Weekly Investment Commentary: When market and election cycles meet
Bottom line up top:
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A lesson in history. U.S. presidential elections have occurred 23 times since 1932, bringing with them increased market uncertainty as investors position portfolios based on expectations for the next four years of shifting political winds. In fact, during that timeframe, the Chicago Board Options Exchange Volatility Index (the VIX, a measure of expected S&P 500 Index volatility), has risen nearly 10%, on average, in election years versus non-election years. But even amid this heightened volatility, U.S. equities have historically performed well in election years. What’s more, equity market returns during the 12-month periods immediately preceding and following a presidential election cycle have been positive more often than not (Figure 1).
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This election year, a defensive portfolio should be a strong candidate. We’re cautious about 2024 given market expectations for an aggressive Fed rate-cutting cycle beginning as soon as March. We believe the pace and scope of this anticipated easing may be too dovish. In our view, the Fed is more likely to keep its finger on the “pause” button until the second half of the year — a scenario that could fuel higher equity market volatility beyond potential political uncertainty as November approaches. Additionally, we’re concerned about U.S. consumers, who are burdened by record levels of credit card debt at elevated interest rates.
“Uncertainty surrounding both politics and interest rates could spark higher market volatility in 2024.”
Portfolio considerations
Our concern about potential risks in the year ahead informs our current equity market views: We suggest focusing less on cyclical exposures in favor of more defensive, less economically sensitive areas. These include market areas such as U.S. dividend growers and global infrastructure.
- Dividend growers are supported by positive fundamentals, sustainable growth potential and ample free cash flow. They have also historically demonstrated resilience during prior periods of heightened volatility and following Fed rate-hiking cycles.
- Global infrastructure companies typically benefit from inelastic demand for the basic necessary services they provide.
Notably, both dividend growth and global infrastructure stocks have historically weathered down markets relatively well. We’re especially mindful of a potential drawdown in the wake of the remarkably strong equity rally in the final two months of 2023.
Regarding fixed income, Nuveen produces a monthly yield spread monitor that evaluates sector spreads as a valuation tool; an abbreviated version is shown as Figure 2.
- Currently, preferred securities and securitized assets — sources of nontraditional income with yields exceeding those of investment grade bonds — are offering spreads wider than their long-term averages. Preferreds are supported by strong underlying credit metrics for U.S. banks (evidenced by the Fed’s 2023 “stress test” results) and by generally better-than-expected bank earnings over the past few quarters. Within securitized assets, we’re particularly favorable toward non-agency mortgage-backed securities, where we see low risks of prepayment given the likely higher-for-longer rates environment.
- By comparison, investment grade corporates have tight spreads — but we think this is justified given the attractiveness of these bonds in an environment where (1) the economy is projected to slow and (2) longer-duration exposure should benefit when rate cuts eventually arrive. The corporate curve is also offering higher yields on longer-dated versus intermediate maturities. Lastly, we anticipate investment grade corporate default rates will remain low.
“We prefer more defensive areas of the equity market, and a focus on select credit sectors within fixed income.”
Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.
Regular meetings of the GIC lead to published outlooks that offer:
- macro and asset class views that gain consensus among our investors
- insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
- guidance on how to turn our insights into action via regular commentary and communications
Endnotes
Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
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Important information on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. Dividend-paying stocks are subject to market risk, concentration or sector risk, preferred security risk, and common stock risk. Concentration in infrastructure-related securities involves sector risk and concentration risk, particularly greater exposure to adverse economic, regulatory, political, legal, liquidity, and tax risks associated with MLPs and REITs. Foreign investments involve additional risks including currency fluctuations and economic and political instability. These risks are magnified in emerging markets. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk and income risk. As interest rates rise, bond prices fall. Below investment grade or high yield debt securities are subject to liquidity risk and heightened credit risk. Preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure and therefore are subject to greater credit risk. Asset-backed and mortgage-backed securities are subject to additional risks such as prepayment risk, liquidity risk, default risk and adverse economic developments.
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