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Our panel reflects on 2020’s year-to-date financial picture and markets’ likely response to whichever party controls the White House in 2021.
U.S. voters are days away from choosing the next president and potentially shifting the balance of power in Congress. But how is the November 3 election likely to influence stock market performance and economic growth in the long run?
Not much at all, if history is any indicator. “We all like to think that our particular candidate or political party has all the answers,” said Don Calcagni, chief investment officer for Mercer Advisors, during last week’s Q3 2020 Capital Markets Update webcast. “But when we look at the data, what we find is that markets do well over time regardless of who controls the White House.”
As he showed in a series of charts stretching from 1929 through 2019, stock returns during an election year average 11.3%. Moreover, nearly every president since Herbert Hoover has seen the market grow overall during their administration.
This latest election season is on a similar track. Even with the drastic economic impact of coronavirus in 2020, S&P 500 stock returns were up 5.6% at the end of Q3 and bond returns also remained exceptionally strong.
Therefore, Calcagni urged clients to stay invested—and true to the long-range financial plan they have created with their Mercer Advisors team—no matter what happens on Election Day. Stephanie Anderson, a Mercer Advisors client advisor, added that it’s okay to make changes in your portfolio if you’re feeling uneasy about the current political and economic environment.
“It’s worth having a conversation with your advisor to make sure that your allocation is appropriate for where you are right now,” Anderson said. “We have an array of tools to help you understand the implications of different decisions,” such as putting more cash in reserve or moving from stocks to bonds.
What else should clients being thinking about as 2020 draws to a close? Anderson and Calcagni offered these suggestions:
Doug Fabian: Hello and welcome to our fourth quarter 2020 Mercer Advisors client webinar. It’s our goal with these broadcasts to update you in the financial markets. Of course, today we’re going to talk about the election and we want to talk to you about what you can do to improve your financial health between now and the end of the year. So, thank you for joining us today. We are recording today’s event and it will be posted on the Insights page at merceradvisors.com.
My name is Doug Fabian, I’m a member of the Investment Committee, I serve as the podcast host, and I’m part of the communications team here at Mercer Advisors. I want to mention to you just a little logistical instruction. The toolbar that you see as a part of the webinar, there is a chat box so we would love to hear from you, please send us your questions. You might have questions and comments about the election, about the markets. Obviously, we can’t give you personal investing advice because we don’t know everything about each person joining us today, but we definitely want to hear your questions on the markets and the election and we’re going to dedicate a good portion of our time here today to that subject.
Now, joining me today is Don Calcagni, our Chief Investment Officer. Don, great to see you again.
Donald Calcagni: Thank you, Doug. Great to be here.
Doug Fabian: And also joining us today is Stephanie Anderson, one of our extraordinary client advisors from the Washington DC area. Good morning, Stephanie.
Stephanie Anderson: Good morning, Doug.
Doug Fabian: Don, let me ask you a question before we jump into our content. What do you want clients to walk away from after they view today’s webinar?
Donald Calcagni: I think if there’s one thing I would hope that our audience would take away from today, Doug, it would be a better appreciation for how to think about elections and markets, how to put them in context and perhaps not think or look too much into the election as a predictor for what could happen in markets, but to understand that elections are just one of many factors that influence markets.
Doug Fabian: Well, one of the nice things we’re going to do today is we’re going to look back in history and we’re going to kind of go through previous elections, look at different administrations, and share a little bit of history. So, I think that’ll be insightful for our clients. Stephanie, you are part of one of the fastest growing offices at Mercer Advisors in the Washington DC area. You, of course, are having conversations with clients every day. What can you tell us about your client conversations heading into the election?
Stephanie Anderson: I think that clients are really asking themselves a series of existential questions, sort of am I going to be okay? Is my family going to be okay? I think when confronted with a life-threatening illness such as this novel coronavirus and this whole pandemic situation, it really causes people to pause and reassess — what am I doing with my life, am I actually engaged in activities that are meaningful and about which I’m passionate? And so I think that’s really the level of conversation that I’ve been having with clients to kind of reassess where they are, where they’re headed. In some cases, people are really reevaluating. If you’ve been involved in a career about which you had very little passion, some folks are saying, “You know what? Life is short and my time on this earth is precious. I’m going to change direction, I’m going to do something else.”
A lot of people, particularly as we approach the end of the year and the holiday season, are very concerned about the food insecurity that we’re seeing. If you watch the news, you see these lines of people as far as the eye can see lined up at food banks to get free food. People are concerned about housing insecurity and unemployment and just people in need. And so the big question is for those who are blessed to have resources, how can they use their time and their talent and resources to help others in need. I think this is particularly meaningful and gratifying for people to be able to think about how they can use their resources to help others.
I am surprised and pleased that folks are relatively sanguine and optimistic about the election. There’s obviously going to be a bit of handwringing, regardless of what situation we find ourselves in. But people are pretty optimistic about the future, which is good. I think it’s more the focus on these existential questions and really, am I going to be okay and if God forbid something were to happen to me, is my family going to be okay, are really the questions that are top of mind for a lot of clients.
Doug Fabian: Great introduction, Stephanie, thank you. Well, Don, let’s take a look at the agenda. Ladies and gentlemen, we’re really going to be focused on three things today. We want to update you — as we do with all of our quarterly webinars — what’s happening with the financial markets, what’s going on with the scoreboard, and then we’re going to talk a little bit about the economy. Then we move to the election and Don has put together a great series of slides to give us a snapshot of the history and what we can learn, and then we want to get to your questions, your Q&A.
