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Whether Clinton or Trump, FAs Must Act Now

October 6, 2016

The financial services business has started its quadrennial exercise of handicapping which investments will outperform in response to election results. Once again, Democrat and Republican portfolios are being presented by strategists as sure-fire ways to take advantage of the peaceful handover of power from the current administration to the next.

We’ve always believed that departure from a well-designed investment portfolio in anticipation of election results is more likely to destroy value than create it. So we don’t recommend election-driven adjustments.

This is not to say the election will have no impact on financial markets prior to votes being counted. Quite to the contrary, we believe the remaining buildup to this election could lead to significant volatility.

I’ll support our belief by first stipulating what moves financial markets. In short, markets discount aggregate investor expectations about the future into today’s prices. When expectations change or actual events differ from expectations, markets move. Expectations can change a lot in a short period of time and actual events can differ dramatically from expectations. Voila! Volatility!

Hillary Clinton is somewhat of a known entity. She is a moderately left-of-center candidate who espouses a Keynesian economic philosophy. She believes in an active government role in managing aggregate demand in the economy through adjustments in fiscal policy. As president, Clinton’s economic policy would be a lot like her predecessor’s, with maybe a slight dose of additional business-friendliness.

Donald Trump was a blank slate. His economic philosophy was mostly unknown, and little could be gleaned from his previous statements about policy. But it really didn’t matter because he was getting crushed in the polls.

So markets discounted a high probability that future economic policy will look a lot like the current one. As a result, they have been mostly quiet until this point in the buildup to the election.

That all changed last month when Trump delivered a policy speech to the Economic Club of New York during which he articulated a supply-side economic philosophy that emphasizes low taxes and regulatory reform over government intervention. Trump is no longer a blank slate. What’s more, he is now polling neck-and-neck with Clinton.

The slam dunk that markets previously expected suddenly looks like a horse race. Now markets have to weigh and discount two very different scenarios relative to economic policy after the election.

Going forward, political headlines will likely have more impact on financial markets as investors adjust their expectations about economic policy. They will likely benefit far more from riding through higher volatility than whipsawing between Democrat and Republican portfolios as polls change.