Mader & Shannon Wealth Management's independence means we are free to focus solely on the needs and objectives of our clients.
We are committed to providing value to our clients and have structured our entire organization around this concept.
We define value in portfolio management as achieving yield and growth objectives with as little risk as possible while minimizing transaction costs and taxes. Active Money Management - The goal of active money management is to protect the client from major downtrends resulting from the collapse of an overvalued market, and still allow the investor the opportunity to participate fully in the growth in value and income that the equity markets have historically provided.
Retaining an independent financial professional is as important for planning as it is for portfolio management. Mader Shannon has no commitment to any product or service that will in any way conflict with the best interests of our clients. Our services are designed to offer objective advice and set reasonable expectations. We take the time to educate clients on suitable financial solutions, carefully exploring risk and performance expectations.
At Kansas City's Mader & Shannon we define value in portfolio management as achieving yield and growth objectives with as little risk as possible while minimizing transaction costs and taxes.
The goal of active portfolio management is to protect the client from major downtrends resulting from the collapse of an overvalued market, and still allow the investor the opportunity to participate fully in the growth in value and income that the equity markets have historically provided.
Active Money Management
History demonstrates that although stock prices move erratically on an hourly, daily, or weekly basis, market averages experience long term trends with respect to intrinsic value. Understanding the state of the markets with respect to this persistent trend of overvaluation or undervaluation is the primary key to implementing an effective active management investment strategy.
The basic strategy of active money management is to reduce the risk associated with bull markets during periods of overvaluation, and to beopportunistic during bear markets that persist during periods of undervaluation. This combination enables clients to fully participate in the long-term capital growth the markets have historically provided.
Active portfolio management does not conflict with the concepts of long term investing. Most of our clients are in fact long term investors dependent on income and growth from their portfolios.
Take a tour of our Trading Room
Mader & Shannon Offers 529 College Savings Plan Management Through TDAmeritrade
Mader & Shannon manages 529 College Savings plans on the TDAmeritrade platform. The plans are sponsored by the State of Nebraska and Union Bank & Trust Company serves as the Program Manager.
The benefits for our clients are as follows:
Mader & Shannon can continuously monitor the plans and make allocation changes periodically through primarily Vanguard funds (currently the IRS restricts changes to twice a year).
Tax parity laws in some states (including Missouri and Kansas) make the state tax deductions available even though the plan is in Nebraska.
Eligibility for tax-free withdrawals for qualified higher-education expenses applies to any nationally accredited school, not just those in Nebraska.
Contact Bret Guillaume at 816.751.0575 or email@example.com to open an account or transfer an existing 529 balance. For more information on College Savings Plans visit www.collegesavings.org
At Mader and Shannon, we believe that an effectively implemented active management strategy can help clients achieve reliable upside participation while also providing excellent downside protection. By dampening the volatile swings in the market, our strategy seeks to provide both a sustainable long-term rate of return as well as peace of mind to our clients.
Strategy & Daily Routine
We take a top-down approach to asset allocation and a bottom-up approach to security selection. We monitor global economic indicators like GDP, employment, wage growth and a host of survey data to determine overall economic health. Interest rates, currency dynamics, and inflation are direct inputs to the valuation of markets, and must be incorporated to a comprehensive global evaluation. Finally, an appraisal of the fundamental health of broad indices like the S&P 500 aids in our assessment about the overvalued or undervalued state of markets.
From that baseline, we select securities that we believe provide the best risk-reward opportunity in the current economic environment. We seek to invest in companies that have good fundamental prospects and are, in our opinion, undervalued. Company-level research centers around earnings and revenue growth, valuation multiples, cash flows, and balance sheet health. Our investment universe consists only of highly liquid, exchange-traded securities.
Because we are an active manager, our outlook and positioning are flexible and dynamic. The only responsible way to make investment decisions is to base them on the most up-to-date and accurate information available. Our task each day is to gather market-related news and data, use it to develop an investment thesis, and then decide whether our current portfolio is ideally suited to perform in a given market environment. Such a task requires discipline, and over the years we’ve developed a daily routine that helps us accumulate and digest an unrelenting supply of information.
The Kansas City Trading Room opens an hour and a half before the US exchanges each morning. By that time, we are already up to date on the developments in Asian markets overnight, how the European markets are trading, and where the U.S. indices are expected to open.