So, please, send us those questions, let me know what’s on your mind, and I will be communicating those questions to the panel here today, and we’re looking forward to that. So, Don, let me ask you to jump right in and take it away with our first slide on what’s going on with the economy and the markets.
Donald Calcagni: Great. Well, thank you, Doug, and thank you everybody for giving us some of your precious time today so I hope you’ll find today quite valuable.
So, to kick it off, let’s just take a look at how the economy is doing. It is no secret that the US economy continues to be mired in a very deep, a very severe economic recession. And so this particular chart is showing us really the size of the recession that we’re currently in. You see that in the bottom right-hand corner, that negative 10%. But it shows us the size of the recession relative to other recessions in American history, at least since the Great Depression, which is that large blue bubble in the upper left-hand corner there, that negative 26.7%. So, year to date, the economy has contracted about 10%. The economic contraction that we’ve experienced thus far is actually about 2-1/2 times worse than what we actually experienced during the Global Financial Crisis back in 2008-2009.
And interestingly, I don’t think it feels as bad as perhaps the recession in ’08-’09, partly because our central bank and our government frankly was very quick to respond with economic stimulus and support in the form of unemployment insurance and things like that. That said, there is no sugar-coating the fact that the economy is in real trouble, the economy is definitely struggling. We’ve seen some signs of a recovery but it’s been very uneven at best and hopefully going forward the economy can regain traction and hopefully will return to its economic growth sometime next year. And many analysts, by the way, are predicting, projecting that we will return to positive economic growth sometime next year and that we will also see a recovery in employment and earnings growth especially sometime towards the latter half of next year.
So, what impact has this really had on financial markets? And perhaps counterintuitively, when we look at stock markets here in the United States, what we see is that the US stock market has actually been positive so far this year, at least through September 30th. So, the data that I’m sharing with you on your screen here, these are stock market returns through September 30th, year to date through September 30th. So, the S&P 500 was up 5.6% and a question I often get is, “Gee, how can that be, Don, you just showed me on the prior slide that the economy had contracted 10% yet the stock market is positive, how can that be?”
Well, I would just remind folks that the way the stock market return is calculated is that the biggest companies have a very outsized influence on how that return is calculated. The reality is that 5.6% return is really from just five stocks, the five largest stocks in the S&P 500 Index. The bottom 495 stocks in the index actually had a negative return of about 3% through September 30th. So, I would just caution that when you see that headline number of 5.6%, that doesn’t mean that the entire stock market is doing well, in fact quite the opposite. Most stocks in the index are negative for the year.
And when we look outside of the United States, we see a similar narrative where we see negative returns, the All Country World ex-US Index down 5%, emerging markets down 0.9%. So, we look outside of the United States, we see negative returns, certainly not as negative as they were back in March but I just want to caution that it really isn’t a rosy picture when we look under the hood just a little bit when it comes to how stock markets are doing.
And Stephanie, perhaps you can help us put factor returns in context but just to set you up here, when we actually look inside the market and we look at different types of factors, factors are just quantitative measures of certain types of companies. What this is showing us is really how certain factors have done year to date. And if I grab my pen here, I would really want to draw your attention to this end of the chart over here. And we can see that these high-momentum stocks have done phenomenally well so far year to date, those are the companies we’ve all come to love. What would we ever do with COVID without Amazon or DoorDash? Our lives would be in jeopardy, I think.
But when we actually look inside the market here, this is really what we see. These high-momentum stocks have done well and the reality is most other types of stocks have not done all that particularly well. Stephanie, anything you want to add here to help us add some context?
Stephanie Anderson: I think this is a particularly useful chart to walk through, just to give clients a context, a broader 30,000-foot context. It’s very easy in the moment to fixate on the large tech stocks or rosier elements of the market. The sheer noisiness of this particular chart, I think, really drives home the point that diversification matters and diversification is important. If we look across the top line of this particular table, there’s no one color that dominates, there’s no one factor that is at the top of the leaderboard throughout all of these 15 years or so that this chart covers.
And I think it’s important again for people to keep in mind that no one factor, no one sector, has a lock on good performance. And because of that, we want to make sure that we have a variety of different factors incorporated into the portfolio to enhance the potential for growth, to help with the ability to manage risk in the portfolio, and ultimately to help to increase the odds that clients will achieve their long-term goals. So, I think it’s really useful, again, particularly in moments of heightened market uncertainty or stress to take a look at this chart. It’s something that I have posted on my refrigerator and I frequently hand it out to clients, it really does help to calm down, let’s pull up and keep the broader context in mind.
Donald Calcagni: For sure. And one of the things I think I would just remind our audience of, at Mercer Advisors, we diversify really across three different layers of the portfolio. Number one is we diversify across asset classes, number two we diversify within asset classes across these different factors, and then within each factor we diversify across many, many different companies. And that’s three layers of diversification that’s at work in your portfolio, working to keep risk at a very manageable level relative to your return targets.
So, what about fixed income? 2020 has been a year for the record books. Obviously, when COVID hit back in late February, early March, the US Federal Reserve, which is the central bank of the United States, took interest rates down to zero. And when that happened, it actually pushed up the value of existing bonds that are out there in the marketplace. And so subsequently, when we look at all of these different types of bonds that are in the marketplace, we see exceptionally strong returns in bonds.
