Election-Proof Your Portfolio
A conversation with Kim Wallace of Renaissance Macro Research, Jonathan Swaney of New York Life Investment Management, and David Dowden of MacKay Shields.
Charlie: Heading into the home stretch of the election, what states matter most for each Presidential candidate?
Kim: Mr. Trump will have to secure Florida and for Mrs. Clinton the importance of Pennsylvania cannot be over emphasized. It is a traditional red and blue state with some purple in the middle, but it is becoming increasingly purple, which makes it very unpredictable. At the same time it is an important electoral haul. The ultimate outcome is likely to be determined by voter turnout.
Charlie: What will Washington look like next year?
Kim: Mrs. Clinton has a lead in the Presidential election. In terms of the U.S. legislature, the Senate majority leader will likely be of the President’s party, largely because of the impact of voter turnout in the key states. The margin in the Senate could be tight, perhaps only a couple of people. In the case of a 50/50 tie, of course, the Vice President serves as the President of the Senate, so the majority would go to the Democrats. It is very unlikely, bordering on impossible, that the Republicans lose the House.
Charlie: How do you think the markets will react to ongoing election news?
Jon: There are many variables that affect security pricing at any point in time. Perhaps, at times, we exaggerate the importance of political events on day-to-day market activity, but politics remains a factor. Given the considerable uncertainty as to how the elections will play out and the challenge anticipating its impact, it is not unreasonable to expect that as we push closer to Election Day volatility will become a bit more elevated.
Charlie: How does an investor deal with this environment?
Jon: In such an environment, I would reiterate the importance of maintaining portfolio discipline and a long-term investment perspective, which includes diversified asset allocation and remaining true to it through the bouts of volatility.
Charlie: Are municipal bonds at risk under election-driven volatility?
David: When volatility picks up we often see inopportune selling throughout the markets. Individual investors tend to make the wrong decisions at the wrong time. And the municipal market, which is heavily weighted to individual investors, is certainly no stranger to panic. But our deep knowledge and understanding of technical and credit fundamentals give us comfort to be on the other side of those trades and to make decisions quickly when we have to.
Charlie: What about the relative valuation of municipal bonds?
David: Municipal bonds are so attractively priced that regardless of where tax rates go in the next administration, investors shouldn’t be worried about the impact of a decline in pricing as they reset based on taxes. Our expectation is that municipal bonds will remain attractively priced relative to Treasury securities, until we truly see a secular rise in interest rates.
Charlie: How does your approach help you locate value along the yield curve or in specific credits?
David: Our view is to maneuver around the curve finding the best value. So now, our view is that the sweet spot has shifted. More specifically, we moved from longer dated 20–30 year bonds to a shorter range of 10–18 year bonds, in steps. By comparison, many investors who ladder municipal bonds tend to have elevated exposures in the 1–10 year range of the yield curve, which today looks expensive to us. As a professional active management team, we are in a good position to conduct a proper analysis on each credit. Bonds that are more credit sensitive will tend to trade closer to their credit fundamentals than their interest-rate sensitivity.
Charlie: How do you view opportunities in taxable credit versus government bonds?
Jon: Under realistic economic growth assumptions of about 2% in the U.S. and 3% globally with tame inflation, we think investment-grade and high-yield credit have more to offer than developed country sovereign debt. That said, one has to have modest expectations—low single digits per annum—about the total return possibilities because we are starting from such low interest rates.
Charlie: Both candidates have talked about fiscal stimulus. In your view, what are the challenges and what is possible?
Kim: The challenges are to cobble together a macro economic program on the fiscal side that convinces members of Congress that fiscal stimulus is both needed and advisable. However, you have to put together a program that you think might work for the economy. There will be an economic program proposed by the President, and Congress will have a tough time saying, “No—we give you nothing.” People will look for immediate job creation. The key will be to avoid getting bogged down in the debate over the infrastructure priorities. Instead, the proposal should address the infrastructure system throughout the country and work on ones that have been under-maintained. I immediately think of the Mississippi Locke system and deep water shipping ports.