Our first task on site is to download the previous day’s transaction and position data from our custodian. Once imported into our portfolio management accounting platform, we can generate performance and view holdings at the firm, strategy, and client levels. The integration of the accounting platform with our Bloomberg and Level-2 quoting systems allows us to aggregate our discretionary assets and constantly monitor them on a tick-by-tick basis, each and every day.
By 8:00, our portfolio management team has scanned our various research platforms for developments on current or prospective holdings. We then discuss our findings and develop our expectations for the coming trading session. If any team member believes a portfolio change is needed, that too is discussed, and before the opening bell rings, we have a plan for the day. From the opening bell, until the market closes at 3:00, the Trading Room constantly monitors holdings and the markets, regularly meeting throughout the day to discuss ideas and potential adjustments.
The Mader & Shannon trading room operation is an intense environment staffed by dedicated professionals who relish the daily opportunity to help clients achieve their financial goals.
As a wholly transparent money manager, we regularly host current and prospective clients in the trading room for market reviews and strategy orientations.
Simply put, wealth management is the process of a team of experts providing the highest quality of financial products and services to improve the financial health of client. In other words, it is the delivery of a full range of services tailored to solve for a specific financial objective or goal.
Wealth management incorporates a full suite of services that include financial planning, portfolio management, tax services, retirement planning, and estate planning. This provides a holistic approach allowing each scenario to be analyzed from every angle to achieve a successful outcome.
Typically, a wealth manager acts in a consultative manner and is focused solely on the client’s behalf. A wealth manager should be a fiduciary, working only with the client’s best interest in mind. Upholding the standard of a fiduciary in the financial service industry must include putting a clients’ interests before your own, acting in good faith and providing all relevant facts to clients, remaining free of conflicts of interest, and ensuring the accuracy of advice given.
Accomplished wealth managers should also hold credentials within the industry such as Certified Financial Planner (CFP®), Chartered Life Underwriter (CLU®), and Charter Financial Analyst (CFA®). The criteria that one must meet to hold these designations demonstrates not only their competency but their commitment in that respective field.
Here at Mader Shannon, we believe it is crucial to understand our clients and what is important to them. The services we provide are structured around our client’s investment objectives and tolerance for risk. We take the time to not only identify but understand our client’s aspirations. We then analyze the information and engage other professionals when appropriate to develop suitable recommendations. Our work is far more comprehensive than simply providing investment advice.
Our services are designed to offer objective advice and set reasonable expectations. We educate our clients on the suitability of our financial solutions, carefully exploring risk and performance expectations.
Typically, when a wealth manager acts in a consultative manner and is focused solely on the client’s behalf they are considered a fiduciary financial advisor. A fiduciary is a person or legal entity that has the power and responsibility of acting for another in situations requiring total trust, good faith and honesty.
Acting as a fiduciary has a very important meaning within the financial services industry. Much has been debated and written as the industry struggles with a self-imposed standard of care. It is often assumed that when choosing a financial advisor, they are all required to do what’s in the client’s best interest, but that is not the case. There are those that are held to a higher standard, and those that are not.
A fiduciary financial advisor is an investment professional who is licensed with the SEC or a state regulator and who are legally required to put their clients’ interests before their own. Having a fiduciary duty to your client should eliminate conflicts of interest and theoretically make a fiduciary’s advice more trustworthy. It is Mader Shannon’s obligation to uphold this standard as an SEC registered RIA (Registered Investment Advisor).
In addition to regulatory bodies requiring a higher standard of care, all the principals at Mader Shannon hold designations that, within their Code of Ethics, require that they adhere to or go beyond the fiduciary standard of care. Fiduciary financial advisor’s often hold credentials within the industry such as Certified Financial Planner (CFP®), Chartered Life Underwriter (CLU®), and Charter Financial Analyst (CFA®) all in which require that professionals act within this standard.
The luxury of being able to maintain our independence translates into a better relationship with our clients. Being able to think and act strategically in the interest of clients and not beholden to a parent company allows Mader Shannon to offer a more fiduciary centric service. Being a fiduciary financial advisor affords our clients a higher level of transparency in the way we provide our service, and perhaps more importantly, in how we are compensated for our service.
