changes in Fed policy well in advance. In this cycle, the yield curve (difference between longer-term rates and shorter-term rates) has been negative for about two years in anticipation that the Fed would eventually cut interest rates. It may therefore take more easing than current market expectations to drop longer-term rates any farther from here. At the very least, an easing cycle would be far from a headwind for bond prices. In general, balanced portfolios have tended to perform better when rates have been falling rather than rising.