It has been reported that the greatest living investor has a file on his desk featuring huge letters that read “TOO HARD.”
Some investment ideas can be met with a quick “no.” Other investment ideas bear themselves out through analysis and go in the “yes” file. Often overlooked is the third “TOO HARD” pile, which should likely be your largest. The too hard pile reflects the wise recognition that we all operate within a defined circle of competence, reminding the would-be investor that he doesn’t have to swing at every pitch.
Actively positioning your investments for TRUMP v. HARRIS has a little of the “TOO HARD” feel but let me share a few thoughts.
Equities
First off, whatever the polls say and whoever ultimately wins this race, stocks are expensive. The Nasdaq-100 now trades at 27.8x[1] this year’s earnings, and 23.4x 2025 estimates. The S&P 500 now trades at 22x this year’s earnings, and 19.3x 2025 estimates. 19.3x earnings translates into an earnings yield of 5.18%.[2] Compare that to a five-year note yielding 4.10% and you can see that the equity premium is fairly small, meaning you aren’t getting paid very much to take on the additional risk and volatility of stocks.[3]
The equity premium is small but stocks remain more attractive than bonds for medium and long-term money because with equities you get:
- the premium already discussed (5.18% versus 4.1%)
- the tax advantages of the long-term capital appreciation of stocks over the ordinary income of bond interest
- future earnings growth
- the ability to offset potential future inflation
In the scenario that Trump wins, we could get additional tax cuts or at least extend the tax cuts set to expire at the end of 2025. The former would grow corporate earnings and the latter might create a little multiple expansion as the market pays more for each dollar of future earnings due to reduced future taxes. A Trump win might also bring regulatory relief that would, on net, reduce corporate expenses and therefore grow earnings.
Biden-Harris ran on raising taxes and we might tentatively assume that large parts of this platform will remain intact, though the likelihood that all their proposals become law are slim.
Biden-Harris promised to significantly raise taxes, to include:
- raise corporate income tax from 21 to 28%
- increase top marginal tax rate from 37 to 39.6%
- tax long-term capital gains and dividends at ordinary income tax rates
- quadruple stock buyback tax to 4%
These changes as well as limits on the deductibility of employee compensation, limits on 1031 exchanges, and tightened estate tax rules would together represent a $5.3 trillion tax hike over the next 10 years.[4]
Let’s consider the impact a couple of these tax law changes might have on stocks.
- If you perform a simple calculation using the amount Mr. Stock Market now pays for $1 of earnings (obviously, earnings represent after-tax money), the corporate income tax hike from 21 to 28% should lead to a 8.9% drop in the S&P 500.[5]
- Taxing long-term capital gains and dividends at ordinary tax rates moves the average investor from paying a 15-20% federal tax to a federal levy in excess of 30%. This change would dramatically reduce the value of many existing investment accounts. Unrealized gains represent a partnership with Uncle Sam and this partnership renegotiation has Uncle Sam deciding to take a bigger piece of the pie.
Similarly, for those relying on dividend income, it might mean they need 15-25% more Southern Company shares to provide the same after-tax money needed to meet household needs.
Bottom line, stocks are expensive but based on alternatives, most long-term investors need to be invested here. Can one dip out of market with the idea that he will buy back in at lower levels? The experience of millions of investors, both retail and professional, prove that this is “too hard” to accomplish in practice.
Bonds
We are in a rare moment in the history of bond markets in that short-term bonds pay the highest yield. With short-term treasuries, you get the highest return and little interest rate risk (the risk of capital losses if interest rates rise). However, with the expectation that the Federal Reserve will soon begin a round of interest rate cuts, investors will likely see lower rates on future bond purchases. This is known as reinvestment risk (e.g., the risk that you will replace a 5.4% bond with a 3.5% bond when your bond matures) and this should lead investors to consider increasing the duration of their bond portfolio. Locking in solid rates[6] for a few years will make sense for many, though this is very much dependent on your situation.
I continue to dislike most everything other than the highest quality bonds. Low-quality corporates and other Treasury alternatives fail to provide the premium required to get you out of the Treasury market.
Trump and Harris would both likely run deficits, a reality that may pinch America at some point in the future, and could lead to far higher rates. On this front, I am concerned but not so concerned that I think there is a better alternative to US Treasuries. Being an independent nation with our own currency and matching printing press provides us with an extremely long runway.
Commodities
Based on current price levels in key commodity markets, the expectation of rate cuts, and the possibility that we might see a weaker US Dollar, I would expect to see the Bloomberg Commodity Index[7] higher going forward. If we see a moderate to severe global recession, my expectation would flip and I would expect to see commodities lower, but perhaps not much lower and I could even imagine commodity inflation as a culprit in certain recessionary scenarios.
Trump’s “drill baby, drill” approach might well drive energy prices lower.[8] Harris’ energy policy might be more likely to drive prices in the energy complex higher.[9] Copper and nickel should do well under Harris as green energy plays, but a robust economy under any president should underpin copper.
Perhaps the most important factor for commodities is the US Dollar. Commodities are USD based and a weak dollar is their best friend.
Crypto
As previously treated in this newsletter, I am not a fan of crypto and will not recommend it for the reasons previously cited. However, as a Trump trade, Bitcoin (“BTC”) looks interesting. Not only does Trump now seem to like crypto, he also favors a weaker dollar[10] and the search for USD alternatives is less than satisfying. The Chinese currency is pegged. The Japanese aggressively manage the Yen in order to devalue it. The Eurozone has obvious issues, not least being disjointed governments and budgeting processes cohabitating under a common currency. The best options to benefit from USD weakness might be commodity currencies like the Australian and Canadian dollars (especially if global interest rates are cut substantially), gold and BTC.
I prefer the former three to BTC because, to my way of thinking, BTC has no real value. It produces no income and exists only as a speculative investment that relies on someone else paying you more for it tomorrow. Paradoxically, because the value is untethered to an income stream, it alludes the most basic attempts at fundamental analysis. Said another way, BTC at $200,000 isn’t really less reasonable than BTC at $65,000.[11] I would not bet against BTC.
In closing, should you make a raft of bets based on TRUMP v. HARRIS? It’s probably TOO HARD.
[1] P/E ratio: 27.8
[2] 100/19.3 = 5.18; this conversion is useful when comparing stocks and bonds
[3] On the treasury yield curve, the 3-10 year part of the curve ranges from 4.1 to 4.22%.
[4] Third-party reviewers performing dynamic scoring forecast a smaller revenue increase due to impacts on GDP, wages, FTEs.
[5] This static analysis assumes no changes in company-level tax management, unchanged valuation multiples and ignores other tax law changes being proposed. The impact would be greater on higher p/e stocks and lower on value stocks.
[6] In 2021, a ten-year note paid less than 1%.
[7] The Bloomberg Commodities Index represents 24 commodities across six sectors.
[8] In the equities space, I would expect energy companies to fare well, even in the face of lower prices, due to expanded opportunities, reduced regulation and increased production.
[9] In the equities space, higher prices would likely be more than offset by “green energy” policies, creating an unfavorable environment for traditional energy companies.
[10] This is seen as supportive of American manufacturers.
[11] For those who have never traded BTC, no price level represents a barrier to entry as the whole game is one of fractional BTC. Anyone can invest $20 anytime, the difference being what portion of one BTC you then own.
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