The following articles provide additional information on fiduciary standards within the industry as well as questions to ask and things to look for when choosing a financial advisor.
Retaining an independent financial professional is as important for planning as it is for asset management. Mader Shannon has no commitment to any product or service that will in any way conflict with the best interests of our clients.
Our services are designed to offer objective advice and set reasonable expectations. We take the time to educate clients on suitable financial solutions, carefully exploring risk and performance expectations
Our Planning Services
We provide the following services for helping clients achieve their financial goals:
Comprehensive Financial Planning
Complete Portfolio Analysis/Review
Company 401k Plans
529 and Education IRAs
Qualified Plan Rollovers
Retirement Cash Flow Planning and Projections
Why an Independent Agent?
There are two types of licensed agents in the life and health insurance industry: a “captive agent” representing one company and an “independent agent” representing multiple companies. Independent agents are also commonly referred to as “brokers”. Captive agents are limited to the products offered by their company while independent agents can select from countless products to fit a clients needs. Obviously, an independent agent is most often going to offer more suitable solutions.
In addition to a professionals independent status, it is important the representive be licensed to offer advice on securities, tax planning, estate planning, to tailor the most suitable solutions. This becomes important for two reasons. Any good financial plan starts with a careful assessment of a person’s objectives, income, assets, and potential inheritance. Unfortunately most insurance agents are not licensed, trained, or qualified to do financial planning, instead they are trained to be transaction driven for commissions rather than driven by the customer's best interest. Sales activity, with little regard for suitability and actual customer objectives, is counter productive and gives the industry a bad name.
A true independent financial planner must be licensed and have advanced training in many disciplines. Unfortunately, most insurance agents/financial advisors are only licensed to sell insurance, annuities, and mutual funds. Such limitation would make comprehensive planning difficult and expensive compared to a more comprehensive approach by an independent financial planner who works in a fiduciary capacity, or solely in the clients best interest. Such a professional is focused on plan design, researching suitable solutions, and performance, versus being product and transaction driven.
Mader & Shannon Wealth Management has always worked as a fiduciary putting our client’s needs first at all times.
Life Insurance As An Asset and/or Retirement Supplement?
In the current environment of low interest rates and bond yields one might ask, “How about life insurance as safe money investment?” For 99% of the 800 plus insurance companies a reliable investment return is not likely. However, a few top rated companies have produced internal rates of return (IRR) in the plus 2% range ten years out and plus 3% range 20 years out.
These returns won’t compete with the S&P 500, but keep in mind, there is a death benefit value permanently attached to this investment. Therefore, one can own a life insurance contract that is an asset as a conservative investment and at the same time provide a significant death benefit. In addition, properly managed, this asset can work favorably as a supplement to retirement.
To sustain a suitable outcome using this strategy working with a professional independent agent is a necessity for a number of reasons. Insurance policies are long term, complex legal contracts with both guaranteed and non-guaranteed provisions which you would want fully disclosed and understood. You must pick an insurance company that has the financial strength and history of supporting a contract of this type. In addition, you want to thoroughly understand the taxation of life insurance proceeds since the are different from other investments.
Like most successful investments, this investment requires management by a knowledgeable owner and a qualified professional. In this case, an insurance professional and a qualified investment advisor should be utilized for the life of the contract. To summarize, a well designed and managed life insurance contract, issued by a top rated company, can serve as key building block to a sound financial plan.
Types of Insurance
Term Insurance vs. Permanent
There are two basic forms of life insurance, term and permanent policies. Each one breaks down into subcategories based on different options designed to meet the needs of the consumer.
Term Life Insurance
As the name implies, term life insurance is issued for a specific period of time from one year to age 100. The purpose of term insurance is to cover a need within the issue period such as protecting an income stream while raising a family, or to pay off a mortgage or business debt in the event of an untimely death. Some term insurance policies offer a guaranteed conversion feature. This policy provision guarantees that the policy owner can convert the policy to a permanent insurance policy at the same underwriting status as assigned to the term policy. Consequently, term insurance can be utilized to fulfill a current insurance need at a low cost until the need for insurance diminishes or cash flow is available for permanent insurance.
Permanent Life Insurance
Permanent life insurance is designed and priced to pay a death benefit or be surrendered for the cash value when the insurance is no longer needed. There are three types of permanent life insurance: whole life, universal, and variable universal life.
