“A plan is only useful if it can survive reality.  And a future filled with unknowns is everyone’s reality.”

– Morgan Housel

If the year 2020 could be described with one word, it should be “uncertainty.”  We continue to navigate through a global pandemic with profound economic implications, coupled with changes in our everyday way-of-life.  Stock market volatility returned late in the third quarter with large technology companies disproportionately rising and falling compared to the broad market.  Most recently, President Trump announced he and the First Lady tested positive for COVID-19, elevating the level of uncertainty regarding not only the election but also the running of the government prior to the election.  Other notable market events during the quarter included:

• The old investment adage “Sell in May and go away” did not prevail this summer, with the S&P 500 Index surging 13% during July and August. It was the index’s best August (+7%) in over 30 years.  While Large U.S. Stocks gave back some gains in September, the S&P 500 finished the quarter up almost 9%.
• The Federal Reserve (Fed) reinforced its ultra-low interest rate mandate, vowing to keep rates low for years and targeting two percent inflation over the long run. Inflation has been relatively low since the 2008 global financial crisis, so a consensus to allow inflation to drift higher is new and noteworthy.
• Efforts to secure additional U.S. government support for the economy and its workforce stalled as stimulus measures were contested in Congress. Hopes are dimming for any additional fiscal relief prior to the November election.
• Despite the ongoing pandemic, the combination of low housing supply, historically low mortgage rates, and high demand lifted prices for single family homes in many areas of the country.

Overall, third quarter returns for the major asset classes were positive:

Index	Asset Class	Third Quarter 2020	Year-To-Date 2020
Barclays U.S. Govt./Credit—Int.	Fixed Income	0.6%	5.9%
S&P 500	Large U.S. Stock	8.9%	5.6%
Russell 2000	Small U.S. Stock	4.9%	-8.7%
MSCI ACWI ex-USA	Foreign Stock	6.3%	-5.4%
S&P Global REIT	Real Estate Securities	2.4%	-19.2%

 

The Election and Your Portfolio

We are now about a month away from what may be the most controversial presidential election of our lifetimes.  Emotions are particularly elevated, given the polarizing media, social unrest in many cities, the pervasive influence of social media in our day-to-day lives, and heightened stress related to the COVID-19 pandemic and its economic fallout.  It seems that every four years the same questions come rushing back into investors’ heads — “Should I sell now and wait until the dust settles?”  “If (insert candidate’s name) wins, should I change my investment strategy?”

While current polls and betting markets show former Vice President Joe Biden ahead of President Trump, the unknown impact of an unprecedented number of mail-in ballots may result in a delay of days, if not weeks, for a final determination of the winner.  Many of us remember the closely contested 2000 presidential election between former Vice President Al Gore and President George W. Bush, in which the outcome was decided by the United States Supreme Court a month after the election.  Adding to the complexity of this year’s election is the vacant Supreme Court seat left by the passing of Justice Ruth Bader Ginsburg.  President Trump has exercised his authority to nominate a replacement Supreme Court Justice and is encouraging an expeditious confirmation process by the Republican-led Senate prior to the November 3rd election.  One thing is for certain:  The next president will have a daunting task — managing the country’s recovery following a global pandemic that caused unemployment to rise to levels not seen since the Great Depression and slowed the economy to a crawl.

What does this all mean for your investment portfolio?  Given the relative stability of our economic system, U.S. history has shown there is not a “preferred” political party for the overall stock market.  In other words, there is not consistent evidence that a Republican or Democratic president leads to higher stock market returns.  Furthermore, when we examine historical eras when a president’s own political party simultaneously holds control of Congress (the House of Representatives and the Senate), the data becomes even murkier.  Assuming our underlying economic structures remain substantially consistent, making emotional investment decisions based on political preferences could impact your financial life far longer than a president’s time in office.

The economy and stock market do not move in lockstep, as witnessed this year (the broad stock market has recovered nearly all its pandemic losses, but many small businesses and workers continue to suffer).  It may be surprising, but every U.S. president since 1929 has presided over a stock market correction (defined as a 10% or more drop in equity prices from previous highs), and most presidents experienced more severe bear markets (defined as a 20% or more drop in equity prices from previous highs).  In fact, every president since 1929 has experienced at least a market correction in every one of their presidential terms, except for former President Bill Clinton, who had a close call to a correction (-8.9%) in his first term in office, followed by a near bear market (-19.3%) downturn during his second term.

