Introducing the Red vs Blue Portfolio Election Tracker

John P. Swift, CFA, CPA Chief Investment Officer
312-259-9595 or jswift@trustbenchmark.com
July 19, 2020

The Market & Red/Blue Portfolios: Presidential Election Outcome Predictor

Of course, we will be turning to our Market Outlook in a moment, but I would like to start off by introducing our Red vs Blue Portfolios that we have been utilizing internally over the past presidential election cycles as an early indicator of the outcome in those contests. The performance of the market during the 100 days leading into the presidential election has been a remarkably good indicator of the outcome of the subsequent election. The market has correctly predicted the winner 9 out of the last 10 presidential elections, and our internal research indicates that if you track two portfolios that are forecast to do relatively better during Democratic and Republican administrations you have correctly forecast the winner in all 10 previous elections.

In 2016, our Red portfolio rallied into the last 20 days before the contest which had us all scratching our heads. Hillary Clinton was way ahead in the polls, but the Red portfolio was rallying relatively strongly versus the Blue portfolio. The actual outcome of that election convinced us more than ever that people will tell bold faced lies to pollsters, but they are very honest with their money.

In preparing our two political portfolios we took into consideration that a re-election of President Donald Trump is thought to mean continued lowering of taxes and loosening of regulations. A second Trump term could also mean continued tensions with trading partners. A win by former Vice President Joe Biden would likely mean increased infrastructure spending and higher taxes.

What follows is the composition of the 30 equally weighted positions within these two portfolios with special thanks to Strategas Research for their work in creating the Challenger Blue Portfolio.

The Challenger Blue Portfolio (Source: Strategas Research)

Infrastructure: The pure play on a Democratic sweep is an infrastructure bill that would likely be considered early in 2021 if Joe Biden wins the election. This program would boost highway, transit, rail, water, green energy, and broadband spending. The representative stocks are as follows:

• Granite Construction / GVA
• Jacobs Engineering / J
• U.S. Concrete / USCR
• Vulcan Materials / VMC
• Xylem / XYL
• American Tower / AMT

Renewable Energy: A Democratic sweep will raise the cost of fossil fuel production through regulation and higher taxes while lowering the cost of renewable energy through subsidies for wind, solar, electric vehicles, and biofuels. Climate change will be an immediate priority for the Democrats. There will be a push for a carbon tax that can be used to pay for infrastructure. Strategas’ out-of-consensus view is that a carbon tax benefits ExxonMobil over Exploration and Development firms that rely on horizontal fracturing drilling methods.

• NextEra Energy / NEE
• AES Corp. / AES
• First Solar / FSLR
• Vestas Wind / VWDRY
• Renewable Energy / REGI
• Tesla / TSLA
• ExxonMobil / XOM

Trade Policy: U.S.-China relations are on a long-term path to decoupling. A Biden victory will slow the speed of decoupling and therefore benefits companies that generate larger portions of their revenue from China (semi-conductors). A Biden administration will be less confrontational with Europe, which benefits Germany and German autos.

• Applied Materials / AMAT
• Broadcom / AVGO
• Western Digital / WDC
• iShares MSCI Germany ETF / EWG

Health care: Democrats are campaigning on lowering drug costs and creating a public option to compete with managed-care companies. Both are negative for health care stocks. Strategas’ out-of-consensus view is that Democrats won’t move forward on a public option and instead will increase access to the Affordable Care Act. Under a Democratic sweep at the state level, Democrats can expand Medicaid, which benefits Medicaid HMOs and hospitals.

• HCA Healthcare / HCA
• Centene / CNC
• Molina Healthcare / MOH
• Thermo Fisher / TMO
• Medtronic / MDT

Marijuana Legalization: A Democratic sweep would push for marijuana decriminalization and a change in the banking laws that will allow banks to handle marijuana transactions.

• Canopy Growth / CGC
• Innovative Industrial Properties / IIPR

State Budgets: Democrats are looking for ways to reinstate the State and Local Tax Deduction (SALT), provide more aid to state and local governments, boost infrastructure spending, and increase the federal contribution for Medicaid.

• iShares National Muni Bond ETF / MUB
• Assured Guaranty / AGO

Consumer Staples and Safety Net: The pandemic has allowed safety net spending to increase temporarily. The 2020 election will determine if these programs continue in areas like food stamps and unemployment benefits.

• General Mills / GIS
• Campbell Soup / CPB

Immigration and Guns: Democrats are likely to push immigration reform at some point. Western Union benefits from this policy. Counterintuitively, a Democratic win will likely lead to higher gun sales.

• Smith & Wesson / SWBI
• Western Union / WU

The Incumbent Red Portfolio

Companies Benefitting the Most from Lower Taxes: Increased taxes negatively impacts all companies, but the impact will be particularly harsh on the following companies who have extremely high net margins, as well as high cash tax pay rates. In other words, they pay their taxes currently and are not able to add to deferred tax amounts through legal accounting practices.

• Activision Blizzard/ATVI
• Adobe/ADBE
• Advanced Micro Devices Inc./AMD
• Amazon/AMZN
• Apple Inc./AAPL
• Autodesk/ADSK
• CDW/CDW
• Facebook/FB
• Fortinet Inc./FTNT
• Google/GOOGL
• Mastercard Inc. Class A/MA
• Microsoft Corp./MSFT
• Netflix Inc./NFLX
• Nvidia Corp./NVDA
• Paypal/PYPL
• Salesforce/CRM
• ServiceNow Inc./NOW
• Vertex Pharmaceuticals Inc./VRTX
• Visa/V
• Zebra Technologies Corp./ZBRA

Oil Exploration: Oil Exploration & Production Companies with a high percentage of their drilling rights located on land leased to them by the federal government are seen to be most at risk under Democratic sweep.

