By Ellen Hazen, CFA®, Chief Market Strategist

August Takeaways:

• Economic data was mixed. New jobs created in the month of July (reported in early August) were below expectations, at only 114,000, compared to expectations of 175,000. Moreover, revisions to the prior twelve months’ estimates were a combined negative 818,000, indicating that previously reported numbers were somewhat overstated. The unemployment rate increased slightly, from 4.1% to 4.3%. Rounding out softer jobs data, the JOLTs (Job Openings and Labor Turnout Survey) for July, reported Sep 4, was light, at 7,600 vs. consensus of 8,100. A negative economic datapoint outside the jobs market was the ISM Manufacturing survey, which weakened to 46.8 from 48.5 the prior month. (A 50 reading is neutral). On the other hand, inflation indicators were neutral, with the Consumer Price Index (CPI) of 2.9% in line with expectations. And retail sales for the month of July were a positive surprise, coming in at 0.4% vs. expectations of 0.1%
• Interest rates declined slightly, leading to positive fixed income performance both for the month and year-to-date. The 10-year Treasury yield declined from 4.03% to 3.90%, while the 2-year Treasury yield declined from 4.26% to 3.92%. This was likely driven by the softer economic data, and embeds expectations that the Federal Reserve (Fed) will reduce interest rates at its September meeting. Credit spreads narrowed slightly, bringing the year-to-date total return for the Bloomberg Intermediate Government/Credit Index to +3.6%
• Large stocks outperformed small and midsized stocks, while international stocks outperformed them all. The S&P500 Index appreciated by 2.4%, significantly outperforming both small and midsized stocks. The S&P Small Cap 600 Index declined by 1.4%, while the S&P Midcap 400 Index declined by 0.1%. International stocks shone, with large developed market stocks increasing by 3.3%. We note that international stocks remain significantly less expensive than US stocks, at an average forward price-to-earnings multiple of 15x vs. 21x for the S&P 500
• The “Magnificent Seven” underperformed the broader S&P 500 Index. These seven stocks were, on average, down 0.3% in the month of August, below the S&P 500 Index 2.4% return. The best-performing of the seven was Facebook parent Meta, which appreciated by 10%, while the worst-performing was Tesla, which declined by 8%. This, plus the previous observation of large company stocks outperforming mid- and small-company stocks, illustrates that market breadth has increased only within the large-cap universe: while the market broadened beyond the Magnificent Seven and extended to international large stocks, it did not broaden to small- or mid-sized stocks, consistent with the view we expressed last month
• Powell’s Jackson Hole speech suggested imminent rate cuts. Fed chair Jerome Powell gave a fairly dovish outlook on August 23, noting that “The time has come for policy to adjust.” The market is currently pricing in a 0.35% reduction in the Fed Funds rate at the September 18 Fed meeting and additional cuts in November and December
• US presidential election developments. Robert F. Kennedy Jr. ended his presidential campaign and endorsed Trump. Polls have become closer in the past several weeks, with most showing Republican nominee Trump and Democratic nominee Harris virtually tied. We believe both candidates’ platforms would drive higher inflation while spurring modestly higher GDP growth

What We Are Watching in September:

• Jobs data to be reported on September 6. If the new jobs created in August are lighter than expected, as was the case in July, we could see the Fed cut by 0.50% rather than the expected 0.25% at the mid-September meeting
• Fed meeting September 17-18. Given recent weaker economic data, market expectations for the September meeting have increased from a single 0.25% interest rate cut to a 40% chance of a 0.50% cut. Before the mid-month meeting, Fed members will see several additional indicators, including new jobs, CPI, and retail sales

Many clients are asking us about our views on the upcoming US presidential election, and on how they should position their portfolios for various outcomes. Our big picture view is that presidential elections do not matter much in the grand scheme of things. US equity prices are much more closely tied to corporate earnings growth, while US fixed income securities are tied to long-term economic growth, interest rates, and inflation levels. Over the past 50 years, the S&P 500 Index has returned an average of 10.1% during election years and 12.8% in non-election years, while the Bloomberg Intermediate Government/Credit Index has returned 6.1% and 6.3% in election years and non-election years, respectively. These numbers are similar enough that we do not believe a strategy change is warranted. As the saying goes, investors are best served to focus on time in the market, not on timing the market.