Doug, remember last year, we had a similar conversation with clients where we said, “Look, the returns that we saw last year in bonds,” we made a bit of a boisterous claim that, “Hey, you’ll never see these returns again, so enjoy them.” I love being wrong when we have positive signs in front of our bond returns.
Doug Fabian: The bond market fixed income in general is just one of those areas of the market that a lot of people don’t understand. They have a tendency just to be looking at coupon and interest rates. And now, since the interest rates are so low, they think that bonds can’t perform and the only thing that interest rates can do is go up. Certainly, we take a different approach when we go about investing in bonds — high quality, shorter duration — so we don’t take interest rate risk, we don’t take company risk where we are investing for high yields. And they’ve acted as we expect them to do, as a real shock absorber for our portfolios, and we continue to expect that they will do that going forward.
In some of our larger client portfolios, we’re using laddered strategies. So, even if interest rates do go up, we’re receiving a portion of that portfolio each year which we can invest out a little longer on the yield curve. So, I want people to have faith in what we’re doing in the bond market because it just continues to add value to your portfolio in terms of risk stabilization and total return. Don?
Donald Calcagni: You know, Doug, I hear it all the time. Stephanie, I’m sure you hear this too, where clients will ask, “I heard this last year and I’ve heard this actually every year for the past 20 years. Gee, interest rates are so low. Why do I own bonds? Why not just sit in cash?” And I think if we look back to March when COVID hit really hard and the market was falling, I don’t remember there being any client saying, “Gee, I wish I owned more stocks and fewer bonds.” Everybody wanted to own more bonds ultimately back in March.
So, bonds are in your portfolio to be shock absorbers, to diversify your portfolio, and to the degree to which we can get some extra yields, awesome. But their primary role, their central role in a portfolio, I would argue, is to add that powerful diversification benefit you see right here on your screen, and these are just amazing returns by any objective measure.
Doug Fabian: Don, one more point on sitting in cash. If you’re sitting in cash, you actually have a negative rate of return after inflation. So, I almost wish that a money market was posting negative numbers because that’s the reality of it. We still have inflation and we expect to see inflation going forward. And so just to think that sitting in cash is a good investment decision, it’s not, because you’re actually experiencing a negative real rate of return.
Donald Calcagni: So, let’s pivot and take a look at elections and markets. Some people think we’re nuts for getting up here and talking about politics, here we are less than two weeks away from what promises to be a very interesting election season. But to be fair, I mean, many of us, myself included and certainly our clients, have questions about, “Hey, what impact might the elections have on markets?” So, we all like to think that our particular candidate or political party has all of the answers but I think when we look at the data, what we’re going to find is that markets do well really regardless of who’s in control of government.
So, let’s just step back for a moment and take a look at stock market returns during election years. Earlier this year or late last year, this is probably one of the most common questions we were receiving from clients and that is, “Gee, should I sit out 2020, sit in cash, because it’s an election year?” Now, certainly, a lot of other things happened in 2020 unrelated to the election, but coming into 2020 we didn’t know that we were going to have a global pandemic but we did know that we were going to have a major presidential election here in the United States.
And so when we actually look at market history going back to 1928, what we observe is that actually the market tends to do really well in election years. The average return for the S&P 500 during election years is 11.3%. So, frankly, if you were to sit out election years, your opportunity cost would be about an 11% rate of return, at least when we just look at simple averages, when we look back across American history back to 1928. That’s a very significant opportunity cost. So, again, when we look at the return data, when we look at the history, it tells us that there’s really nothing unique to election years that would suggest that we should sit out of the stock market during election years.
And in fact, if anything, what we observe when we look at history is that most of the time, really with the exception of only four years, markets have been positive during election years. So, by any measure, when we look at returns in election years, when we look at the probability of a positive return during election years, this tells us you should remain invested. There’s no argument that you can make, at least based on the election, that you should not be in stocks during election years. And we just saw this a few moments ago. I showed you that despite COVID, despite murder hornets, and everything else that has been in the news for 2020, that the stock market, the S&P, is positive 5.6% through September 30th.
Now, before I leave this slide, I want to drive home a very important point. Let’s take a look at 2008, Barack Obama versus John McCain, negative 37%. That data point obviously jumps out at us off the page, right? That’s a severely negative return and it was an election year. But I would ask — does anyone seriously think that the market was down 37% because it was an election year or did it have a little something to do with the fact that we had a global financial crisis, that the entire financial system went into cardiac arrest? I would argue there were other things going on in the world in 2008 that ultimately led to a very severe market decline. It was not the election. The market decline actually began in August of ’07 and really exacerbated throughout 2008, they hit their nadir in September-October of 2008, and the market actually hit bottom in early 2009. None of that had to do with an election.
So, this is where it really gets fun. So, if we go back and look throughout history, back to 1929, and we look at the average stock market return under different presidents, and then if we were to categorize them by political party, what does it look like? And the first thing that we observe is that the average return for any year during a presidential term is about a positive 10% return. Again, a very handsome return that I think more than anything just tells us that stock markets work and that they’re great places to build wealth over time.
