The Threat Partisan Thinking Presents to Your Portfolio

Editors’ Note: Our political commentary is non-partisan by design. We favor no party nor any politician and assess political developments for their potential economic and market impact only.

Midterm elections are just nine months away, and, well, buckle up: The ongoing redistricting process is reducing the number of swing districts, which looks set to make this the shoutiest midterm campaign in recent memory. For investors, this is not great news. Not because it is inherently bad for stocks—it isn’t—but because politics has infected how people think about most everything these days, including economics and markets. Setting your political opinions aside is vital to seeing the market clearly—and it is risky as heck not to do so.

The new congressional maps are still rolling in, but it is increasingly apparent that competitive districts are going the way of the dodo. This isn’t surprising—where state legislatures control the process, the majority party has every incentive to protect incumbents. This is increasing the number of safe seats, converting those that merely “lean” Republican or Democratic to a hard advantage. For example, as Bloomberg highlighted this weekend, the Cook Political Report rates just 2 seats in Texas’ new House map as “toss-up” or “leaning” to either side, with 36 safe seats (12 Democratic, 24 Republican).^[i] This is a big change from 2020, when 12 seats were competitive and only 24 safe. (11 Democratic, 13 Republican—the state picked up two House seats this year based on 2020’s census.) The New York Times crunched all the numbers and concluded fewer than 40 House seats nationally will be competitive this year, down from 73 a decade ago.^[ii]

If your main goal is to stay sane during the campaign and vote for the candidate of your choosing, this isn’t great news. When candidates contest competitive seats, they tend to use more moderate rhetoric, aiming to gain the support of independents and centrists. Safe seats, by contrast, generate shouting. In both parties, incumbents in these seats risk primary challenges if they are too moderate. So to keep intraparty rivals at bay, they have to shout all the fringe talking points from the rooftops—playing to the party’s extreme wing.

If you have wondered why progressive rhetoric is getting so much louder from the Democrats—and why populist rhetoric is getting so much louder from Republicans—we think this goes some distance toward explaining it. A prime high-profile example, in our view, is Senate Majority Leader Chuck Schumer’s decision to push floor votes on progressive priorities that stand little to no chance of actually passing the evenly split chamber. In years past, the political incentives seemingly pointed him toward moderation and bipartisanship. But now, with a challenge from Rep. Alexandria Ocasio-Cortez potentially in the offing, his political survival could depend on tacking further left. There are plenty of similar examples within the Republican Party as well.

Add to the shouting the simple observation that every facet of life has become politicized—including economic and investing life. Inflation. Income growth. Unemployment. Interest rates. Supply chains. Corporate governance. Stock buybacks. How broker/dealers can execute their customers’ stock trades. All of that and more!

Illustrating this issue: The University of Michigan’s Consumer Sentiment Survey has long showed a partisan gap in economic expectations, and people’s viewpoints are increasingly detached from reality. When a Republican president is in office, survey respondents who identify as Republican have higher sentiment readings than Democrats and independents—their assessment of current conditions and expectations for the future are rosier. When a Democrat is in the White House, it flips—Democratic respondents see a much brighter future. Yet, an objective look at economic data and market returns shows conditions don’t flip when the Oval Office gets a new occupant—this is sheer bias at work. As the survey’s director, Professor Richard Curtin, noted last month: “Unfortunately, the size of the partisan divide in expectations has completely dominated rational assessments of ongoing economic trends. This situation is likely to encourage poor decisions by consumers and policy makers alike.”^[iii]

We think you could add “investors” to that last sentence. We have been in this business a long time and have heard many, many investors from one party worried stocks will tumble if the other takes power. It doesn’t matter which party—partisan investors just tend to think their party’s policies are the right prescription for what (in their view) ails the economy and the other party’s policies would just make things worse. The mentality afflicts both sides, creating a risk that people will make radical portfolio decisions that run counter to their investment goals. Those who don’t like the results could sell at the wrong time and miss what we think is likely to be a strong post-midterm rally. Those who love the results could overlook emerging negatives or take on too much risk with illiquid positions or leverage.

So prepare yourself now. When thinking about your investments, take your “voter” hat off and put on some noise-canceling headphones. Turn off the section of your brain that thinks in terms of sheer “good” and “bad” and think like markets do. Stocks don’t prefer either party, and they don’t care about politicians’ personalities. They simply weigh whether the actual risk of sweeping legislation is higher or lower than what everyone expected during the campaign. To us, these midterms look very likely to deliver gridlock, bringing legislation to a standstill. That will likely be a positive surprise to those who get caught up in the noise, which creates a lot of room for stocks to rally in relief as gridlock becomes more apparent. Maybe it even lets people see past partisanship in their estimation of the economic outlook.

Seeing markets clearly when politics adds noise and fog isn’t easy. It takes discipline and a concerted effort. But it is necessary if you want to stay on track to reach your long-term investment goals.