Historical Election Playbook - Transcript

Welcome to RBC’s Markets in Motion podcast recording August 28th, 2023. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.

  • Three big things you need to know: First, historically, the US equity market tends to have a weak start in Presidential election years before rallying back ahead of the event, while trends tend to turn choppy again in the months around the event itself. 2024 could be different given the unusual circumstances in the upcoming race, but the history is still worth a quick look back.
  • Second, while last week’s mega cap Tech earnings were generally viewed as strong, it didn’t change the fact that the Large Cap Growth trade has tactical problems (i.e., overvaluation, stretched positioning) that need to be resolved.
  • Third, developments in our high frequency indicators were mixed for equities this past week, with improvements in earnings revisions trends and individual investor sentiment, but continued deterioration in trends for US equity funds flows. Overall, we remain concerned that the “breather” in the US equity markets that’s been underway hasn’t fully played out yet, but also consider ourselves to be more neutral than bearish on stocks from here.

If you’d like to hear more, here’s another five minutes. While you’re waiting, a quick reminder that you can subscribe to an audio only version of this podcast on Apple and Spotify. Now, the details.

Takeaway #1: It’s Time to Revisit the Historical Playbook Around US Presidential Elections

  • On the heels of the first Republican debate for the 2024 Presidential election, we took a quick look back at the historical playbook for the S&P 500 in previous Presidential election years. The election has been coming up more in our conversations with clients recently, but a clear consensus narrative hasn’t emerged yet. We’ve published these charts in an effort to keep the conversation going and to get more clarity on how investors are thinking about the event.
  • For our part, we noted a few weeks back that Presidential election years tend to be positive ones for the US equity market, but are weaker, on average, than other years in the election cycle. This time, we looked at daily trading in the S&P 500 throughout all of the Presidential election years going back to 1932. Typically, the stock market has a rough start to a Presidential election year, then stabilizes and rallies back heading into the event. Trends turn choppy in the months immediately before and after the event.
    • These trends are all pretty much intact if we limit our analysis to the last few decades or those that see a Republican or Democrat emerge as victorious. One difference that we do see is that stocks tend to do better after the election if a Republican wins than if a Democrat wins.
    • Interestingly, the stock market generally followed the historical path in each of the last two Presidential election years when Trump won (2016) and Biden won (2020).
  • Of course, 2024 will be unique given the four criminal cases underway for former President Trump, the current front runner for the Republican nomination in both polling and betting markets.
  • While there is a lot of uncertainty about when these cases will actually go to trial, the current calendar suggests that their presence will loom large throughout the year.

Takeaway #2: The Big Cap Growth Trade Still Looks Tactically Problematic, Despite Its Longer-Term Fundamental Appeal

  • While big cap Tech’s widely anticipated earnings were generally viewed as strong last week, it didn’t change the fact that the Large Cap Growth trade has tactical problems that need to be resolved.
  • Growth valuations have only corrected modestly relative to Value and remain well above their long-term average.
  • The weekly CFTC data for asset manager positioning in Nasdaq 100 futures continues to suggest that the Large Cap Growth trade is overowned.
  • Earnings revisions continue to favor Growth relative to Value, but the gap has started to narrow suggesting that Growth’s dominance on the earnings front is fading.
  • Flows to US equity Growth funds have also flipped from positive to negative, while Value flows are still negative but stabilizing.
  • To be clear, we continue to think Growth stocks look appealing from a longer-term fundamental perspective. GDP is expected to be below trend in the next two years, an environment that tends to see Growth stocks outperform. But in the shorter term, the overvaluation and crowding problems in Growth need to be resolved. 

Wrapping up with Takeaway #3: What Else Jumped Out From Our High Frequency Indicators This Week

Developments in our high frequency indicators were mixed these past two weeks. A couple things jumped out:

  • EPS revisions for the S&P 500 have returned to positive territory in August. The rate of upward EPS estimate revisions to the upside has moved back up to 55% on a four-week average, a positive shift from July when the rate of upward revisions had slipped slightly below the 50% mark indicating that mostly downward revisions were in place.
  • Individual investor sentiment has gotten less bullish. Net bulls in the AAII survey fell in the latest update to -3.6% in the weekly print and 12.3% on the four-week average. Earlier this summer, net bullishness hit 1 standard deviation above its long-term average, a level that tends to be followed by weak 12-month forward equity market returns. This tends to signal that optimism on stocks has gotten too extreme. While we aren’t back to the deeply bearish levels that highlighted a contrarian opportunity to buy stocks at the start of the year and post SVB, it’s a step in the right direction.
  • GDP forecasts are no longer baking in negative GDP on a Q/Q basis in 2023. The emerging idea that the US won’t see a single quarter of negative GDP growth in 2023 has helped support S&P 500 pricing this year. But it’s equally important that expectations regarding 2024 GDP growth aren’t ramping, which helps explain why stocks have stalled a bit lately.
  • US equity funds flows continue to weaken. Flows to US equity funds tracked by EPFR had shifted to negative territory on a four-week average, while flows to US bond funds remained steady. Global equity funds flows have also deteriorated. As noted earlier, US outflows have been driven by outflows from Growth funds.

Overall, we remain concerned that the “breather” in the US equity markets that’s been underway hasn’t fully played out yet, but also consider ourselves to be more neutral than bearish on stocks from here.

That’s all for now, thanks for listening. And be sure to reach out to your RBC representative with any questions.