But really interesting is the next thing that we observe is that when we bucket the returns between Democratic administrations and Republican administrations, we see the Democratic administrations had a much higher average stock market return than Republican administrations — basically 14% versus about 6.3%. And so many of us, when we look at that, that’s a big counterintuitive. I think there is a popular perception that one particular political party is “pro-business” and the other is perhaps “anti-business.” And I put that in quotations because I think that’s a very simplistic way of looking at the world. And when I say simplistic, I mean inaccurate, I think there’s a lot more going on here. But interesting, when we look at the data, it’s Democratic administrations that had much higher stock market returns.
Now, before my Democratic friends call their Republican friends and say, “Ha! I told you,” what I would just caution is that we really have a very small sample size here. In fact, I would argue it’s far too small to draw any statistically meaningful conclusions that one party is any better than the other. You have a data set here that’s only 14 different political administrations. So, statistically, I’m not going to get into the nerdy stuff on statistics, but if you just look at the sample size here, it frankly is meaningless. There’s no data here that tells you that one party is better than the other.
And in fact, when we actually look at the data, it’s poor Edgar J. Hoover who’s really pulling down the Republican average in a really bad way. And really, maybe it was his fault but I don’t think it was his fault that we had a Great Depression that started on his watch. But when we look at the other negative years, they’re pretty much offsetting one another. We had George Bush in his second term and then we had Roosevelt right on the eve of the Second World War, they tend to cancel each other out.
So, I want to play with the data just a little bit, because you may be thinking, “Hey, I don’t believe him. Democrats are better,” or my Republican friends are probably saying, “He has no idea what he’s talking about, fake news,” right? What I want to do is say hey, let’s back up for a moment and let’s actually play with the data just a little bit. And this is what I mean when I say that the data is statistically insignificant. If we were to just chop off all of the stock market returns for the years prior to 1948, so poor Edgar J. Hoover, we give him a break, we take him out of the data. We remove Roosevelt, the Great Depression, the Second World War, okay?
But if we just look at stock market returns from 1948 forward, what we actually see is that the result flips and Republican administrations, when they had full control of government, actually had higher returns than did Democrats. And that’s what I mean is when you can just remove one or two data points from your data set and get a very different conclusion, that tells you that you probably don’t have enough data to draw an accurate conclusion that one party is any better than the next.
Now, before I leave this slide, I just want to highlight your economic growth at the bottom of the slide. If we actually look at, “Gee, how did the economy do under different political parties?” What we see is that the economy grew the most when Democrats had full control of government. Again, I would just caution here for a moment. Part of this has just to do with history, the Democrats controlled government in the post-war years, the ’50s, the ’60s. Economic growth was a lot higher back then because we had the baby boomers and everything else going on. I’m not exactly sure that the Democrats themselves had anything really to do with that economic growth number.
And I think the real takeaway for us as investors is, look, when we actually look at history, the market has done phenomenally well under both Republicans and Democrats. And so when we look back to 1928, we can see that the market has generally been upward sloping. It has not been a straight line, obviously. We’ve had a number of issues over the years that have challenged the markets. But I think my message to our listeners is, “Look, capitalism works. Financial markets work. They’re not pretty, they’re not risk-free, but they definitely work.” And regardless of who controls the White House, regardless of who controls the Senate or the House of Representatives, the reality remains that the market over time continues to grow, continues to build wealth for all of us as investors.
And in fact, there’s only been three administrations in American history since 1928 where we did not see the stock market deliver positive returns over their presidential term and that was George Bush, the second George Bush. He came into office when the dot-com bubble was on the cusp of bursting, it bursted really on his watch. We also had the tragedy of 9/11 on his watch. Does that really mean that George Bush is responsible for those negative returns? I would argue that that probably is not a very strong argument. Richard Nixon — he was dealing with Vietnam, and he took the US off the gold standard and we had stagflation, the Arab oil embargo, and so on and so forth. And then of course, poor Edgar J. Hoover who takes responsibility, I guess, for the Great Depression.
So, the reality is most presidential administrations have witnessed a growth in the stock market on their watch. Doug, I think at this point I’ll hand it back to you and perhaps we can open it up for some Q&A.
Doug Fabian: Great, great. Well, there is a lot of questions in the queue and I just want to again encourage clients to send us your questions, we’re going to do our best to get through as many as possible. Don, great question here — how should we differentiate between the economy and markets? And to put some context in this, obviously we had very bad economic data of late. I think the fourth quarter is going to be positive but we were digging out of a big hole. We’ve seen this recovery in the stock market. We’re seeing a worse decline in the economy than we had in 2008, somebody could say, “Why isn’t the stock market down more?” So, what’s going on with those things?
Donald Calcagni: Yeah, well, like I explained earlier, when we look under the hood, the reality is most stocks in the market are negative. There is a small handful of stocks, your Amazons, your Apples, Zoom [Laughter], companies that have done very well because of the situation in which we find ourselves, right? But the reality is when we look at the majority of stocks in the market, they are not positive for the year. And in fact, like I said, if you remove the top five stocks from the S&P, the bottom 495 stocks actually had a negative return of about 3% through the end of September. So, that’s point number one is that be careful, the market isn’t doing as well as we think.
Point number two is that you got to keep in mind that economic data is what I call “backward-looking data.” It’s really a record of what happened, right? That’s very different from asset prices or stock prices. Stock prices are forward-looking, right? What stock prices are doing is pricing into today future expected cash flows on the company, right? So, stocks are forward looking. That’s why earlier I referenced that analysts are forecasting a recovery in the economy in 2021. We’re forecasting a recovery in S&P 500 earnings in the latter half of 2021. So, there’s a key difference there as economic data is always backward looking, it’s never forward looking. We’re telling you what unemployment is today, what the economy did over a prior period of time, whereas stock markets, bond prices are forward looking. So, those would be my two key points.