Charlie: What does that mean for the municipal bond market?
David: We see a strong need for infrastructure financing, and there is a tremendous gap in the financing needs. One thing worth mentioning is the possible resurrection of Build America Bonds (BABs) for schools in inner-cities and infrastructure projects. BABs could take some burden off state and local government issuance. Every dollar that is issued in BABs is a dollar not issued in tax-exempt bonds. The secondary effect of BABs could be to suppress the issuance of municipal bonds, making existing municipal bonds more attractive.
Charlie: How is the health of some of the biggest municipal bond markets?
David: We are very pleased with the performance of New York and California. New York Governor Andrew Cuomo has had six balanced budgets in a row. In addition to fixing the financial balance sheet at the state level, he has moved into the local levels while maintaining an impressive 91% funded status in the pension. We also see some very big projects coming to New York, including LaGuardia International Airport. For a New York investor whose tax rate is over 8.8%, municipal bonds can be a great investment.
California is a much different economy than most other states. It’s like a country. And Governor Jerry Brown has been able to achieve some great changes in the state. Notably, he removed the super majority in the legislative branch, speeding up the time it takes to push through legislature. He worked to regain control of the rail financing from the local level to the state level. Additionally, Proposition 53 will be on the ballot this year. If passed, no financing for a project greater than $2 billion can come to market without a vote by the people. This could put a limit on bond issuance, which will reduce the supply of future issuance.
Charlie: What about a word on U.S. and global equities?
Jon: In the near term, one can certainly point to things that can keep an investor up at night, such as Brexit, slower-than-desired economic growth, and the Fed signaling it is moving toward another interest rate increase. Beyond these events, the U.S. market is likely in an era where price-to-earnings (P/E) ratios and profit margins don’t change much and therefore earnings growth, dividends, and modest share repurchases amount to mid single-digit per annum total returns.
Looking outside the U.S., the mix of valuations and growth prospects are more attractive in emerging market equities in our view than for developed international equities. In addition, Brexit offers hard to calculate uncertainties and Europe faces
other challenges, such as immigration, too.
Active management is an investment strategy involving ongoing buying and selling actions by the manager. Active managers purchase investments and continuously monitor their activity in order to exploit profitable conditions. Active management typically charges higher fees than passive management.
Brent/West Texas Intermediate crude is a major trading classification of sweet light crude oil that serves as a major benchmark price for purchases of oil worldwide.
Brexit is an abbreviation for “British exit,” which refers to the June 23, 2016, referendum whereby British citizens voted to exit the European Union.
CME Group Inc. is an American futures company and one of the largest options and futures exchanges.
A commodity is a basic good used in commerce that is interchangeable with other commodities of the same type; commodities are most often used as inputs in the production of other goods or services.
Correlation is a statistic that measures the degree to which two securities move in relation to each other.
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
Build America Bonds (BABs) are taxable municipal bonds that feature tax credits and/or federal subsidies for bondholders and state and local government bond issuers.
Earnings-per-share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. Earnings-per-share serves as an indicator of a company’s profitability.
The EBITDA/EV Multiple is a financial ratio that measures a company’s return on investment (ROI).
A master limited partnership (MLP) is a type of business organization that exists in the form of a publicly traded limited partnership. There are two classes of partners in a master limited partnership: limited partners and general partners. Limited partners are investors that purchase units in the MLP that provide the capital for the MLP’s operation and that receive periodic income distributions from the MLP’s cash flow, whereas the general partners are responsible for managing the day to day operation of the MLP and that receive compensation based on the performance of the MLP’s business venture.
The Organization of Petroleum Exporting Countries (OPEC) is an organization founded in 1960 to coordinate the petroleum policies of its members, and consists of the world’s major oil exporting nations.
The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.
The price/earnings to growth ratio (PEG ratio) is a stock’s price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period.
Proposition 53 was a California ballot proposition on the October 7, 2003, special recall election ballot, which failed to get passed.
