The U.S. election is a nail-biter, and the world is anything but calm. Yet the stock market has been remarkably tranquil.
The market’s uncanny ability to overlook the uncertain political outlook in the United States may reflect an assumption that national elections don’t really matter for the stock market — a supposition borne out by stock returns over more than a century.
Yet while the stock market has mainly been upbeat since the summer, fixed-income markets are sending out worrying signals.
Interest rates in the bond market have soared since the Federal Reserve began cutting the short-term rates it controls on Sept. 18. Oddly, economic conditions in the United States have probably been tightening, even though the Fed has started trying to loosen them. And in an apparent sign that fixed-income markets are fretting about the swelling U.S. government debt burden, the cost of insuring the debt has risen sharply since September — to levels vastly higher than those for other major countries.
So there’s a lot going on as the election approaches. Here’s a quick breakdown of the biggest issues facing investors, what the markets are telling us now about the election and why owning some safe investments makes sense, even if the bull market in stocks keeps powering along.
Stock Returns
The stock market gets most of the attention, and for good reason. It has generally been wonderful for investors — this year, over the last decade and, really, for much longer than that. Elections haven’t made much of a difference.
Bonds haven’t done nearly as well, not lately or over the long haul. But I view them as essential investments anyway, because they tend to be less volatile than stocks and can usually be relied on to hold their value.
The bond market is often a good barometer of the state of the economy. Recent tidings from bonds and other related markets appear to reflect concerns about the implications of the election, and may augur poorly for the stock market in the months ahead.
First, consider the outperformance of stocks. Fueled by robust corporate profits — with the exception of a couple of short slumps in the spring and summer — stocks have been on a tear in 2024, with a total return for the S&P 500 of 23.3 percent through October, including dividends.
This past week, mixed earnings reports from Alphabet, Meta, Microsoft, Amazon and Apple contributed to a brief pause, but probably not an end, to the market rally.
The longer-term returns for U.S. stocks have been impressive. Despite terrible years — with 2022 a particularly horrendous one — the S&P 500’s overall performance over the last decade has been splendid. Including dividends, it has generated a total return of 13.2 percent annualized and 246 percent cumulatively.
That decade includes the coronavirus pandemic, wars in Iraq and Afghanistan, as well as in Ukraine and the Middle East. Politically, it encompasses the Biden and Trump administrations and the tail end of former President Barack Obama’s. Regardless of who held office and of problems in the economy, U.S. corporations kept returning to profitability and the overall stock market managed to find ways of resuming an upward course.
Bond Problems
The bond market has provided less solace. The market is fretting about the certainty of the rising government debt burden and the possibility of higher inflation ahead.
The most important benchmark for investment-grade bonds, the Bloomberg U.S. Aggregate Bond Index (yes, it’s a mouthful) lost money based on bond prices alone this year. Thanks to the interest paid out on bonds — and reflected in the dividends of bond funds — the benchmark eked out less than a 2 percent total return this year. Over the decade, its total return has been only 1.5 percent, annualized.
Why have bond prices dropped? Interest rates over the decade rose from rock-bottom levels in response to higher inflation. This is textbook stuff: When rates rise along with inflation, bond prices fall, as a function of basic bond math. Higher inflation leads to higher interest rates.
What’s starting to happen now, though, is that even though inflation has been falling and the Fed has cut short-term rates in response, rates set in the bond market have been rising.
The bond market may be responding to the implications of a victory by either major-party presidential candidate, but especially by former President Donald J. Trump.
Both candidates’ policies are expected to lead to big increases in the already sizable U.S. debt burden. But the federal budget deficit is likely to swell much more if Mr. Trump were to win and also gain control of Congress, making it easier to cut taxes as promised. Big budget deficits tend to stimulate the economy. They could contribute to an uptick in inflation.
The Fed is expected to reduce rates again this coming week. But if inflationary and expansionary impulses in the economy seem strong after the election, the Fed might have to slow down its rate cuts or even reverse itself.
Global Risk
Treasuries are the ultimate safe asset against which all others on the planet are priced. But another, ancillary market — for credit default swaps — is painting an ugly picture of U.S. government finances.
Credit default swap prices reflect market estimates of the likelihood that a sovereign nation like the United States may be unable to pay its obligations. What those prices are showing is troubling.
Since mid-September, as the campaign season has heated up, the cost of a credit default swap to insure U.S. bonds maturing in one year has more than doubled. That price surge doesn’t mean there are any imminently critical problems with U.S. debt, but it puts the United States in dubious territory. By this measure, U.S. debt is riskier than that of every major nation and even of smaller ones, like Hungary and Bulgaria.
That’s not merely a reflection of the presidential candidates and their policies but also of the dysfunction of Congress, which in the past has engaged in periodic brinkmanship over the nation’s debt ceiling — and has not resolved the longer-term issues regarding the debt.
It’s not clear how high the U.S. debt level — more precisely, the ratio of debt to gross domestic product — can go before the bond market pushes Treasury bond rates high enough to force substantive action from politicians in Washington. That happened during the Clinton administration, the last one to have balanced the U.S. budget.
Rising bond yields can be worrisome. They don’t merely hurt investors’ portfolios, but also weigh on the economy, increasing the cost of home mortgages and corporate financing. Eventually, they can be expected to affect stock prices, which incorporate these myriad costs.
This presents investors with a quandary. Treasuries and other investment-grade bonds have been safer than stocks. Rebalancing your holdings from stocks to bonds when the stock market rises has been an effective way of preserving wealth.
I’m still viewing Treasuries and other investment-grade bonds this way, but it’s becoming increasingly difficult to do so.
Elections Barely Register
The history of the stock market provides some comfort: It has tended to rise, and if you hold on long enough, it hasn’t mattered who has won a particular election or what other issues the country has faced.
Since 1900, in five of 21 presidential administrations, the Dow Jones industrial average has climbed, according to Bespoke Investment Group, an independent financial research firm. The Dow has annualized gains of 7.2 percent under Democrats versus 6.6 percent under Republicans, but this history is too short to draw statistically valid conclusions about the two parties.
That said, this election could be different. Partisans on both sides say the stakes this year are incalculably high and if the wrong candidate wins, the United States may move in a truly disastrous direction. As I discussed last week, financial and economic analysis, as well as long-term investing, need to be radically revamped if a country runs off the rails.
Until events prove otherwise, though, I’m assuming that the United States will muddle through and that U.S. history is still useful in thinking about the markets. If that core assumption holds, most investors will probably be in better shape if they shrug off the election, and everything else.
Another set of numbers from Bespoke makes the point powerfully. Since President Dwight D. Eisenhower’s inauguration in 1953 through March 20, $1,000 invested in the S&P 500 only during Republican administrations grew to $27,400. If it was invested only when Democrats were in power, it grew to $61,800. But if you ignored politics and stuck with the markets all that time, you would have had $1.69 million.
That, in a nutshell, is why so many investors have prospered by shrugging off market news — as well as the guidance of Wall Street brokerages — instead holding cheap, broad index funds for many years, and just capturing market returns.
Focusing on that big picture may be helpful over the next week or so. Avoid big financial decisions while the world is in flux and just get through it.
That’s my mantra, anyway. I’m hoping fervently that one day soon, U.S. markets and politics will all seem boring.
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