Elections and equities

As the U.S. presidential elections approach, the equity market’s volatility tends to increase and remain stable. Historically, volatility tends to subside immediately after the election, regardless of the winning candidate. On average, markets have seen about 5% gains in the first 1 to 3 months post-election. Over a longer period of 6 to 12 months, returns are typically higher if the incumbent party wins, as this protects the status quo and supports existing trends.

This phenomenon coincides with seasonality. On average, the months of August and September tend to be more negative and volatile. This is exacerbated in election years since the U.S. presidential elections are always held in November.

Turnover erodes compounding

For heavily taxed investors, the benefits of holding onto their investments as long as they continue to grow and compound are significant. Selling investments triggers taxes, which reduce the amount of capital available for reinvestment. As a result, the new investment would need to generate a significantly higher annualized return to match the after-tax value of the original investment. Therefore, avoiding unnecessary sales is a key strategy to preserve more capital for compounding over the long term.

High turnover can also increase explicit costs such as fees and transaction costs because each trade typically incurs brokerage fees, custody feed, and applicable market costs. In addition, the larger the trade, the higher the impact of implicit costs, such as market impact and bid-ask spreads.

The less taxes and transaction costs paid, the more money invested.

“Our favourite holding period is forever” Warren Buffet, 1988.

Follow the leaders

The market’s strongest stocks often set the tone for the rest. Their performance can be viewed as a guide for broader market movements. One should be more cautious if a leading stock shows signs of exhaustion, if they are technically extended on a very bullish sentiment, or if they break down below key support levels without significant fundamental news. Monitoring the narrative around leadership stocks and watching their fundamentals is important.

Tempestuous price and serene fundamentals

Fundamentals tend to be serene, while prices are tempestuous. Market sentiment, news reconciling large information asymmetry, events resetting expectations, liquidity, momentum, and technical factors are all responsible for these dynamics. Understanding the stimulant of a large price move is an integral part of an investment decision.

Consumer income

Consumers can access 3 types of income

  • Past – coming from savings
  • Present – coming from current employment or business activities
  • Future – coming from credit leveraging future income (borrowing money to be repaid in the future including loans, credit cards, mortgages)

Assessing the health of an economy and predicting future consumption and economic growth potential, involves a comprehensive analysis of cycles and trends of savings, employment income, and credit.

Extreme valuations

Investing in something just because it is cheap is likely a value trap.
Shorting something just because it is expensive is a death wish.

Gravitating towards the rational outcomes

Markets and securities are often overbought or oversold, and they can maintain or extend those conditions for a long time. The outcomes that are more likely to happen may not happen until long after they first became likely. Markets can have a long time lags before turning around and reaching levels supported by a well-reasoned conclusion.

There are two famous quotes describing this:

  • “Being too far ahead of your time is indistinguishable from being wrong” by Howard Marks
  • “Markets can stay irrational longer than you can stay solvent.” by John Maynard Keynes

Big market moves

Most of the big market moves can be separated into two pieces:

  • Fundamental piece – first half to 2/3rds of the move driven by market events
  • Sentimental piece – remaining 1/3rd to a half driven by build up momentum leading to market froth

IG growth

The investment grade (IG) market grew fivefold between 2006 and 2023, while the balance sheets of IG market makers shrunk during that period. This increased the sensitivity of credit spreads to liquidity.

During the same period, more liquid Fixed Income products, like treasuries and mortgages, have much smaller increases in volatility. This is because a higher fraction of market makers’ balance sheets is committed to providing liquidity in those assets. Market makers prefer those higher quality assets.