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How the US Presidential Election Will Affect the Stock Market

Sep 27, 2016

In this issue:
» Exports of Developing Countries Are Under Pressure
» Why Smaller Isn't Necessarily Better
» ...and more!
00:00
Rohan Pinto, Research analyst

Yesterday, when the Sensex was down more than 300 points, I saw a report claiming that 'experts' were advising against buying stocks.

I didn't get it. Why were they suddenly bearish? Weren't they bullish just the day before? Do the views of 'experts' change every day?

A little later, I understood why the markets were nervous. I hadn't realised just how close we are to perhaps the most important event of the year, the US presidential election.

It will be held on 8 November, exactly six weeks from today. The first of the three TV debates is over. Donald Trump and Hillary Clinton have finished a 90-minute verbal wrestling match.

No wonder the markets are getting jittery. But how will the election affect your stocks?

There are two answers to this question: the complicated and the simple.

Let's handle the complicated one first. The reasoning goes something like this...

The US economy is in a fragile condition. It still hasn't recovered from the last recession. It's struggling to grow despite record low interest rates. Productivity is falling. Unemployment is high. Salaries are barely rising. There's just too much debt and too little growth to pay for it.

The conclusion?

The last thing the economy needs right now is a president who will 'shake up' the system. In other words, the markets are afraid that Trump will win.

Now, before I come to the simple answer, let's understand why this line of reasoning is so common. It's because many people don't care about a basic truth about the markets.

A stock is not a just ticker symbol rolling across the bottom of a TV screen. It represents ownership of a business. If the business does well, so does the stock.

Now, the problem is not that people don't understand this. They do. But they also understand that this link between stock and businesses does not appear to hold true on a day-to-day basis.

As long as there's no important news about the fundamentals of the business, stocks usually move on the basis of sentiment alone. If Trump is 'bad for sentiment', the 'experts' start to worry.

This brings us the simple answer. It goes like this...

The US presidential election is important. The next president will play a crucial role in shaping US economic policy. This policy will affect every economy in the world. But the impact of an individual business in a given country will probably be minimal. This is especially true if the business is in good financial health and run by competent people.

The conclusion?

No matter what happens to market sentiment, fundamentally strong businesses tend to remain strong. This is especially true in bad economic conditions, when weaker firms go bust.

So, if Trump wins, and the world economy goes into a recession, should you be worried?

As long as you're holding the best of the breed businesses in your portfolio, the answer is NO. You can sleep well at night because these will be the companies that come out on top when the recession ends.

This is why we're not worried about Donald Trump. We don't concern ourselves with market sentiment too much.

What do we concern ourselves with? Ensuring that the long-term link between stocks and businesses, works in our favour.

You can do this too. Just buy the stocks of great businesses when they are available at reasonable valuations. Then hold them until the sentiment agrees with you.

How important is the result of the US presidential election for stock market sentiment? Let us know your comments or share your views in the Equitymaster Club.


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------------------------------

03:10 Chart of the Day

According to a report released by the United Nations Conference on Trade and Development (UNCTAD), the overall world trade in 2015 witnessed a marked slowdown. The worrying signs are that data for the year 2016 might just be even worse. The primary reason for a slowdown is a secular weakness in the demand growth of the developed economies. Merchandise exports were further impacted due to a slowdown in China and by a fall in oil and commodity prices.

Why are Developing Countries Exports Shrinking?


The south east Asian countries who are primarily export driven economies have had to bear a severe brunt due to this decline in exports. Exports in these economies was down 0.3%. China, witnessed their trade exports decline by 0.9% in 2015 while India saw its exports decline by over 2%. The UNCTAD report finds that the decline in wage growth in both developed and developing economies to be equally responsible for the trade slowdown. For developing economies, its excess reserve of labor pools and the potential of multinational enterprises to shift production to other countries further constraining wage demand contributed to the wage income decline. An increase in wage inequality has thus caused under consumption in the world, this has impacted investment growth as well as trade.

While wage incomes were on the decline during the period of 2002-07, when world trade grew, however, that period was marked by credit fueled bubble which artificially drove consumption for some time. In fact, the present helicopter money employed by the developed nations will only add to an even more inflated asset bubble and make the inequality worse. Demand growth in developed economies and wage inequality thus remain key concerns that need to be addressed for the global trade to revive.

03:50

Smaller firms are known to create wealth faster than their larger counterparts, however, that might not always be the case. The recent June quarter results have once again exposed the fragility of these small companies to their external environment. According to Livemint, on a relative basis, small companies have been laggards vis-a-vis their large and medium sized counterparts.

Excluding banks and the volatile oil and gas sectors from the universe, the results from smaller companies have been disappointing. While firms having revenues over Rs 1,000 crores reported a 2.1% growth in its net sales and a modest growth in operating profits. Firms below Rs 250 crores have struggled and posted a decline in both their net sales and operating profit over the year. The bank credit growth seems to confirm this, there has been an increase in bank credit data to large industrial units while the small and medium industrial units have witnessed a decline.

It is interesting to note that while the fundamentals for many small firms seem to be deteriorating, many of these small companies have witnessed a sharp run-up in valuations. We think some of these companies are clearly in an overheated space and there is a case for being highly selective before making investments.

04:25

After opening the day on a positive note, the Indian stock markets trimmed some of its gains but continued to trade above the dotted line. At the time of writing, the BSE-Sensex was trading up by about 72 points while the NSE Nifty was trading up by 26 points. Sectoral indices traded on a positive note where stocks from the IT and healthcare sector witnessed maximum buying interest.

04:50 Today's Investing Mantra

"In this business, if you're good, you're right six times out of ten. You're never going to be right nine times out of ten." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Rohan Pinto (Research Analyst).

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Equitymaster requests your view! Post a comment on "How the US Presidential Election Will Affect the Stock Market". Click here!

3 Responses to "How the US Presidential Election Will Affect the Stock Market"

jules

Sep 27, 2016

please forward "How the US Presidential Election Will Affect the Stock Market".

Like 

mathai

Sep 27, 2016

indian stock markets is overheated. p e ratio unsustainably high . market is waiting for a trigger real or false. which they will seek out this month or the next. market will fall by 20% by the end of this year.

Like 

SK

Sep 27, 2016

Excellent article. Fully aligns with my strong views as well.

Like 
  
Equitymaster requests your view! Post a comment on "How the US Presidential Election Will Affect the Stock Market". Click here!
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