Whole Life is the oldest of these policy types. It features guaranteed minimum premiums, guaranteed minimum interest rates credited to the cash value, and guaranteed death benefits payable at death. Whole life issued by a top rated company can still be a very good value even though it is not as flexible as the more recent policy types.
This policy type is a product of the computer age and is often referred to as Flexible Premium Adjustable Life. Due to the capacity of computers to conduct and maintain countless calculations, actuaries are able to expose the moving parts in a life insurance policy. Interest crediting rates, mortality costs, even expenses and premium taxes can be illustrated with ease. This allows for flexible premiums and face amounts, along with interest rates that reflect current portfolio yields. For the first time, policies could be designed to better fit changes in insurance needs and family budgets.
Universal life policies illustrate two interest rates, the “guaranteed minimum” and the “current” rate. The “minimum” is a contract guarantee while the “current” is credited as a product of the insurance company’s return on assets. The current rate is the basis for the “projected benefit” column in the illustration. It is important to understand that the cash values of the whole life and universal policies are invested as a general asset of the insurance company until surrendered or paid as a death benefit, therefore the financial strength of the company is very impotant.
Today the most popular feature of universal life is the guaranteed death benefit feature. Although this feature is only available from a handful of the strongest companies, it provides the lowest cost guaranteed benefit ever offered in a permanent life insurance policy. In addition, these guarantees can be structured for varying life expectancies.
Variable Life and Variable Universal Life
Variable policy cash values are not an asset of the insurance company and are managed as a separate asset in select funds much the same as a 401(k) portfolio is self managed. Although the insurance company is the custodian of the funds, the policy values are segregated from the general assets of the company and not subject to their creditors in the event of insolvency.
There is a critical difference however from managing a 401(k) allocation versus a variable life allocation. Variable Life policies have significantly higher expenses due to monthly insurance costs. As a general rule, monthly expenses of 2% to 4% or more are charged for insurance and administration costs. Consequently, a 10% return for 401(k) allocation could net one-half that in a VUL policy with a similar allocation. As a result, asset management is more difficult with variable policies than a typical 401(k) or an IRA. We recommend two rules of thumb for successful VUL ownership:
First, over fund the policy in the early years to maximize tax free growth inside the policy. Second, manage the portfolio as a sophisticated investor or retain a professional asset manager to assist you.
The obvious benefit of variable universal life is that assets can be grown in a most favorable tax environment, which, if successful, can reduce long term insurance costs or grow the tax free death benefit to larger amount than the original amount. However, there are no guarantees and the margin for investment failure is narrow. One must weigh the risk of investment results in variable life policy against the guarantees offered by competitive universal life policies.
How Much Insurance Do I Really Need?
In the vast array of information regarding life insurance there seems to be no one consistent way of determining how much you need. We believe client's should take part in determining what's necessary and understand the process rather than rely on internet 'calculators'. The following article was written by Brian P. Daley CLU. It was published in the Society of Financial Service Professionals' Life, Health & Disability newsletter, of which Mr. Daley is the editor.
Four Simple Steps
Determine the amount of annual after-tax income your survivors will require to maintain their current standard of living if you were to die today.
Subtract from that amount the annual after-tax income earned by your surviving spouse if your spouse plans to work outside of the home if you were to die today. The difference is the family's annual shortfall.
Divide the family's annual shortfall by 5 percent, as we assume that over the long term your survivors will be able to earn somewhere around 5 percent net after income taxes, transaction costs, and management fees on whatever cash they have available for investment after your death. (One may select 3 percent, 4 percent, or even 7 percent for that matter, but 5 percent is generally fair).
The resulting figure is the approximate amount of cash required, from whatever sources, at the time of your death to provide sufficient annual income without invading the principal until the eldest child is ready to begin college.
Adjust this amount to reflect your unique and specific circumstances.
Will the surviving spouse's career plans or income needs change significantly following your death?
Will your spouse be receiving any imminent inheritance or income from elderly parents or from another source?
Are the children's education costs already fully funded, or are they beyond school age? Is there a special needs child who will require lifetime care?
What is the likelihood and what are the probable financial consequences of remarriage?
How long will it be until the surviving spouse will have access to tax-qualified monies such as 401(k) assets?