Given that clients and investors are interested in the economic prospects of a Republican or Democratic presidency, following are our key observations.

First, the race is currently close to a toss-up. Whether looking at recent national polls (Nate Silver or 538), at swing state polls (Real Clear Politics or The Hill), or betting markets (PredictIt or Polymarket), the race is very tight. More importantly is the fact that, at present, the most likely outcome is divided government, with one party controlling the presidency while the other controlling at least one part of Congress. Markets (and corporations) like certainty, and the gridlock that divided government often produces tends to create more certainty, because changes are more difficult to enact.

Taking a closer look at the plans unveiled by each of the candidates, our overarching conclusion is that both fiscal spending and the deficit will be higher no matter who wins. Both candidates plan to enlarge the child tax credit, which is estimated to cost just over $1 trillion in tax revenue. President Trump would also extend the 2017 tax cuts and reduce the corporate tax rate, further reducing tax revenue. Ms. Harris would expand the Earned Income Tax Credit and extend a portion of the 2017 tax cuts, while raising some other taxes (corporate taxes and stock buyback taxes).

The higher deficit under either candidate is likely to mean higher long-term interest rates and higher inflation. These plans will also act as a fiscal stimulus in 2025 and beyond, boosting GDP higher than it would otherwise be. GDP will be further aided by the fact that this fiscal stimulus will be simultaneous with monetary stimulus provided by the Fed lowering interest rates.

Both candidates have other planks that will increase inflation. Trump’s across-the-board 10%+ tariffs would likely be inflationary, as companies would simply pass along the higher prices to consumers. Similarly, his proposed immigration crackdown would noticeably increase wage costs for corporations in certain sectors, such as meatpacking. Harris’ intent to “ban price gouging” (for example, in groceries, prescription drugs, and rent) could reduce prices in the short term, but could also lead to shortages longer-term, which could be inflationary.

Some areas are more specific to each candidate. For example, Harris has proposed increasing both housing supply (by reducing permitting requirements) and housing demand (by offering $25,000 to first-time home buyers). These will likely benefit companies like homebuilders. Similarly, Trump has proposed reducing regulation and encouraging increases in oil drilling and fracking, which will benefit exploration and production oil companies. Both candidates might be good for defense spending (Trump for domestic, Harris for Ukraine). In general, though, given that it is likely either will face an opposing congress, these plans may not materialize.

To reiterate, we believe investors should focus more on company fundamentals and economic fundamentals than on the upcoming election, at least when positioning their portfolios. The best action is to stay the course. However, we do see some investment opportunities based on our evaluation of candidates’ proposed policies and the likely impact on GDP, on interest rates, and on inflation.

Higher GDP growth created by the intended fiscal (and monetary) stimulus will benefit risk-on assets, such as growth equities and high-yield bonds. The higher interest rates that are likely to result from higher GDP growth may benefit banks, as the yield curve un-inverts.

Our view that inflation will likely be modestly higher (as a result of the higher fiscal deficits likely under either candidate) leads us to an allocation to Treasury Inflation Protected Securities (TIPS). Other areas that do well in a higher inflationary environment are some commodities and real estate. Conversely, long-duration fixed income may underperform in such an environment.

At the end of the day, history tells us that equity and fixed income markets do not perform materially differently in election years vs. non-election years, nor as a function of which party controls the White House or Congress. Consequently, we remain focused on fundamentals for our client portfolios, while remaining mindful of potential investment opportunities arising from the election.

Disclosures