Doug Fabian: Great, great. Stephanie, I think this is an excellent question for you. Now that bonds have rallied, would it be appropriate to shift money from my bond portfolio into stocks?
Stephanie Anderson: I think it depends on the situation of the particular investor. In some instances, folks have come through this period of market turbulence and they are feeling quite comfortable with the level of risk that they have experienced. In those sorts of circumstances, again, keeping in mind your overall ability to stomach volatility and your particular longer-term return focus and objectives, it may very well be appropriate. I don’t know that I would do it as a knee-jerk response but I would keep it in the context or the framework of your overall longer-term goals for return and your ability to stomach volatility in the markets.
Doug Fabian: So, we’ve gotten a couple of questions from clients about inflation. And so, Don, just comment in general — just where inflation’s at today, what our expectations should be. Obviously, we have currency risk when we own dollars and if the dollar were to weaken. But where do we stand in terms of inflation and how — and I’m going to come back to you, Stephanie, and talk about how we build inflation into our financial plans — but Don, just give us an update on inflation.
Donald Calcagni: Yeah, it’s a great question, Doug. Right now, inflation is averaging about 1%, we’re well south of the Federal Reserve’s 2% target. So, the central bank, the Federal Reserve, they would like to see annualized inflation of about 2%. And importantly, about a month and a half, two months ago now, the Fed actually changed its inflation target to be an average of 2% over a period of time, which is really just their way of saying, “Hey, look. We’re willing to tolerate much higher inflation to try to make sure that the economy does not spiral into deflation,” right?
So, if you go back to April, we actually saw powerful deflationary headwinds hitting the economy like a brick. In fact, over the last 10 years, that’s what central bankers have been more concerned about is deflation not inflation. So, we do have positive inflation at the moment but not nearly enough, the Federal Reserve would be much more comfortable if we had higher inflation. Now, what I wouldn’t our audience to interpret that as, I wouldn’t want them to think, “Oh, my gosh. They’re trying to wipe out the purchasing power of all of my wealth.” That would be a bridge too far, that’s an exaggeration. They’re just trying to make sure that the economy does not enter into a deflationary spiral. So, 3%, 4% inflation, I think is in the cards for the Federal Reserve.
Obviously, when the government spends, when the central bank prints money through what they call quantitative easing, and they’ve pumped cash into the economy, in theory that is inflationary. The reality is though the economy is not firing on all cylinders, and when you have the economy in a recession, you have lots of room for the federal government and for the central bank to engage in stimulus in an attempt to resurrect the economy and to get the economy growing again.
So, I think short-term inflation is not a real big concern, I would encourage our clients not to obsess over inflation in the short term. I think longer term it’s something that policy makers are going to have to pay some attention to. And by “longer term” I mean 5 or 10 years out. And clients should still very much be planning for inflation in their financial planning. They should be incorporating that into their financial planning, because I don’t think it’s going to go away. My message is that I just don’t think it’s a real problem right now and we shouldn’t obsess over it.
Doug Fabian: And Stephanie, comment because you’re in the trenches, you’re building financial plans for clients. How are we going about factoring inflation into our financial plans today, just from a company policy perspective?
Stephanie Anderson: Sure. One of the primary ways to factor inflation in is when doing the financial plan, to take a deep dive on a client’s expenses. I mean, you don’t have control over everything but one of the few things we do have some control over is how much we’re spending. And so inflation is factored in quite explicitly through expense projections, we can project out. Let’s say we have assumed a life expectancy of 100 years for a client. We’re going to project those expenses out on a straight line basis at a base rate of inflation, but I also have the ability to vary the rate of inflation depending on the particular line item.
So, for example, I might inflate medical expenses at a higher rate than I would sort of your routine month in, month out housing expenses or some other sort of basic living expenses of that sort. So, we can, in fact, toggle and fine tune the rate of inflation or the rate at which expenses are growing over time. I’ll also note that in some instances, clients may want to take a conservative approach, which is fine, again, if that’s your particular posture and focus longer term.
The challenge is to make sure that you’re not taking too conservative an approach because putting large sums of money in cash, for example, while it might feel good and there certainly is a place for having liquidity, we all have to be cognizant of sort of the impact and the implications of inflation over the long term. So, we want to be exposed, whether it’s to fixed income or equities, whatever the appropriate proportion happens to be, so that you have some potential for return and aren’t subject to sort of the slide or the backslide of inflationary pressures.
Doug Fabian: Well, let’s jump back into the election and there are a number of questions from clients on the election. Don, I want to go to the issue, and we haven’t touched on it so far, of a contested election and the impact on the markets. How would you answer that question?
Donald Calcagni: It’s interesting, I gave an interview to Bloomberg News about a month ago [Laughter] where I predicted that in October we would see a spike in market volatility. Again, I’m not afraid to be wrong and I’m glad to be wrong, that we’ve actually had a fairly anemic market here for the past few weeks.