Such factors can increase or decrease survivor's dependency upon income from the estate and, therefore, are appropriate for you to consider when estimating the amount of coverage required by your survivors.
An Example: Assume a survivor will require $100,000 of annual after-tax income and that the spouse does not work outside the home. Dividing $100,000 by 5% equals $2 million. Thus a principal of $2 million would be required to generate uninterrupted annual after-tax income of $100,000. Depending upon your age and circumstances, the principal might be comprised of qualified and/or non-qualified investments, partnership capital, trust funds, and any current group or personal life insurance proceeds. The difference, if any, between the $2 million and the total of these other monies is the amount that may be necessary to make up through the purchase of new individual life insurance.
Third Quarter 2020 Market Update
Clients and Friends,
Welcome to the 2020 homestretch! It’s been quite a year, and the final three months are sure to offer plenty of sensational developments. This newsletter will bring you up to speed on both the US economic recovery and the much-anticipated election. Best efforts were made to avoid the words unprecedented or extraordinary, but keep in mind that much of the news and data are both.
As always, we are keeping a trained eye on the potential risks as we approach year-end. We are pleased with our performance thus far and are looking forward to finishing strong. If you have any questions or concerns, we’re here. Just let us know how we can help.
As we assess the strength of the economic recovery and gauge its future prospects, the U.S. consumers’ ability and appetite to spend will play a key role. The former will largely be determined by incomes. Even though millions of people lost their job during the sharpest recession in history, aggregate personal income is actually higher than it was before the pandemic. For that, we can thank a fiscal stimulus package of unprecedented size that sent direct payments to Americans and increased unemployment benefits to such levels that many people filing claims received a temporary raise. As evidenced below, Personal Income has declined from March levels, but remains 4.8% higher than it was a year ago.
However, stimulus payments have subsided, and gridlock in Washington has reduced odds of another large package. Barring a breakthrough in negotiations, the private sector will be responsible for maintaining consumers’ ability to spend. Since our July update, the unemployment rate has fallen from 14.7% to 7.9% - a marked improvement, but still more than double the 50-year low of 3.5% achieved in February. And while many of the jobless still believe their positions will return with the end of COVID-related shutdowns, an increasing number shifted from ‘temporarily-unemployed’ to ‘not temporarily-unemployed’ in the latest BLS report. The longer shutdowns (and the virus) last, the harder it will be for struggling employers to stay afloat. If the jobless are correctly classified (and an increasing number of workers no longer have jobs to return to), it will be difficult for employment growth to continue at its current pace.
The lives of workers in some industries, notably leisure and travel, have been completely upturned, while many of the people that managed to keep their jobs had to significantly change their lifestyles. The forced, widespread transition to work-from-home has wholly altered the employment landscape. But it’s also helped fuel a surge in the housing industry. After weeks, or in some cases months, of time in captivity, families have a newfound appreciation for large and versatile living-spaces. Suddenly, millions of people need a home office, or two, and a learning area for children. A rampant appetite for spending was put on display – consumers couldn’t use their increased incomes on travel or entertainment, so instead pushed sales at home improvement stores to all-time highs. And those without homes to improve were willing to spend to get them. Despite an ongoing recession, new home sales are at the highest level in more than a decade, and traffic of prospective home buyers is at a record.
Aiding the booming housing market are record-low rates. The average rate on a 30-year mortgage is now just 3.04%, compared to more than 4.50% at the end of 2018. It’s not just mortgages, though. Driven by lower benchmark rates from the Federal Reserve and Federal government guarantees on business loans, banks have issued more loans than ever before, and all at low rates. Unfortunately, it may not last. Loan default rates have stayed low throughout the pandemic, thanks to widespread forbearance agreements, but defaults are set to rise as those agreements come to an end.
Banks are wary of the losses new, risky, loans could generate - in a survey of senior loan officers, 61% said they were tightening lending standards on consumer loans; similarly, more than 70% said they were tightening standards on commercial and industrial loans to large, mid-sized, and small firms. If both consumers and businesses lose access to credit as a result, it could be a drag on the economic recovery. Lower credit quality consumers would be forced to reduce spending levels, and many industries hit hardest by the pandemic would struggle to return to normal.
