Will Drama in DC Ruin Your Retirement Savings?

The past weeks and months have been rife with political drama here in the nation’s capital, which has left many of our clients feeling unsettled about the future – in particular, about their own financial future.  They worry whether political uncertainty might negatively impact the stock market.  However, while it is certainly true that political events can cause significant market declines in the short-term, that is not what dictates the direction of the market over the medium- to long-term.

Stock Prices Reflect the Expected Performance of Companies, Not Political Figures.  The stock market moves based on changes in the stock price of individual companies.  While sudden political shocks may impact how these prices move over the course of a few days, over the longer-term, stock prices are dictated by the expected earnings of companies.  As Michael Santoli of CNBC observed last week, “Financial markets don’t routinely reprice according to shifts in the public mood or the relative effectiveness of leaders, they work to discount future corporate cash flows and interest rates.”  For most companies, political drama is not relevant in terms of its impact on long-run earnings.

By contrast, policy changes that affect the macroeconomy or that affect a company’s industry directly may influence a company’s long-run earnings, but again, the impact may be less than the financial media would lead you to believe.  Why?  Because companies are comprised of dynamic people, who will not take policy changes as a given but will react and adjust so that their company can continue to be profitable in the new policy environment.  Granted, not all companies will adjust effectively, but that is why we advocate holding a well-diversified investment portfolio.  If one company fails to adjust or is disproportionately hurt by a policy change, another company will likely step in to benefit from its demise.  Thus, e.g., if you own mutual funds that hold stock in all public U.S. companies, you will likely hold stock in the winner as well as the loser and will not be significantly affected by the change.

Volatility in Politics Does Not Translate into Volatility in the Market.  Although political drama continues to pepper the news, the stock market is hitting record highs and interestingly, has experienced unusually low levels of volatility this year.  A key indicator of volatility, the Chicago Board Options Exchange’s implied volatility index – otherwise known as Wall Street’s “fear gauge” – declined this week to its lowest level in over a decade.  It has averaged well below historic norms over the past year, despite an eventful year in politics, domestically and internationally.

As we regularly counsel our clients, try to tune out any apocalyptic messages propagated by the financial media about how current events may impact your portfolio.  Based on its performance over the last 90 years, we have faith in the market and the ability of those leading public companies to react and adjust to changes in politics and policy.