I have a book coming out next month, about how the market is likely to evolve now that interest rates have stopped their 40-year decline. Rates stopped falling in 2020 (the 10-year Note), but the book’s actual publication is occurring in 2024, during a presidential election. (I write slowly….) In the book, I dedicate a chapter to questions of political economy. The chapter argues that investors are too siloed; they’re not paying enough attention to politics. Similarly, politicians have only a limited understanding and interest in the capital markets. That siloing is risky in the best of times; in 2024, it has the potential to be downright dangerous. As the manager of dividend-focused stock portfolios, I spend much, if not most, of my time thinking about risk. Once basic investment and operational concerns are addressed through process, diversification, and explicit risk controls, what is left is concern about low probability but high impact events. What if an asteroid hits the planet? What would that do to our income streams?
Heading into presidential election years, stock-market investors are met with an avalanche of analysis by third-party pundits. That material reviews in great detail the market’s reaction to presidential elections, when the party in power changes, years when it doesn’t, when Congress is aligned with the President, when it isn’t, when it’s split, when the Fed is raising near-term rates, when they are drawing them down, when unemployment is high, when it is low, when it is rising, when it is falling, when the Yankees are winning and when they are not.
The answer is that the market does a little better, or a little worse, or about the same as usual. There is an average outcome; there is a median outcome. It might even constitute a roughly “normal distribution”, albeit one with only 19 data points, starting with the first post-war election in 1948 and going through 2020. (Contrary to what you might assume, the market does better during Democratic administrations, but as you might expect, it does better in election years when a Republican wins.)
A world that is normally distributed would suggest that I need to chill. But is political economy something that would, pardon the pun, normally be normally distributed? The historian in me thinks not. If one steps back from the daily struggle in the markets, it’s not at all clear that political outcomes and their economic ramifications would be normally distributed. Yes, on most days there is no revolution. On very few days there is an attempted coup or change in government, or some other sharp swing in the reigning political economy. But that is not the same thing as having highly predictable outcomes that form smooth curves. In short, I’m not convinced the emergence of the social “sciences”—treating human behavior as if it were the hard-ruled world of physics—in the 1950s and 1960s is going to last the test of time. My historical appreciation and critique of Modern Portfolio Theory, published in 2018, directly addressed this issue. It was not well received. Either I was wrong, or I was early. The “test of time” may not be over yet.
But there is a separate and more important reason to step back from the current approach as we enter election year 2024. We may be looking at the wrong data set. Political economies do not happen every two or four years. They occur over decades if not centuries. The definitions here are subjective, but in terms of the political economy in which the US stock market has operated since the end of the Second World War, we’ve really only had two instances. And we’re in the process of shifting to a still-to-be-determined third one in real time.
The first period ran from 1945 (really from the mid 1930s) until 1980. It implied a larger role for government trying to manage an economic system through various monetary and fiscal levers. That made sense given the challenges of the time: responding to the Great Depression and the competition from directed economic systems abroad. Much of it was associated with the macroeconomics outlined in Keynes’s The General Theory (from 1936). Democratic administrations played by the Keynesian protocol; so did Republican ones. From that perspective, there was minimal difference between the two parties. Any statistical conclusion about election-year outcomes was minor compared to the generally stable capital markets context. Nitpickers will find plenty of differences between some policy or market development in 1950 and one from 1970, but the broader continuities were far greater than the changes.
The paradigm changed around 1980 to the well-known global neo-liberalism championed by the University of Chicago and often associated with Milton Friedman (though Frederick Hayek would do just as well.) That paradigm featured the largely unfettered march of capital, globalization of trade, and economy-wide deregulation. US consumers enjoyed decades of deflation in core economic categories as we outsourced production of everything to lower cost locales and bought it all back cheaply at Walmart. This period featured the de-industrialization of the United States on an epic scale, offset by the emergence of a world-leading service and tech-driven economy. It also featured the flourishing of the stock market. Some might say it was a golden age of speculation, especially when equity risk rates hovered around zero for the decade-long period after the GFC.
The challenges to this paradigm of political economy began appearing with Donald Trump’s emergence in 2016 and Brexit, and then more clearly a few years later with the consequences for the global supply chain of the initial Covid wave in 2020, Trump’s attempted coup in early 2021, and Russia’s invasion of Ukraine in 2022. After forty years, long-term Interest rates stopped going down, also in 2020. In short, folks in 2024 are no longer as thrilled about the market the way a brown-suited Ronald Reagan inspired voters, business people, and investors in 1980. The consequences for the American middle class and American industry and American security have simply been too great. Cheap, abundant goods are no longer sufficient, despite the roaring stock market.
So if we are out with the old, what about the new? What will the new political economy look like? I don’t know, but investors will naturally wonder what the new order will bring to the stock market. More regulation is an easy answer, so I will skip it. What I think investors take for granted at their peril, however, is the high market multiples enjoyed in the recent decades of the outgoing model. Market multiples reflect many factors: interest rates, growth rates, academic models, etc. They also reflect investor sentiment, not just optimism in the future, but also trust in the institutions that constitute the financial system. High trust translates into high multiples.
That’s where the 2024 presidential election comes in. Trust in core US institutions is a central, if not the central, issue in the election. Should trust prevail, it may be reasonable for investors to continue to count on the high multiples that we have become accustomed to, despite the uncertainty associated with the emergence of a new political economy. If distrust prevails, those high multiples become less likely. Low trust translates into low multiples.
So during the course of 2024, while many market observers will be reading the regulatory or trade or foreign currency or technology (AI) tea leaves for clues about near-term earnings and the long-term contours of the emerging political economy, I will be keeping an eye on the elections and the courts, both for the specific outcomes there and for the reaction of the populace. It won’t be a pleasant way to spend the year, I acknowledge, but it will be far more important for investors than figuring out a company’s quarter or the implication of a weight loss drug on the price of this or another consumer stock tomorrow morning. I wish you a high-trust 2024 and beyond. The alternative will not be pleasant or profitable. Think about that as you go to the polls and react to them.