Investors hope a clear and decisive winner will be declared in the presidential election this November. If the election is contested or results are delayed due to record mail-in ballots, we believe investors should expect to see near-term volatility increase in the U.S. stock market. Similar volatility occurred in 2000, after the famous “hanging chad” election that saw a six-week delay before George W. Bush was eventually declared the winner.
Despite this potential short-term speed bump, continued record Federal Reserve monetary stimulus coupled with a high likelihood of additional significant fiscal stimulus regardless of the election outcome, it is probable the U.S. stock market will continue to be supported. Beneath the surface, however, there are potentially diverging paths. While the stock market – and even the economy in aggregate – may not differ materially under a Biden versus Trump win, a change of leadership could trigger a rotation towards more traditionally value-oriented stocks.
If Biden wins and has the necessary support in the Senate and House of Representatives to increase tax rates and deliver a $2 trillion spending deal, reflationary areas of the economy could disproportionately benefit. In fact, reflationary plays and generally more value-oriented stocks could assume market leadership.
In our view, technology growth stocks, market leaders over the past five years that are currently trading near all-time highs, could experience valuation compression if GDP growth accelerates and forces the Fed to increase rates earlier than current consensus for 2023. These stocks are the ultimate long-duration assets, and their valuations would be pressured by higher discount rates. In 2000-2002, when the tech bubble burst and growth stocks declined by double digits, value stocks went on to deliver strong results.
Fed policy and ever-declining interest rates have proven to be among the most important factors driving the U.S. stock market over the last two decades. However, with the current Fed balance sheet at historically high levels at over 25% of GDP, no one really knows how big is too big. In addition, with many key interest rates near zero, the marginal benefits of further Fed stimulus are waning. Fiscal stimulus, as Chairman Powell made clear in his recent update to Congress, is paramount. More importantly, history has shown that stocks ultimately follow earnings as profits—not politics—drive markets. Simply put, we believe U.S. corporations will need to deliver earnings growth to drive investment returns for investors.
Stick to the Fundamentals
Regardless of who is sworn in as president in January, during these uncertain times, our best advice to investors is to stay the course and keep focused on company fundamentals. At Scharf Investments, we have invested client assets through six U.S. presidential administrations since our firm’s inception nearly 40 years ago. We continue to adhere to a time-tested investment process that seeks to withstand adverse market conditions while offering attractive returns relative to industry benchmarks and peers. Through our value-oriented investment strategies, including our flagship Core Equity Strategy, our investment team looks for attractively priced, quality companies trading at significant discounts to estimated fair value, strong favorability ratios, and high earnings predictability, thus differentiating us from traditional value managers.
This material includes forward-looking statements based on Scharf Investments’ experience and expectations about the securities markets and the methods by which Scharf Investments expects to invest in those markets. Those statements are sometimes indicated by words such as “expects,” “believes,” “seeks,” “may,” “intends,” “attempts,” “will,” and similar expressions. The forward-looking statements are not guarantees of future performance and are subject to many risks, uncertainties and assumptions that are difficult to predict. Therefore, actual investment returns could differ materially and adversely from those expressed or implied in any forward-looking statements.