When a president comes into office, the prevailing economic and market environments undoubtedly alter a president’s legacy (or lack thereof).  Economic and market metrics — interest rates, stock market valuations, unemployment, tax rates, inflation, and economic growth — are always different.  By design, the president has very little direct control over the Fed and monetary policy.  When looking back through history, the Fed may have an even more important role in long-term economic conditions than the president.  The upcoming election is bound to generate some volatility, but it is not something that can be “traded” ahead of time without taking substantial risk of getting it wrong.  A study by Vanguard showed that from January 1, 1964 to December 31, 2019, the volatility of the S&P 500 Index was 13.8% in the 100 days before and after a presidential election.  This was lower than the 15.7% annualized volatility for the full 56-year time period.

Potential Estate and Tax Planning Implications

Although we believe it is risky to make investment decisions based purely on the outcome of the election, a change of administration could significantly impact tax and estate planning   strategies.  If former Vice President Joe Biden prevails and the Democratic Party gains control of Congress, there may be a limited window of time around year-end for some individuals and families to mitigate the impact of a presumably more progressive income and estate tax regime.

Key income tax provisions from the Biden campaign include:

• Raising the top marginal income tax rate back to 39.6% (currently at 37%),
• Increasing the corporate income tax rate to 28% (currently at 21%),
• Adding an additional 12.4% payroll tax to earnings above $400,000,
• Taxing capital gains and dividends at ordinary income tax rates for those with annual incomes of more than $1 million, and
• Imposing a 15% minimum tax on corporations with “book income” of $100 million or more, a move that would limit large companies’ use of certain tax breaks.

President Trump, on the other hand, has not disclosed his proposed tax policy for a second term but has made numerous comments indicating a push for additional tax cuts if re-elected.  It is also widely expected that the Tax Cuts and Jobs Act, scheduled to expire in 2025, would be made permanent.

In addition to potential changes in income tax rates, estate taxes and exemptions could be altered significantly under Democratic leadership.  The current lifetime gift and estate tax exemption amounts are $11.6 million per person ($23.2 million per married couple).  Estates exceeding the federal exemption amount may be subject to 40% tax.  The current exemption amounts were established under the Tax Cuts and Jobs Act passed in 2017 and are scheduled to revert to half the current exemption amounts at the end of 2025.  Any changes in legislation reducing or redacting the exemption amounts could prompt some high net worth individuals and families to accelerate gifting to heirs.

Whatever happens to income and estate tax policy, we will be prepared to discuss and plan around the potential impact on your specific financial situation.

Year-End Planning

As we enter the final months of 2020, we would like to remind you of some potential tax saving strategies to consider.  For those who are charitably inclined, appreciated stocks may be prime candidates for gifting.  Subject to IRS rules and limitations, a security held for more than one year and one day can be gifted to a public charity while the donor may receive a tax deduction.  The amount that can be claimed as a charitable deduction for federal income tax purposes is the fair market value of the security on the date of the gift.  For the donor, gifting an appreciated security  is oftentimes superior to giving cash since the gift of appreciated assets results in a tax deduction and no capital gains tax is paid on the appreciation of the gifted security. For 2020, cash gifts can also take advantage of a temporary 100% of Adjusted Gross Income (AGI) deduction limitation put in place by the CARES Act.  In addition, those who are over age 70½ may consider making a Qualified Charitable Distribution (QCD) from traditional IRA accounts.  The gifted portion up to $100,000 is excluded from taxable income and QCDs can be made in 2020, even though Required Minimum Distributions (RMD) have been waived for this year.

In addition to the ongoing strategies we employ in managing investment portfolios, our financial planning process also heavily emphasizes tax efficiency.  Our financial planning strategies include Roth conversions, bunching/timing charitable contributions using donor‐advised funds, and other tax-saving portfolio distribution strategies.  We would be glad to discuss these strategies in the context of your specific situation.

We appreciate the trust our clients have placed in us to guide them through these very challenging times.  Although the fall season may feel a bit different this year, we hope you and your family enjoy the holidays.  We encourage you to call or e-mail anytime you would like to discuss your portfolio or your financial plan.