Compulsory Political Commentary
Every four years, we dread writing our third-quarter update. The disdain originates not from seasonal affective disorder, but from an obligation to make broad pronouncements about the market impact of the upcoming election. While governmental policy is an inescapable input into markets, election season injects emotion into the equation. And emotion is the enemy of sound decision making in markets.
This election is as contentious as nearly any other in our country’s history, and you already know why/how we got here. In the interest of being fully transparent in our analysis, let me offer this relatively simple disclaimer: Our analysis of the potential outcomes is entirely focused on the impact on markets and the economy. We do not intend to express any judgment on the merits of a policy based on its values or social implications. Please keep in mind that a great deal of our data and conclusions come from reputable third-party sources. If you’d like to engage in a more detailed conversation, please let us know; we’ll be happy to share our sourcing and logic.
We won’t spend much time on polling or odds of the various outcomes because there are so many sources available. And if you’re interested enough to read this politics section, you probably already know which sources you prefer. Given the current polling and seats in-play, there are four probable outcomes:
1. President: R Senate: R House: D (status-quo and probable gridlock) 2. President: R Senate: D House: D (probable gridlock) 3. President: D Senate: R House: D (probable gridlock) 4. President: D Senate: D House: D (blue-wave)
Of those outcomes, only the fourth configuration likely results in a significant change to the policy outlook. If there’s a silver lining to our terrible political discourse, it’s that a split in the branches by party probably means we’re in for at least two years of gridlock. Typically, gridlock in peaceful times has resulted in positive outcomes due to predictable and stable ‘rules of the road’ for businesses.
In our view, there are positive cases to be made for most potential outcomes. Both candidates, and both parties, have shown a propensity to run budget deficits and support accommodative monetary policy. In the short-term, spending more than you tax, or taxing less than you spend will create a surplus of dollars for the private sector – and markets live in that private sector.
Say what you will about the long-term dangers of deficit spending, the past 20 years have led to a broadly espoused conclusion that the reserve status of the U.S. dollar has afforded the U.S. a capacity to borrow and spend that few other countries have ever enjoyed. Low interest rates and a stable currency have bolstered the concept that global markets can easily absorb U.S. debt. We are not downplaying the potential consequences of reckless financial management, but those consequences are likely longer-term in nature. And while not within the scope of this note, we’re happy to set up an individual review of this important concept as needed.
Let’s review the projected fiscal programs of the two candidates:
The Biden plan is directly from the campaign, and the Trump plan has been compiled and scored from a combination of his public statements and specific programs set to expire from the 2017 tax legislation. All figures are cumulative of each candidate’s incremental taxing/spending over the next four years and do not reflect existing tax/spending programs.
Before the pandemic, the United States was on pace for a $1.0 trillion per year budget deficit, which was the largest since the great recession of 2008 and 2009. Assuming the existing deficit persists over each of the next four years, by 2024, we’ll have a baseline addition to the national debt of $4.0T. Under the Trump plan, we would add roughly $334 billion to that baseline, and under the Biden plan, we’d add $2.5T. And the aggregate budget deficit over those four years would be $4.3T under a continuation of the Trump administration, or $6.5T after the first term of a Biden administration. In other words, these proposals would constitute a roughly 20-30% increase in the national debt over the next four years. It’s worth noting that this analysis does not account for the prospect of additional pandemic aid, which could come in at $1.6-2.4T. If either pandemic aid plan is eventually passed, we should assume a baseline addition to the national debt of nearly 40% over the next four years. Unsurprisingly, an addition to the debt of that magnitude in such a short period would be unprecedented.
The thought of adding to the country’s already substantial debt load may not feel like a favorable scenario to most people reading this newsletter, and it’s completely understandable. But remember, in the short-term, the government’s deficit is the private system’s surplus.
By all accounts, both administrations will likely offer very accommodative fiscal policies. They would also probably prefer a continuation of accommodative monetary policy. The Federal Reserve is currently exerting historic levels of monetary accommodation. Through active measures (quantitative easing and zero interest rate policy) as well as guidance about future accommodation, they’ve successfully kept financial markets buoyant and interest rates low.
The Federal Reserve is an entity that sets its policy course independently, but the president nominates the chairman and board of governors. It is unlikely either president would make any changes until Jerome Powell’s chairmanship ends in 2022. And given the successful monetary policy experiments over the past 12 years, it’s tough to see why Biden or Trump would appoint a chairperson with a dramatically different philosophy than Mr. Powell.