A real estate investment trust (REIT) is a type of security that invests in real estate through property or mortgages and often trades on major exchanges like a stock. REITs provide investors with an extremely liquid stake in real estate. They receive special tax considerations and typically offer high dividend yields. Investment in REITs carries with it many of the risks associated with direct ownership of real estate, including decline in property values, extended vacancies, increases in property taxes, and changes in interest rates.
The S&P 500 Forward Price-to-Earnings (P/E) Ratio uses estimated net earnings over next 12 months. Estimates are typically derived as the mean of those published by the analysts at S&P.
A share repurchase is a program by which a company buys back its own shares from the marketplace, usually because management thinks the shares are undervalued, reducing the number of outstanding shares.
Standard deviation is a measure of the dispersion of a set of data from its mean.
The S&P 500 Energy Sector is a category of stocks that relate to producing or supplying energy. This sector includes companies involved in the exploration and development of oil or gas reserves, oil and gas drilling, or integrated power firms.
Sovereign debt refers to bonds issued by a national government in a foreign currency, in order to finance the issuing country’s growth.
Valuation is the process of determining the current worth of an asset or company.
The Bloomberg Commodity Index (BCOM) is a broadly diversified commodity price index distributed by Bloomberg Indexes. The index tracks prices of futures contracts on physical commodities on the commodity markets.
The IA SBBI U.S. Large Stock Total Return Index was created by Ibbotson as a broad based, capitalization-weighted index which measures the total return performance of U.S. equities.
The IA SBBI U.S. Corporate Total Return Index was created by Ibbotson as a market value weighted index which measures the performance of long-term U.S. corporate bonds.
The IQ Global Resources Index uses momentum and valuation factors to identify global companies that operate in commodity-specific market segments and whose equity securities trade in developed markets, including the U.S.
The MSCI EAFE Index serves as a benchmark of the performance in major international equity markets as represented by 21 major MSCI indexes from Europe, Australia, and Southeast Asia.
The MSCI Emerging Markets Index is a float adjusted market capitalization index that consists of indices in 23 emerging economies designed to measure equity market performance in global emerging markets.
The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. As of June 2007 the MSCI World Index consisted of the following 23 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States.
The Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector.
The S&P 500® Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock market performance.
The S&P GSCI Index (formerly the Goldman Sachs Commodity Index) serves as a benchmark for investment in the commodity markets and as a measure of commodity performance over time.
Past performance is no guarantee of future results. An investment cannot be made directly in an index.
Before You Invest
All investments are subject to market risk, including possible loss of principal.
Bonds are subject to interest rate risk and can lose principal value when interest-rates rise. Bonds are also subject to credit risk, which is the possibility that the bond issuer may fail to pay interest and principal in a timely manner.
Diversification cannot assure a profit or protect against loss in a declining market.
Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.
High-yield securities (junk bonds) have speculative characteristics and present a greater risk of loss than higher quality debt securities. These securities can also be subject to greater price volatility. There is no assurance that investment objectives will be met. It is possible to lose money while investing in securities.
Municipal bond interest is exempt from federal income tax and, in many states, interest from municipal bonds issued in an investor’s state of residence is exempt from state income tax.
Small- and mid-cap stocks are often more volatile than large-cap stocks. Smaller companies generally face higher risks due to their limited product lines, markets, and financial markets.
Stocks are considered to be at greater risk during times of extremely high valuations than at times of low or moderate valuations. The other risks associated with investing in stocks are economic risk, inflation, and market value risk. There are also additional risks associated with investing in small, international, and high-yield stocks. Dividends are not guaranteed.
Treasury securities are backed by the full faith and credit of the U.S. government as to payment of principal and interest if held to maturity. Interest income on these securities is exempt from state and local taxes.
The information contained herein is general in nature and provided solely for educational and informational purposes. New York Life does not provide legal, accounting, or tax advice. You should obtain advice specific to your circumstances from your own legal, accounting, and tax advisors. Use of a financial professional does not guarantee investment success. Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sale of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.
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