Article
Elections and Fed rate cuts: the perfect recipe?
24 October 2024
Welcome to Uncommon Truths, Paul Jackson and Andras Vig’s regular in-depth look at the big topics impacting markets.
US assets have tended to perform better in the year after an election than in the year before (based on data since 1988). That could be good news if the pattern is repeated this time.
However, the same is not true for Fed rate cuts, with performance tending to be better in the 12 months before the first rate cut than after (perhaps because the rate cuts usually occur when the economy is struggling).
Each cycle is different. Could the mid-1990s be a template for now? The Fed started easing in July 1995 from rates similar to the recent peak; the economy didn’t experience recession (and hasn’t so far) and the election was on 5 November 1996 (the same date as this year but not coincident with Fed easing). But growth is not as strong as then, equity valuations (and concentration) are much higher and government finances are far weaker.
Some have suggested that recent market strength reflects a belief that Donald Trump will be the next president but Paul is not convinced. He feels the election is wide open and doubts that restricting trade, deepening fiscal deficits and undermining Fed independence will benefit US assets or the dollar. He remains Underweight US equities within his Model Asset Allocation and prefers equally weighted approaches to US stocks.
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FAQs
The optimal portfolios are theoretical and not real. We use optimisation processes to guide our allocations around “neutral” and within prescribed policy ranges based on our estimations of expected returns and using historical covariance information. This guides the allocation to global asset groups (equities, government bonds etc.), which is the most important level of decision. For Uncommon Truths, the optimal portfolios are constructed with a one-year horizon.
We’ve chosen to include equities, bonds (government, corporate investment grade and corporate high-yield), real estate investment trusts (REITs, to represent real estate), commodities and cash, on a global level. We use cross-asset correlations to decide which decisions are the most important.
Using a covariance matrix, based on monthly local currency total returns for the last five years, we run an optimisation process that maximises the Sharpe Ratio. Another version maximises Return subject to volatility not exceeding that of our Neutral Portfolio. The optimiser is based on the Markowitz model.
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