One could argue that if there ever is a time to stress diversification in an investment portfolio, it would be 2020 post-election.
Markets are forward looking, constantly trying to price today what they feel the future will bring. During an election year, that means pricing in policies and agenda items of the eventual winners of the presidential and congressional elections.
This year also has the added consideration of a global virus that greatly affects certain aspects of the markets.
Every person across the country typically focuses on the presidential elections, but potentially even more important this year were the senatorial races. As of the writing of this article, Republicans hold 50 seats and Democrats hold 48 seats with two still outstanding.
However, the two Senate races in Georgia are still undecided and will remain that way until early 2021. Under Georgia law, a race must advance to a runoff election if no candidate received over 50 percent of the vote. Both Georgia Senate races have resulted in zero candidates receiving over 50 percent of the vote, resulting in runoff elections for both seats on January 5, 2021. Until then, political control of Congress is uncertain.
What does this mean for markets? During President-elect Biden’s campaign trail, he proposed the idea of raising the capital gains tax rate. A capital gains tax rate increase retroactive to January 1, 2021, might incline investors to sell their winners before that date, thus paying less in taxes.
What companies have generally been the winners this year and for the last 3-5 years? The tech companies. With polls showing Biden ahead, the tech sector declined for a few weeks leading into election night. However, the chances of a capital gains tax increase were lowered by what is looking like a Republican-controlled Senate (although still undecided as previously mentioned), resulting in gridlock across Washington.
Another aspect of the markets that is potentially affected by this likely gridlock is the small cap space. A Republican-controlled Senate lowers the amount of the potential fiscal stimulus bill. What companies need fiscal support the most?
Small cap companies hurt by the shutdown that don’t have the large balance sheets to weather a shutdown or slow economic reopening. For a few days after the election, the small cap indices underperformed.
To throw a monkey wrench into all these post-election market dynamics, potential successful vaccine news the week after the election dismantled the technology stocks versus small cap stocks dynamic that occurred immediately after the election. Small cap indices skyrocketed from the chance of a faster economic re-opening due to a vaccine that would alleviate some of the populations’ concerns of becoming infected.
On the flip side, the technology names that were rewarded from the potential gridlock in Washington were punished by markets, mainly because they are viewed as the work-from-home investments, benefitting from shutdown fears.
Short term market dynamics can cause discomfort for investors. Discomfort can be alleviated with a well-diversified portfolio. Within a diversified portfolio, rebalancing opportunities can occur during these extreme short-term market movements. Every circumstance and event is unique, bringing many questions to market participants each time they occur. In my opinion the ideal solution this year, and every year, is a diversified portfolio based on an investor’s objective.
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