Monthly Outlook: November 2024
Markets have rallied for the better part of two years now and the S&P 500 hit another new high earlier this month. The NASDAQ and international stocks, too, are near all-time highs. This leaves the market at peak valuations levels, with a 28x P/E ratio and a TMC/GDP of 1.9x. Bubbles aren’t that surprising, that’s not the point. The big question is why markets are so exuberant, just five days away from critical elections that are so polarizing, so uncertain with 50/50 polls, and so different in their expected outcomes? Normally, so much uncertainty would lead markets to recede and consolidate as they await the election outcome. When we look back at elections in 2012, 2016, and 2020, we see more consolidation than we see this year. And yet, this election seems closer and more contentious than those. It doesn’t make sense.
The investment news channels are full of advice and opinions about how investors should “play” the election. If Trump wins, then buy this industry and short that one. If Harris wins, do the opposite. And we hear if Congress goes this way or that, do that or this. It’s all very confusing and, frankly, it’s all just conjecture. Not only does no one know how the elections will go, they can’t know how the markets will respond. Guessing and agonizing over possibilities isn’t the answer.
Investing for Election Outcomes and Other Uncertainties
Investing always involves risks and uncertainties. Elections are just one type of uncertainty. For that reason, the most sensible approach for investing during election cycles is the same as any other. It really doesn’t change our process or strategy. We start by assessing your objectives, risk tolerance, time frame, taxes, liquidity needs, and so on. From there, we determine a sensible mix of assets that will fit your situation. This will give you your long-term stock/bond asset allocation mix. Let’s say you settle on a mix of 70%/30% stocks/bonds for the long haul. But this is just your starting point. It doesn’t mean you should hold 70%/30% through thick and thin, through booms and busts, through bull markets and bear markets, and through every election cycle. Like life itself, markets are cyclical, and there’s a time to be fully invested per your long-term strategy and there’s a time to pause. The challenge is how to know the difference.
Strategic vs. Tactical Allocation
In our example, your long-term allocation mix that should give you the results you want is a 70%/30% stock/bond mix. This is your “strategic allocation.” Based on historical market returns, such a mix has delivered annualized returns of about 8%/year. The problems, however, are all of the drawdowns that occur along the way to shake your resolve. Markets consistently have drawdown losses of 20%, 30%, or more about every other year. The S&P500 has had 56 drawdowns of >10% over the last 100 years, for example. That’s simply too much volatility to achieve a modest 8%/year for most people. For that reason, it’s best to allow yourself a “tactical allocation” that builds in a range for each asset class. For example, your tactical allocation might be 30%-75% stocks and 25%-35% bonds. This allows you to deviate from a static allocation during drawdowns or periods of uncertainty. But there’s a catch here. How do you know when to sell stocks to reduce risk and drawdown loss? Getting it right will reduce your losses. Getting it wrong will make you lag during an uptrend.
Trend Following and Trading Rules
Knowing when to trim stocks within your tactical allocation range can be done in many ways. You can listen to analysts and their best guesses and opinions. But history proves that predictions are notoriously hard and usually wrong. Look at this election cycle with new highs in stock markets despite 50/50 voter polls and heightened risk. No one predicted that. You can listen to your “gut” and allocate based on how you feel about the economy, political scene, and markets. This strategy, too, is usually a bad one and leads most people to “chicken out” from investing and making gains. Instead, we use a rules-based, trend-following strategy to determine your tactical shifts. When the price of an ETF crosses its moving average trendline, that’s our signal to trade. It’s unemotional and always keeps us on the right side of the trend. As we go into next week’s elections, every ETF is uptrending and so we’re in. If the price trends change, we’ll change.