The Effects of the Uncertain Political Environment on the Economy and Stock Market

What is it we can learn from the last market downturn and subsequent recovery?

The stock market has been doing very well lately and continues the advance that began eight years ago. On March 9th, 2009, in the depths of the great recession, the S&P 500 touched 666, representing a 58% decline from the prior peak of 1,576 in October, 2007. As of writing this, the S&P 500 sits at 2,375, an impressive 257% increase from the bottom and a 51% increase over the prior peak. These returns are even higher when adjusted for dividends.

While looking back doesn’t help us when positioning portfolios for the future, it can be valuable to review history and glean any information we can to improve investment decisions going forward. So, what is it we can learn from the last market downturn and subsequent recovery? It is this: The point of maximum investment opportunity is also the point of maximum pessimism and fear. Unfortunately, at that moment a lot of investors do the opposite of what they should do, they sell. Because our brains are hardwired for survival, we are conditioned to cut and run. We feel losses more painfully than we get satisfaction from gains. We are more willing to take a certain, knowable loss than we are willing to chance it at an unknowable future, even if the probability says the outcome is better.

Not only did selling at the market bottom lock in losses, investors who pulled out did not earn back any of the gains the market delivered the past eight years. Hopefully, understanding human behavior better will help us from making similar mistakes in the future. At the same time, we need to understand our own “line in the sand” as far as the amount of loss we can handle before we can’t take it anymore (i.e. lose sleep). That information will help us guide how one’s portfolio should be invested. It’s likely if you are meeting with your TPG Advisor and keeping them informed, you’ve probably already taken the necessary steps to endure the next downturn.

The current bull market is ranked near the top of historical bull markets both in terms of percentage gain (3rd) and number of years (2nd). But that doesn’t necessarily mean it can’t go higher or on for longer. Bull markets don’t tend to die of old age, they tend to die around the time of recessions which usually coincide with the Federal Reserve tightening monetary conditions too much. While this bears watching, the leading economic indicators we follow are not flashing recession.

“What is interesting is the disconnect between how well the economy and stock market are doing, along with the lack of volatility, and the heightened uncertainty surrounding the political environment.” The following chart depicts this phenomenon. The blue “VIX” line represents stock market volatility. You can see it is very close to historical lows. The white line, which represents economic policy uncertainty is close to historical highs. This is a departure from the close relationship these two series have had in the past.

“This tells us that while economic policy is uncertain (because nothing has been enacted yet), the market is betting Trump’s pro-business policies will see the light of day”. Regardless of what might cause volatility to increase from these low levels, or stocks to decline, we know it is inevitable. These kinds of things can never be timed, but we can prepare by understanding what our gut reaction is going to be and use history as a guide to demonstrate why we should fight those urges.

If you have any questions, please don’t hesitate to contact us.

Statistics are sourced from Bloomberg and Yahoo Finance.

Michael Gallagher, CFA® – Portfolio Manager at The Partners Group

Founded in 1981, The Partners Group has been serving the financial and insurance needs of employers, medical professionals, and successful individuals for over 35 years. We are an independent consulting firm with services including employee benefits, business consulting, retirement planning and investment services, commercial and individual insurance. The Partners Group has offices in Bellevue, WA; Portland, OR; Lake Oswego, OR; Bend, OR; and Bozeman, MT. For more information, please visit 800-722-6339.

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