But the reality is we have not seen a spike in volatility. But if we actually look at the options markets, which I’m not going to get into the details of how they work, but the options market to some degree can be used to predict volatility in the future. And when we look at options pricing, the options market is predicting that volatility would peak sometime in mid-November. So, I think the options market is pricing in the possibility of a contested election. Now, what I would say also is that when we look into December and January, the options market is predicting that that volatility will come back down and return to its longer-term trend volatility.
It’s important for our audience to remember that we have constitutional mechanisms already in place for dealing with contested elections. We saw this in 2000 with Bush v. Gore, that went to the Supreme Court. So, the court system can be used to resolve contested elections. We also have a constitutional mechanism where the House of Representatives would step in to resolve any contested elections, perhaps in the event of a tie. I think we have lots of mechanisms for resolving these issues.
Is it a real concern? Yes, I do think it’s a concern. But I think when we actually look at the fact that we have mechanisms to resolve a contested election, the reality is this — you shouldn’t try to time it, you should remain diversified, and all of these mini crises, whether it’s contested election or COVID, they all ultimately have a beginning, a middle, and an end. A contested election will be resolved, we will have a president on January 21st that will be either Donald Trump or it will be Vice President Joe Biden. It’s going to be one of them. So, it will be resolved and the market will ultimately return to its long-term trends. And I think frankly, over the longer term or even the intermediate term, there’s very little that I would concern myself with with respect to my portfolio.
Doug Fabian: Another question from the audience — really talking about the issue of policy during an election cycle, and policy that is implemented once a new administration might be in place. And so the question here is are you saying that policy changes implemented by a particular party won’t have an impact on market performance? And of course, we don’t have a final say. If you could just go through that process, Don, of what somebody says is their policy and what actually gets implemented are two different things.
Donald Calcagni: Yeah, I mean, absolutely, you see this all the time, right? We saw it with Joe Biden during the Democratic primary where he had to run to the left in order to win the primary but since the primary has ended, he’s come back towards the middle a bit and has arguably selected a candidate that is more moderate than I think many people realize. At least that’s my personal view when I look at her policy positions.
But here’s the reality — the political platform is just a proposal. Presidents don’t make laws, [Laughter] Congress does. And so at the end of the day, that’s really where the horse trading will take place and that’s where the proverbial sausage is made is in the halls of Congress between the House members and ultimately the Senate. And then the President really only signs off or can naturally veto a proposed legislation. So, it doesn’t mean that the President doesn’t have enormous influence, of course he or she would have enormous influence over what that legislation looks like. But I think it’s important to understand that we’re electing a President, not a king or queen as it were. So, at the end of the day, we have a democratic process and so the ultimate policy that becomes law is often very, very different from what we hear candidates say during the campaign. So, that’s point number one.
Point number two is markets very rapidly price in new information. JP Morgan, just two days ago, made a comment that the market is already pricing in a blue wave, which means then that the market is pricing in any proposed tax increases that the administration has put forth as policy proposals. So, markets are very quick to price these things in, but going back to our very first slide, there are lots of factors that influence markets, right? Certainly in a very simplistic academic way of thinking, all things equal, higher taxes are bad for stock prices, I’m not going to take issue with that. But that’s a very simplistic way of thinking of the world. Democratic administrations tend to also be more stimulative with their government spending. They spend more typically and government stimulus helps to grow the economy.
So, Goldman Sachs’ position, which I think is accurate, is that while a Biden administration would raise taxes and that would hurt stock prices, they would also engage in more infrastructure spending which will also push stock prices back up. So, their view — which I agree with — is that in reality, a Biden administration would probably be net neutral ultimately for stock prices when you actually look at all of their policy proposals. So, I agree with the question that policy definitely influences markets, but it’s not a simplistic, linear, cause-and-effect relationship. There’s lots of other things going on in the world that influence stock prices. In fact, the biggest influencer of stock prices right now, frankly, is COVID and not taxes and I would argue not even the election.
Doug Fabian: Stephanie, a lot of questions in the queue about taxes and proposed tax legislation that may happen post-election. Talk to us about how you’re having conversations with clients about their tax situation. How do you go about addressing that conversation? What are you talking about with clients between now and the end of the year from a tax perspective? We, as a firm, do believe that taxes will be going up long term, no matter who is elected, just because governments are starved for money and revenue. So, just looking at it from that perspective, talk to us about what you’re doing with clients.
Stephanie Anderson: Sure. One of the really significant topics of conversation over the last couple of months, and this will continue through the end of the year, is Roth conversions. Particularly for those clients who are anticipating that when they hit age 72, that their RMDs are going to be, in many cases, quite significant. It oftentimes makes sense to do those conversions and pay the taxes now while taxes are quote/unquote “on sale” at least through the sunset period, the currently scheduled sunset period of 2025, end of 2025. So, Roth conversions has been a big topic of discussion and analysis and implementation for many clients who put that in place so that they don’t have to concern themselves or worry about future tax increases going forward.
The other issue is again, given the low capital gains tax rate structure that we have in place, is to look for opportunities to harvest gains in the portfolio between now and the end of the year. To the extent that a client has some positions that might have embedded losses, unrealized losses, this is a great opportunity to do some cleanup in the portfolio by harvesting those gains. And again, to the extent that there are losses that are present, to use those to get to as tax-neutral a position as possible.
