FINANCIAL INSIGHTS Share on facebook Share on twitter Share on linkedin Share on email We are all aware that substantial changes are on the horizon when it comes to financial planning. Specifically, when it comes to retirement income planning. Whether it is taxes, inflation, the national debt, or the market,
Political Investing: Focus on the Fundamentals
When investing in a highly politicized climate, tune out the political noise and focus on the fundamentals. Focusing on the fundamentals while political investing is the real driver of investment returns. Mark Twain once said, “Never talk about politics or religion in polite company.” He could have added money to that list as well.
In these politically passionate times, we’re living in it is ever more important to keep a level head when it comes to your investments and retirement planning. Political investing brings in too much emotion which can derail a financial plan. Working with a financial advising team such as Patriot Advisory Group can help guide and coach you through any political environment.
I had a conversation with one of our long-term clients late in 2020 regarding political investing. Let’s call this client “Mary”. With the change in presidency, Mary called and wanted to liquidate all her accounts and positions, including her IRA’s. This would have caused penalties, fees, huge taxes, and not to mentioned blowing up a plan we’ve been working years on. I finally explained why that would be a very bad idea. She finally admitted she got the idea from her cousin.
Don’t be “Mary” and let political investing take your eyes off the ball. Instead, speak to a financial professional to guide you through potential political investing mistakes.
Political Investing Highlights
Here are three key political investing highlights to think about:
- Strong political views can influence your investment decisions
- Election outcomes have a negligible effect on investment performance
- Fundamentals have historically had a greater impact on stock returns
Investors have a lot on their minds these days, including the continuing COVID-19 pandemic and the slow recovery from the ensuing recession. November’s presidential election also adds political noise to investors’ desire for clarity and understanding.
Investor perceptions of risk and reward influence the decisions they make in their portfolios-and political investing leanings can distort these perceptions. Politically inclined investors tend to see the markets as less risky and more attractive when their preferred party is in power. In contrast, those whose party is out of power are likely to feel more pessimistic and see greater risk in the markets.
In this age of information abundance, how should investors read and use the news for their benefit? Tune out the noise if you’re looking for prudent guidance and actionable insights. Then, pay attention to the fundamentals, which have a bigger influence on market value than the fickle winds of the political climate. Working with an advisor can help identify these fundamental shifts in political investing.
People tend to have strong feelings about both politics and money. In many cases, these feelings are closely tied to their backgrounds and personalities. There’s nothing inherently wrong if someone holds strong political beliefs, but it’s important to recognize the influence strong political views can have on different decisions we make, including how we invest money for the future.
This is a critical topic for Patriot Advisory Group and our investors to discuss because political tribalism seems to be at a high point right now. Our country has been through highly politicized periods before, but many of today’s investors may not have lived during those times or may not realize how strong the pull of political tribalism can be.
WHAT IS POLITICAL TRIBALISM?
Before we continue let’s remind ourselves what political tribalism means and how it can influence political investing. People with strong political beliefs may self-segregate into tribes of like-minded individuals. Often, they develop a close identification and loyalty to the tribe. This can occur whether the preferred political party of the tribe is in or out of power.
Within tribes, trust is often given to information sources that reinforce existing political beliefs. Views from outside the tribes are usually rejected or ignored. Even established or well-regarded facts are judged for inherent biases.
This contributes to confirmation bias among individuals that can affect decisions they make, including those related to money and investing.
Recent surveys by the Pew Research Center show that political tribalism is stronger now than it was 25 years ago. Around 45% of politically inclined people – both Democrats and Republicans hold very unfavorable opinions of the other party.
There are many reasons why the gap between the two political parties has widened during this time, but several trends have occurred along with the rise in partisanship. These “other” trends are what a financial advisor should be tracking for you.
For one, the media landscape has grown more competitive in recent decades, with the evolution of cable television, the Internet, and social media. In particular, news coverage on television networks and online platforms has focused more on politics as media companies pursue higher ratings and engagement in search of ad revenue and profits.
Two, trust in a wide range of traditional institutions has declined over this time, from the government and religious organizations to the media, business, and higher education. In the past, the American public viewed these institutions as sources of expertise and authority. The erosion of trust has downgraded the value of expertise and increased awareness of institutional bias.
During election years, especially those when control of the White House is at stake, political tribalism tends to blossom. The shifting dynamics of tribal sentiment before and after Election Day can be astounding to watch. The most recent presidential election offers a prime example.
Throughout 2016, Democrats were broadly optimistic about the state of the economy and the future of the country. That is until Donald Trump won the White House. Then these sentiments shifted nearly overnight to a more pessimistic outlook.
The opposite trend could be seen among Republicans. Sentiments about the state of the country and the economy among the GOP faithful were largely negative before Election Day. After president Trump’s election, Republicans were as jubilant as Democrats were despondent. Nothing else had essentially changes except control of the Executive Branch. At Patriot Advisory Group, our 30+ years of experience has navigated our clients’ portfolios through very diverse political climates.
