Excerpted from the most recent issue of George Putnam’s The Turnaround Letter, published by New Generation Research
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The 2016 presidential election is (finally!) just around the corner. Plenty of ink, electrons and hot air have been expended describing the candidates and their issues. Leaving the political commentary to others, what might we expect for the stock market after the election?
According to Stock Trader’s Almanac, next year might be rather dull: Since 1833, the Dow Jones Industrial Average has historically had its weakest year (+2.5% on average) in the first year of the four-year election cycle. S&P Capital IQ’s more recent time period (1945-2015) for their index suggests a more encouraging 7.6% return next year. If we just look at the last two post-election years (2009 and 2013) we should be exuberant: the S&P 500 return averaged 29.5%. (But of course, 2009’s 26% gain followed the 37% loss in 2008.)
From a purely historical perspective, investors would want to favor Hillary Clinton: Since 1900, when the Democratic Party wins an election the Dow Jones Industrial Average produces a 9.0% average annual return compared to a 6.0% average under Republicans. Since 2001, the choice would be stark: under Democrat Obama, the stock market’s average annual return has been 14.4%, while under Republican Bush the return has averaged -1.3% (though this is again skewed by the big losses in 2008 under Bush and big gains in 2009 under Obama). Returns under Democrat Bill Clinton were even better, averaging 18.2% during his eight-year term in office from 1993-2000.
While fascinating, these historical results unfortunately offer no real value in setting an investment strategy. Economic events, starting-year valuations and even commodity prices can overwhelm the impact of one political party over another.
How about campaign promises? Does it make sense to pick or avoid industries based on the agendas that the winning candidate had whole-heartedly embraced? Here, too, that is probably not a wise strategy. The distance from a campaign promise to a company’s earnings and cash flow can be vast. The promise may have been (no surprise?) insincere, or could be set aside to make room for more urgent matters. Perhaps Congress scuttles or waters down the legislation. Or, even if the promise is fulfilled, it may already be priced into stock prices. As a result, the fulfillment of a campaign promise can even have the opposite effect on stock prices from what investors expected. Healthcare stocks, for example, were supposed to be hurt by ObamaCare, yet this group has been one of the best-performing industries in the market over the last few years.
A common temptation is to mix emotions with investing. Your candidate won, and so you are more optimistic–or your candidate lost, and now you’re more pessimistic. Stocks don’t know who you voted for. Avoiding emotionally-driven post-election buying and selling will be beneficial to your financial health. For more intrepid investors, it can be profitable to take advantage of other investors’ emotions. If shares of good companies are aggressively sold off because of political fears, they could make for a smart contrarian investment.
One such group is the pharmaceutical/biotech industry. Companies in this group are under pressure because investors expect a Clinton administration would go after high-priced drugs. Increased price regulation would hurt pharmaceutical/biotech companies by cutting into their current profits and by impairing their ability to fund future research. At the risk of sounding like the TV ads for their drugs, we’ll list some other threats that these stocks might face: aggressive competition, FDA approval delays or failures, merger integration difficulties and production quality problems.
Nonetheless, we believe that most of these risks–including the Clinton risk–are already priced into the stocks at current levels. Therefore, if any of these concerns prove to be unfounded or overblown, these stocks could rise smartly. The two stocks discussed below, along with three others detailed in my most recent value investing newsletter, appear to have been oversold based on election-related fears:
Allergan (AGN) – With nearly $15 billion in revenues, Allergan produces the widely recognized Botox skin treatment, as well as other patented and generic pharmaceuticals. In a busy 2015, U.S.-based Allergan was acquired by Ireland-based Actavis which was renamed Allergan, and then it agreed to merge with Pfizer, only to have that deal later terminated. Currently Allergan has one of the industry’s most robust pipelines with over 70 mid-to-late stage new drug programs in development. Operating margins are over 50%. While clearly focused on growth, its capable management emphasizes effective use of its capital, including a sizeable stock repurchase program. Allergan shares have declined over 35% from their 2015 peak. At 12.8x estimated 2017 earnings, this high-quality growth company appears to be a bargain.
Bristol-Myers Squibb (BMY) – This biopharmaceutical company focuses on creating treatments for diseases such as cancer, cardiovascular disease, hepatitis and HIV/AIDS. Bristol-Myers shares have fallen sharply recently, down over 30% since early August, largely caused by the failure of a lung cancer trial. Despite this, the company reported a surprisingly good second quarter, and so the future may not be nearly as dire as the market expects. While the P/E appears high, it is well-below its longer term average and just above the S&P 500’s current multiple. These low expectations, plus a 3% yield, make Bristol-Myers shares worth a closer look.