Doug Fabian: Great, great feedback. Don, let’s go back to another issue that has come up here and that is how is Congress — and again, we have pending another stimulus package, if it’s going to come before the election, after the election, certainly post-election into 2021, if another stimulus package is necessary to save the economy, to rescue many Americans who have not been able to find employment in this new pandemic environment, I think Congress is going to go back to the well. They’re going to come up with another stimulus package. So, the question is where’s all this money coming from? How can we afford this? The national debt has become significant and we’ve been talking about this our entire careers, so give us the latest update on this, Don.
Donald Calcagni: Yeah, no, this is probably the most popular topic among academic economists right now — trying to figure out how worried should we be about the debt. So, there’s a lot of points that I would make here, Doug, and I want to be sensitive to our time. But number one, now is not the time to suddenly become fiscal conservatives, [Laughter] right? The time to do that frankly was three years ago, not now. And so the reality is the country is dealing with a crippling pandemic and we have a host of issues that in my view, are really interfering with our country’s ability to grow our economy in a healthy and sustainable way and I won’t get into that here. But now is not the time to suddenly worry about the debt. There will probably be a time when we have to and should begin worrying about the debt again.
Where’s the money coming from? Like I said a little bit ago, we have very low inflation at the moment, the economy isn’t even close to overheating. The economy is not firing on all cylinders, we have unemployment, we have underemployment, and we have low interest rates. All of those things tell us that the economy has a lot of room to go before inflation becomes a serious problem. So, what that means is where’s the money coming from? Well, it’s going to come from quantitative easing, our central bank, and basically going to the basement of the Treasury and crank up the printing press, print money, and buy US Treasury bonds, and effectively finance government debt through the printing press.
Now, I know for a lot of folks who don’t understand economics or monetary policy, that that feels threatening, and I would say we should be concerned about that, but probably not for the reasons that you would think and I would argue now’s not the time to be concerned about that. So, Doug, you made a comment a little bit ago that our view is that taxes are going up eventually. If not under Trump, then under Biden. If not under Biden, then under somebody else. I think the reality is the country is facing some pretty large outlays that it has to meet, whether it be Social Security or healthcare or education or modernizing our military to deal with a changing global world order.
The reality is there’s a lot of demands on government. So, they’re going to raise taxes to help fund perhaps another fiscal stimulus, they’re going to fire up the printing press. So, it’s going to come from the printing press and it’s going to come from tax increases. It’s going to come from a combination of those two sources of cash.
Doug Fabian: So, let’s shift the conversation over to our clients and just their mindset, what should they be thinking about? Obviously, we’re doing this webinar 10 or 12 days in front of the election. Certainly, we may have a contested election, we may have market volatility. I think clients should be expecting that there’s going to be market volatility and that’s just part of being an investor.
But what should you be doing between now and the end of the year? And Stephanie, you touched on taxes and making sure that you’re having conversations with your advisor. This Roth conversion, this has been one of our biggest years as a firm in asking clients, putting forth in front of clients, running the numbers on doing Roth conversions, because this has significant long-term tax impact on not only our clients’ future income but on the next generation. So, we have that. We have looking at your balance sheet, maybe realizing some capital gains, no one is changing any tax laws between now and the end of the year. Okay, we know what the tax rules are between now and the end of the year. So, maybe this is a time to be realizing some gains, offsetting some losses as you mentioned, Stephanie.
But talk to us — we’re coming into the holidays, and this is going to be a very strange holiday season because we still are living with a highly contagious virus out there and so whether or not people can socialize like they normally do. But certainly, we’re going to be communicating with family and friends. So, Stephanie, you and I had a good conversation, particularly around the subject of doing some longer-term legacy and estate planning. If you wouldn’t mind sharing that story, I think this is an appropriate time.
Stephanie Anderson: Sure, sure. I think as we go into the holiday season, it is going to be a curious holiday season as you point out, Doug. I think a lot of families are in the process of having these group calls to figure out what does the holiday season look like, how will we celebrate this year? It’s a great time to come together and have conversations about sort of the importance of the family, the values of the family, and making sure that everyone is kind of on the same page as to what it means. What it means to have the wealth, and how the wealth should be transferred, and how the wealth should be managed, and what should be done with the wealth, I think is particularly important. And as families gather, whether that’s in person with appropriate social distancing and precautions or whether it’s virtually, it’s a great opportunity to have these kinds of legacy and family values kinds of conversation. And the big question to ask and answer is are my papers in order, are my documents in order, and if God forbid something were to happen, does my family know what my wishes are, and do they know how to carry out those wishes?
And it reminds of the story that, Doug, you and I had spoken about. When I was in the 9th or 10th grade, my father was diagnosed with terminal cancer, and the doctors told him that he had three months to live, and the instruction was, “You’re not going to be here for very long. You need to go home and get your paperwork in order.”
And my dad was a particularly organized and detail-oriented guy, he had a binder that he kept on his desk that had tabs in it, as the attorney, the accountant, all the investment information, the insurance information, he even had burial information, and how he wanted that to be handled. And his words to me were, “There can be sadness and there can be tears, but there cannot be chaos.” And so he said, “When you get the word that I have left this earthly plane, you’re to go and find this binder and it will give you instructions, it’s your roadmap as to everything that needs to happen.”
And I remember at the time, I was what, 14 or 15. One, you’re digesting just the enormity of the message that you’ve just heard but also you think, “Who on earth sits down to put together a binder with instructions?” When you fast forward, the doctors told my father that he had three months to live. He wound up living for 10 years, I think his oncologist was more surprised than anyone. But ultimately, he wasn’t able to outrun cancer forever and we did have to use that binder. It had gotten a little bit dusty in the intervening years, but I will tell you it was the most thoughtful and considerate thing that he could have done for us. There was sadness and there were tears, but there was not any chaos at all. We had that binder, we were able to go through the binder in a stepwise fashion and tick off things.
