Friday charts: Should we keep our politics out of our portfolios?

In 2016, Paul Krugman predicted that the election of President Trump would permanently impair our investment returns: "If the question is when markets will recover,” he wrote for The New York Times, “a first-pass answer is never." 

The S&P 500 is up about 330% since then.

In 2009, Michael Boskin warned that President Obama’s economic policies would derail American capitalism: “Obama’s radicalism is killing the Dow,” he wrote for The Wall Street Journal. 

The Dow is up about 609% since then.

It’s a common sentiment. The single most widely held opinion in America might be “the other party will wreck the economy.”

The data suggest this is a rare point of bipartisan agreement.

Researchers studying voting records, confidence surveys, and brokerage accounts from 1980 to 2000 found that we let our politics inform our investing: "Investors become more optimistic and perceive the markets to be less risky and more undervalued when their own party is in power," the study concluded.

A separate study of millions of US investment accounts reached a similar conclusion: “Republicans increase the equity share and market beta of their portfolios following the 2016 presidential election, while Democrats rebalance into safe assets.”

I can’t blame them. It’s deflating when the other side wins a big election. And it makes you feel like you have to do something — anything, really. This is the “action bias” that evolution has wired into our brains.

Selling stocks is an action we can take when we think something bad has happened. And what else are you going to do? Moving to Canada is a pain (and it’s too cold there, anyway).

The instinct isn’t entirely wrong, either. You’re probably right that the other party’s policies will harm the economy — because both parties’ policies usually do.

But they’re probably less damaging than you think, especially after the legislative process has watered them down.

They also matter less than we think. In a $30 trillion economy, the impact of any given policy change is likely to be marginal relative to world events.

Obama’s first term began in the depths of a financial crisis, for example. Trump’s first term ended in a pandemic.

If the US economy can survive those traumatic events, surely it can withstand some misguided policy making?

That has mostly been the case so far.  

There is, however, one large counterexample: Europe.

When I traded European equities in the 1990s and 2000s, European markets felt competitive with US markets. A little behind the curve in terms of financial sophistication, perhaps, but catching up.

It no longer feels that way. Europe has produced just one important tech company (ASML), one great internet-era company (Spotify), and zero important AI companies. Its two best sectors — pharmaceuticals and luxury goods — have their roots in the 19th century.

This has been consequential for investors. From the lows of the financial crisis, the performance of US and European markets have wildly diverged. The STOXX Europe 600 index has underperformed the S&P 500 by a whopping 370 percentage points over the past 20 years (444% to 74%).

I don’t think it’s controversial to say that policy choices are largely to blame — byzantine regulations, rigid labor laws, clean energy mandates and more have made it hard for European businesses to compete. 

So maybe we should worry about policy after all?

The US has the structural advantage of changing its mind every four or eight years, which has perhaps allowed bad policy choices to cancel each other out. Europe, by contrast, has stuck to roughly the same agenda for two decades.  

But that’s just how it’s worked out so far. And the only thing we know for sure is that the next 20 years will be different than the last 20. Maybe the bipartisan ballooning of the federal deficit will finally hit a tipping point. Or maybe one party or the other will ban data centers. Or undermine the Fed.

It’s easy for investors to be pessimistic about politics.

So far, though, optimism has always won out.

Even at the most dismaying of times.

Let’s check the charts.

Partisan thinking:

We used to judge presidents by the economy. Now, we judge the economy by presidents. Consumers are confident about the economy when their preferred party is in office, irrespective of how the economy is doing.

Independent thinking:

In the University of Michigan surveys of economic sentiment, independents are almost exactly the average of Democrats and Republicans.

Returns are non-partisan:

Time in the market beats timing the market. The cost of sitting out every four years compounds quickly.

The clock starts next week:

Capital Group calculates that since 1950, the S&P 500 has returned an average of 15.4% in the year following a midterm election — nearly twice the return of all other years during a similar period.

You are here:

On average, the post midterm gains start as soon as the election is over.

Bipartisan agreement?

US federal debt hit 100% of GDP this week. Neither party seems to have noticed.

The American century:

The S&P 500 is up 427% over the past 20 years. The Eurostoxx 50, however, is up just 27%.

I blame politics.

Have a great weekend, independent readers.

— Byron Gilliam

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