Should the 2024 Election Change Your Portfolio?

Though locked in a struggle over whose method rules the social sciences, the economist and political scientist at least agreed on their division of labor: the former focuses on production and profit; the latter studies politics and tracks elections. No longer. Some economists now speak of the need to create a so-called “election portfolio” that tracks the winning chances of a candidate, investing in industries they are likely to support and going short on those that might lose out. Political polarization, the theory goes, means holding a diversified portfolio is no longer enough to hedge against an aggressive president who subsidizes specific sectors to the detriment of others.

The argument revolves around the efficiency of markets in incorporating the presidency as a variable that might influence future cash flows. In an article The Economist ran this week arguing for the relevance of the election portfolio, they noted how when the Democrats won Georgia in 2021, giving them the Senate and the House, treasury yields rose by 0.1 percentage points. Given the Biden administration spending largesse that followed, the yield increase looks modest in hindsight. Markets failed to price the impact of the president’s fiscal policies fully. Therefore, holding a portfolio that tracks Biden’s election chances could offer significant speculation opportunities. If markets underprice how much renewables will benefit from Biden’s patronage and underestimate how much coal will lose out, going long on renewables and shorting coal could mean substantial returns.

The election portfolio’s relevance relies on Trump and Biden having radically different economic priorities. It depends, for instance, on renewables doing abnormally well if Biden is president and coal reversing its decline with Trump in office. Yet JPMorgan Chase’s analysis of previous elections highlighted that the S&P 500 grows by pretty much the same amount whether a Republican or Democrat is in office. And while political polarization has undoubtedly increased, meaning parties no longer represent a unified front on economic issues, it has also amplified inter-party conflicts. For example, President Biden’s Build Back Better Plan was radically cut down into the Inflation Reduction Act by moderate Democrats, minimizing the effect his environmental subsidies could have had on the stock market.

Besides, political rhetoric only weakly tracks government policy. Despite pushing for more green subsidies, a 2021 report by Public Citizen, a left-leaning non-profit, found that President Biden had a higher per-month approval rate of offshore oil and gas drilling permits than Trump had in his first three years in office. Similarly, while Trump lamented how wind turbines allegedly kill whales, Republican-governed states lead Democrat ones in wind turbine development. Ultimately, national economic trends matter more than who happens to sit in office. On balance, both the Biden and Trump administrations favor protectionism, industrial policy promoting American manufacturing against China, and increased military spending (although Trump would export less of it to European allies). Moreover, since the executive has limited legislative ability, a divided Congress effectively removes much of its economic influence. For instance, which party wins Congress, not the presidency, will determine whether Trump’s tax cuts persist when they expire in 2025.

Finally, markets are forward-looking, whereas public policy impacts GDP, which is reactive. An analysis by Dimensional Fund Advisors, an investment firm, plotted GDP against equity premiums in the same year and generated weakly correlated results. However, plotting a given year’s GDP against the previous year’s equity premiums showcased a clear positive correlation. Because markets look to the future, the relationship between the stock market and GDP lags by at least a year. In other words, should a Biden or Trump presidency presage growth in specific industries against others, markets have probably already factored in those trends in current prices.

The growing concern with hedging a portfolio against the presidency reflects worries about American democracy’s decline in both left and right circles. In a liberal democracy, a robust rule of law implies that the office of the presidency should only marginally impact an investor’s portfolio. Indeed, as The Economist noted, politics usually sways the market in emerging economies. Hence, the call to hedge your portfolio highlights the concern of rot in America’s liberal democracy. Two famous democracy indexes, Freedom House’s “Freedom in the World” and The Economist Intelligence Unit (EIU) Democracy Index, have increasingly bumped down the score of U.S. democracy. In Freedom House’s reporting, the U.S. scores roughly 10 points lower (on a scale of 100) than other Western democracies, like Germany or Canada. At the same time, the EIU classifies America as a “flawed democracy,” in the same category as India, while most other Western democracies are “fully free.”

News headlines have amplified the despair, including a report last year by the Brookings Institution, a liberal think-tank, on “Understanding Democratic Decline in the United States.” Dig deeper into the rankings, and the pessimism seems unwarranted. Neither Freedom House nor the EIU claim that the rule of law in America has weakened or that civil liberties have eroded. Instead, the U.S. score has dropped on evidence of increasing income inequality (in Freedom House) and an uptick in political polarization (for the EIU). The merits of these concerns aside, neither deals with the weakness of the democratic process itself, even by stretching the definition of “liberal democracy” to the limit.

The perverse effects of political polarization and rising income inequality are easily understandable. Few in America today claim they should not be investigated thoroughly and addressed by government policies. But the belief that the next presidency will upend markets so drastically that investors should radically change their portfolios depends on a view of politics influencing economics that better fits a country under the thumb of strongmen or generals than the United States, with its strong rule of law. Let the political theorists worry about politics and stick to orthodox portfolio theory.