And I’ve recently had this experience with a couple of clients who sadly have had family members who have died in recent weeks. And their paperwork, because they’re working with Mercer, their paperwork was in very good order, and the process of transitioning and getting things to that new normal has been very smooth. It doesn’t mean that it happens quickly or it happens overnight, but it has been happening without chaos and without hiccups.
And so I think this story that I learned personally and that I’ve seen play out with clients is a very important one, particularly as we go into this year-end holiday season. One, to that question, “Am I going to be okay? Is my family going to be okay?” A big part of that is to make sure that your wishes are communicated, that they’re codified in terms of an up-to-date estate plan, and that the people that you task with carrying out your wishes know what they are, and know with confidence that they can proceed and carry on on your behalf.
Doug Fabian: Thank you, Stephanie. I think that’s a fantastic message for clients and just quite a personal story, so thank you very much for sharing that.
Don, I wanted to ask you in particular, a lot of client questions around the subject of what if, and are we going to go into another depression, and is the tax man coming for all my money. But there’s real concern about volatility and obviously, we can’t predict what’s going to happen. We certainly didn’t predict the COVID decline nor the COVID recovery, and certainly, markets have always overcome stresses in the past. But talk to our clients about risk and their risk profile and how we believe if you want to make a risk adjustment in your portfolio, now’s the time to talk to your advisor about that. Don?
Donald Calcagni: I mean, absolutely. Risk is an intensely personal thing, right? I mean, nerds like us can talk about esoteric sort of quantitative ways of measuring risk, but when I think about the human dimension of risk, it’s a lot of the things that Stephanie has discussed throughout today’s discussion. So, I think it’s very personal, it’s very human.
So, I definitely encourage clients to have a conversation with your advisor around what impact negative returns or market volatility might have on them personally, on their goals, on their planning. Because that’s where risk becomes real. I can give you all kind of fancy numbers and formulas and spreadsheets, but at the end of the day, that’s where risk becomes real, when you’re confronted with the possibility of not being able to retire in a very dire situation or delaying retirement or spending less in retirement, that’s where risk becomes very real. And so I would definitely encourage clients to have that conversation with their advisors.
I would also make another point, Doug, and that is look, we all have our views on this particular election. And that’s what makes our country great is we all have different views and that we all respect one another and respect those different views. And so I understand that we have clients who are uneasy with the upcoming election. We have many clients who have very strong views on one party or one candidate versus another and I fully respect those views. And what I would encourage them to do is talk to their advisor about perhaps making a change in their portfolio.
I don’t see any harm in a client reducing, for example, their stock exposure in their portfolio between now and the end of the year. If that’s what it’s going to take for a client to sleep at night, to feel better about where they’re at financially. At the end of the day financial planning, wealth management, everything we do at Mercer Advisors is about helping our clients live more fulfilling lives. And if ultimately that’s what it takes for you to sleep at night, then we strongly support that and would never want a client to stay in a portfolio that they would be uncomfortable with. And your advisor can help you understand what the implications of that decision might be.
For example, maybe there’s capital gains taxes, maybe that would ultimately mean that you have to work a little longer or spend a little less. But I definitely encourage clients — have that conversation with their advisor. Make risk real, make it personal. Don’t make it some number on a spreadsheet, understand what impact that would have on you and your family, and then shift gears accordingly so that you can sleep at night.
Stephanie Anderson: I think that’s a great point, Don, that risk — we can talk about efficient frontiers and esoteric discussions about risk, but it really comes down to kind of a gut check, one, and two, can I sleep at night? If you’re having difficulty sleeping at night or if you just feel uneasy, it’s worth a conversation with your advisor to make sure that your allocation is appropriate for where you are right now.
The other thing that I like to discuss with clients is to make sure that you have an appropriate liquidity reserve. Obviously, we don’t want to tie up huge sums of money in cash, but whether you’re working and particularly if you’re retired, having a reserve of cash, whether it’s a year or some other number, it depends on the individual, helps people to sleep at night and helps them to stay the course. Because they know that there’s sufficient liquidity such that their standard of living is not going to be impacted and so it really saves us from ourselves. We’re not inclined to make decisions that we might later regret simply because we’re concerned about making sure that cash flows and expenses are covered.
And we do, in fact, have — to your earlier point, Don — we have an array of tools and analysis that we can do to understand the implications of these different decisions. But ultimately, if you’re feeling a little uneasy or can’t sleep, then it’s worth a conversation with your advisor to consider some different options, potentially.
Doug Fabian: Well, panel, we are at time, I want to thank you both for joining us. I mean, obviously, to all of our clients — we know we’re right in front of an election, we are going to be communicating with you multiple ways post-election. So, we will continue our dialog through our advisors, through Don’s emails, and through our newsletters. Remember to look at our Insights page where we have a lot of information, special reports, webinars like this. But we’re going to get through this election cycle and we’re going to keep marching forward to make sure our clients achieve and maintain their economic freedom. So, Stephanie, thank you very much for joining us today. Don, great presentation once again. And to all of our clients — thank you for joining us today on our client webinar.
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