Negative scenarios are always easier to think up. Risk-aversion is very natural, especially amid a global pandemic, social unrest, and a no-holds-barred political food fight. While we won’t dwell on the political or social negatives, it’s worthwhile to review a few of the market-negative scenarios that could unfold over the next 1-12 months. Again, this is a relatively short-term focused exercise. They are not presented in a particular order, and the decision to lead off with a Biden administration negative was determined by a coin-flip.
Biden Policy Negative?
The headline grabber/low-hanging fruit of the potential Biden negatives is a possible increase in taxes. If you want to go line by line on where these taxes might be levied/increased, please refer to the table above. When measuring the negative impact of increased personal income tax and payroll taxes, you must have a discussion of incentives and behavior – two notoriously difficult areas to measure. In the behavior and incentive discussion, you’d also have to weigh potential positives of the increased spending that would result from the incremental revenue raise. Increases/decreases to statutory corporate rates on the other hand are mathematically straightforward. JP Morgan has done the math, and the corporate income picture under the Biden tax plan for the S&P 500 is as follows:
Before considering spending programs or tariff reductions, JP Morgan calculates that the new corporate taxes could cause a 7.2% contraction in S&P 500 earnings. The long-term annualized earnings growth for S&P 500 earnings is about 7%. So, the question under this scenario is: Is losing a full year of S&P 500 earnings a catastrophe?
Trump Policy Negative?
Restrictive international trade policy is the key risk to earnings from a second Trump administration. Much like long-term fears around running persistent budget deficits, the multi-faceted and complex U.S.-China relationship is worthy of detailed analysis. But for this note, we’re reviewing the direct policy impact on corporate earnings and investor confidence.
The market volatility during the escalating trade war in 2018/2019 was dramatic at times. Still, it didn’t get out of hand because both sides had a vested interest in keeping the relationship from completely falling apart. That ‘mutually assured destruction’ feature of the first trade war was at least in part due to President Trump’s desire to win reelection in 2020. In a second Trump term, it’s unclear whether there would be much sensitivity to sudden bouts of trade-war induced market volatility. An unbridled approach that leads to a dramatic decoupling between the U.S. and China would be very disruptive to supply chains and investor/consumer confidence. A less dramatic trade war would likely see a renewed 2-5% drag on S&P 500 earnings, just as we saw in 2018/2019. The prospect for a prolonged conflict could also dampen valuation multiples.
Of all the fundamental risks posed by either an unverified republican platform or a full-fledged shift in policy preferences, the most concerning short-term risk to markets is an almost self-fulfilling one. Every election, we tend to present a measure of consumer comfort for each party. As you’d expect, the party in power generally has higher consumer comfort at the individual voter level. Rarely has that phenomenon been more pronounced than right now. The chart below is the difference in confidence between republican and democrat consumers. When the purple line is trending to the upper-right, republicans are increasingly confident in their financial situation relative to democrats.
Note the dramatic increase in republican consumer confidence immediately after the 2016 election of Donald Trump. That shift in confidence coincided with substantial capital inflows into the U.S. equities. The concern here is that a Biden win could cause those same investors to change their optimistic tune. And if the inverse of the 2016 reaction occurs, we may see more investors willing to return to the sidelines until they feel better about their prospects.
Ironically, the most troubling outcome has very little to do with the policies of either candidate or their sponsor party. And if you’ve made it this far into the politics section of this quarter’s newsletter, I’m guessing you already know where we’re headed. It is, of course, a contested election. From a market perspective, the only playbook for a contested election is Bush v. Gore in 2000. Notably, the defining feature of the year 2000 in market history is not the contested election, but instead that March of that year marked the peak for the dot-com bubble. That should give us hope that our markets can handle the uncertainty as our legal process plays out.
Our plan heading into the election is to continue our 2020 strategy of keeping our exposures balanced. We view the potential outcomes with a hint of positivity and a healthy respect for the unpredictability of the risks. Our active management approach has shined in many periods of dramatic volatility – including the COVID crash in March of this year. And given that track record of risk mitigation, we feel perfectly suited to managing the unique risks and opportunities that the upcoming months will yield.