• Devon Energy/DVN
• EOG Resources/EOG
• Murphy Oil/MUR

Defense Spending: Although Joe Biden has promised no significant cuts in defense spending, this view is not widely held by the majority within his party who look for defense spending cuts to allow for an increase in budgets for other programs.

• iShares U.S. Aerospace & Defense ETF/ ITA
• Northrup Grumman/NOC
• Boeing/ BA
• Lockheed Martin/LMT

High Drug Prices: The Israeli drug manufacturer, Teva Pharmaceutical, has been under scrutiny by House lawmakers for their alleged role in colluding to keep drug prices too high for a variety of different drugs. The Trump administration has supported Teva as a critical ally in the fight against the coronavirus.

• Teva Pharmaceutical/TEVA

Big Banks: Big banks have benefitted from less regulations and lower taxes under Trump, but will fare relatively worse under a more restrictive, higher tax pledge from Democrats.

• JP Morgan Chase/JPM
• Bank of America/BAC

The “Way-Too-Early” Returns:

We are only a week into the last 100 days before the election and most of the real action takes place in the last 30 days. So, do not read too much into this small sample size, but what follows is how these two portfolios have performed over the first week of this “Last 100 Days” contest. In future notes we will update you on the performance of these two portfolios and the market.

Market Outlook

It was a busy week in the markets. Close to 200 S&P 500 companies reported their results for the June quarter; Republicans unveiled a $1 trillion coronavirus stimulus proposal; the House Judiciary Committee held a hearing on antitrust matters involving four of the country’s largest companies; the Federal Reserve conducted a policy meeting and Fed Chair Powell held a related press conference; the worst‐ever contraction in U.S. GDP was recorded; and the U.S. Dollar Index weakened to a two‐ year low.

Corporate Results: With more than half of the S&P 500 companies already reporting results for the 2nd quarter, 71% are beating revenue estimates, and 74% are beating earnings expectations.

U.S. Fiscal Stimulus Package: Talks are deadlocked with the two sides still extremely far apart. If we get to August 7th without a broad deal, I am looking for a piecemeal bill dealing with unemployment benefits and liability protections. It is possible that the recent spike in the household savings rate may buffer some of this elimination of the $600 federal unemployment benefit, but clearly the deeper we get into August without a deal, the more investors will be taking risk off the table.

House Judiciary Committee: The “Large Technology Company” hearings, while mildly entertaining, did not mean much. The Market so far has been treating this bi-partisan handwringing on big technology company practices as empty threats. But will the election change that? Stay tuned.

Federal Reserve Policy Meeting: The Fed event this past week was largely a non-event, and Chairman Powell’s message delivered at the concluding press conference continues to be was dovish as expected. His remarks recognized the May-June improvement in economic data, but the tone around growth is still decidedly cautious, and he noted that activity and employment remain far below pre-pandemic levels. He also acknowledged the recent flatlining and reversal in economic activity given the sharp increase in COVID cases.

The September Fed meeting will most likely bring additional policy steps with specific forward guidance and a traditional quantitative easing schedule along with the new monetary framework. While financial markets are operating normally, Chairman Powell says this is not a reason to moderate the asset purchase pace as those are now helping to provide incremental accommodation. He also indicated that he is not concerned about inflation at all, calling the virus a deflationary shock hitting an economy already suffering from disinflationary headwinds.

U.S. Dollar Weakness & the Surge in Gold Prices: The dollar has been in a steady downtrend against other major currencies, namely the euro since mid‐May. This week, the U.S. Dollar Index slipped to 92.54, which was its lowest level since May 2018.

Although the weakness in the U.S. dollar has been attributed to various influences such as concerns about the widening budget deficit, the rise in national debt, strengthening of the euro, resurgence of coronavirus cases in the U.S., worries about increased volatility in the U.S. market as the presidential election draws closer and the unwinding of carry trades as foreign currencies strengthen against the greenback, the most common cause of U.S. dollar weakness can be attributed to the suppression of U.S. interest rates.

In fact, real interest rates became negative at the start of the U.S. pandemic in March which has only happened on three other occasions: 1947 during the post WWII reconstruction phase, 1974 during the fallout of the Oil Embargo, and most recently, in 2011 when the Federal Reserve first launched what has become know as Quantitative Easing.

During the last three occurrences of negative real interest rates, Gold prices have surged. The only exception was in 1947, but the U.S. was on the gold standard back then and the price of gold was fixed to support the value of the U.S. dollar.

On the two images that follow I am tracking real interest rates over the past two periods of negative real interest rates (top graph) and the price of a troy once of gold (bottom graph). During the 2011-2012 period of negative real interest rates you can see that gold topped out at $2,000/once but declined rapidly during the first half of 2012 in anticipation of an increase in nominal interest rates. I expect that we will see a similar pattern, but how long the gold rally lasts will be correlated to how long these super low interest and inflation rates persist. Based on the Fed Chairman’s stance this past week, low interest rates are here for some time and we may see gold setting record prices soon.

Catching Up

We look forward to catching up with each of you, and we will be reaching out to schedule a time to meet over the phone or by a Zoom/MS Teams video link. In the interim, if you would like to get something on the calendar, please send me a note with some dates and times.

Warm regards,