INVESTING UNDER THE INFLUENCE
When speaking to a client who wants to make an emotional political investing decision, I refer to it as “investing under the influence.”
The absence of diverse or challenging viewpoints can have an undue influence on investors who live inside these ideological bubbles. Loyalty to the “tribe” can distort their judgment and lead to emotional decisions that run counter to their personal investment objectives. Another term I like to describe these ideological bubbles is a political echo chamber, you only want to hear what you want to hear and reject anything else. This can lead to a political investing disaster.
A research paper on the role of politics in investment decisions found that politically-minded investors tend to be more optimistic about market opportunities when their preferred party is in power. As a result, they may take on more risk than they should and expose themselves to potential losses if the market fails.
Conversely, investors whose political party is out of power exhibit greater pessimism about the future. Consequently, they may pull assets away from the market to lower their exposure to risk. But the greater risk these investors face is missing out on market gains.
Investors under the sway of political tribalism may see a connection between politics and investment that does not exist. Market history shows that stock returns have been good under both Democratic and Republican presidents. Even one-party legislative control has had no discernible effect on market returns.
When politically-minded investors connect electoral victories and market performance, confirmation bias is in full effect. For these investors, it can be affirming to believe their deeply held political views translate to financial gain. And politicians may try to link their policies with economic and financial success-it makes for memorable bumper stickers, rousing speeches, and favorable headlines.
But the fact is, government policy or political control of a different branch of government has a negligible impact on the direction of the financial market. What drives market performance most of all is economic and business fundamentals.
HEADLINES VS. FUNDAMENTALS
When investment firms talk about “fundamentals,” they’re referring to the results achieved by businesses and the overall economy. This is the hard data such as statistics or similar information s that can be measured and compared so investors can judge the potential of a particular investment opportunity.
Fundamentals can include (but aren’t limited to) sales, revenue, cash flows, and debt ratios. Perhaps the most important business fundamental to consider is earnings are the primary driver of equity market returns. When a firm can grow earnings, share profits with investors, and re-invest in its business, the value of its equity shares tends to increase.
Moreover, companies that deliver consistent earnings growth offer the best potential for long-term appreciation of their equity shares. You can see the link between earnings and equity growth in the long-term trends of both illustrated in the chart below. Over time the annualized growth rate for S&P 500* company earnings and the price index are just about equal.
The chart also shows equity returns and earnings growth don’t always move in sync. When gaps appear between equity prices and earnings. It reveals a market that’s not fully efficient. In many cases, these periods of short-term equity volatility are event-driven- emotional reactions to news headlines.
It’s not unusual to see declines within bull markets. During a long-term trend of growth, short-term volatility can create ideal opportunities to buy equities “on-sale” when prices are discounted.
Investors can watch certain indicators for shifts in the market or economic trends and prepare for the likelihood of a change in the cycle. For instance, the Index of Leading Economic Indicators (LEI) comprises several fundamental indicators (i.e., employment, wages, factory orders, building permits, etc.) that offers a one-look summary of economic performance. These indicators are important drivers of company performance-when these indicators show strength, it likely points toward positive corporate earnings, which in turn drive stock market returns.
Similarly, when these leading economic indicators are declining, it may show potential for worsening business conditions and subsequently a tougher climate for stock market returns. In the past, when changes in the LEI Index have turned negative on a year-over-year basis, a recession has occurred usually. (The only exception in this trend occurred during the long expansion of the 1990s.)
As the chart below shows, the LEI turned negative at the outset of the COVID-19 pandemic. This corresponded to the end of the previous phase of expansion. Investors should pay attention to this index for signs of change in the economic cycle.
We’re living in an age of information abundance. For an investor, that can be a blessing; anyone with enough curiosity and time can unearth knowledge on any asset class or market trend under the sun.
But the abundance of information can also be a curse. It’s not unreasonable to say today’s investors have too much information at their fingertips. While some of this information is valuable, a lot of it is simply “clickbait,” designed to distract attention or provoke emotional reactions. In a sense, information abundance has turned into an information glut.
To sort through the information glut, investors must rely on their own judgment to extract the good data from the bad. That requires some degree of trust in providers of information, such as news outlets, market analysts, and research firms. A healthy amount of self-awareness is also helpful to recognize internal biases and to challenge existing beliefs.
The outcome of the 2020 election will clarify one big unknown that has dogged investors all year. But the other big uncertainty—the coronavirus pandemic—has no timetable. The direction of the pandemic depends on the development of vaccines and treatments, as well as effective government responses. We can be fairly certain a vaccine will emerge someday and allow the global economy to return to a period of growth, but when that will happen is anyone’s guess
We believe other events have a high probability of occurring in the next year, and investors are likely to see headlines around these events. But the ultimate takeaway from this data and the current political climate is to speak to a financial professional to help you navigate all the “noise” and stay focused.
Patriot Advisory Group offers multiple pieces on how to help you make sound financial decisions in these highly politized times.
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