The Politics of Stocks, Part 1: Introduction

Join Oak Harvest CIO Chris Perras as he begins Part One of a new series, “The Politics of Stocks.” Chris dives into the components of stock returns and the impacts of politics on markets here on the February 15th, 2019 edition of Oak Harvest’s Stock Talk: Keeping You Connected to Your Money!

Chris Perras: This is Chris Perras, Chief Investment Officer at Oak Harvest Financial Group, with a February 15th edition of Keeping You Connected to Your Money. Each week, we try to recap the prior week’s events, share with you our views and thoughts on what’s in store for the market in the weeks and months ahead. Additionally, we try to educate you a little bit along the way. This edition and the next four are going to be of the educational variety. I’m going to title them, The Politics of Stocks. This is the introduction to the politics of stocks.

This week, we had a client come in and ask us, what is the impact of stocks by politics? What’s going on in Washington, the policies, the behaviors? It’s a great question. I’m going to cover it in the next five calls. Much of this material is going to be on our website. You can go to our website at oakharvestfg.com. It would be under the heading of investment management. You can look for that tab on our website at oakharvestfg.com. Look for the investment management tab, then look for the ideas and insights subtab. When you go down to that subtab, look for the lessons from the market. Almost all of this material that I will be talking about over the next three weeks is going to be on our website in that location.

To answer the question about how do politics affect stocks, we first have to answer the question of what drives stock market returns over time. Are the returns random, or are they rational? Is the behavior of stocks just totally a casino, or is there actually rational behavior over time that drives stock prices?

Academic research is pretty consistent across the board on this, and that over time, stocks are very efficient in assimilating all known information into the prices. That’s the efficient market theory that a lot of you have heard about. It doesn’t mean that all that information is correct, but it means that it is assimilated into the price of the stock.

Over time, there are three components of equity market returns, and all of this is on the website. Go look for it when you get a chance at oakharvestfg.com. The first component of equity market returns is a company’s growth in its earnings and free cash flow. That’s number one. That’s the most important.

Number two is the change in the valuation you pay for those earnings and that cash flow over time. That’s better known as a PE ratio. So that’s the second component of PE ratio.

The third component of return over time is the dividend yield. Now 90% of the time, the dividend yield is the cash that company gives a shareholders reward for that ride they take with the management team investing in the company or giving you and returning money. The third component of a return of a stock is its dividend yield.

If politics change any three of these components, they’ll affect stock prices. They can affect them both positively and negatively. Most of the times, politicians only affect portions of the stock market. They affect regulations on certain industries. They affect taxes on certain industries, tariffs, what’s going on right now in China, certain industries. The steel industry is having a lot of tariffs placed on it. That’s a very small portion of the US economy. Seventy-three percent of the US economy is service. The tariffs that are going on in China aren’t affecting the service economy here domestically.

What is more important than the politics and the politicians in Washington DC is really what’s going to be– I’m going to talk about it on part five, and that’s the Federal Reserve and their policies. They are probably 80% to 90% of what determines stock prices, because they provide the liquidity to the markets. They’re the ones who are out there determining policies that companies have ability to access capital markets. They control how much money is in the economy, whether it’s getting easier to borrow money or getting more difficult.

Even in times, like last year, you saw tax policies by Trump that were very, very beneficial to most companies in the publicly traded stock market at lower tax rates, shareholders rewarded. The stock market has a couple of great runs in 2018 because of the political policies that were pushed through in the prior year and 2017. Those policies flowed into the stock market. The issue was this all during 2018, the Federal Reserve was seeing that euphoria build up and that additional capital investment that was going to start because of those tax cuts.

The Federal Reserve, in order to combat inflation, was raising interest rates all year. The Federal Reserve was negating everything that was going on that was positive. From a tax perspective that Washington DC had done in 2017 and ’18, the Federal Reserve was taking the punchbowl away as people were trying to drink from that. That’s really the first lesson. It’s an intro to how politics affect the stock market.

Stock market returns are really three components. They are a company’s growth in earnings and cash flow, the change in valuation you pay for that earnings and free cash flow, and the dividend yield of a stock.

In the next three segments, we’re going to delve down into each one of those components, and how Washington DC and politics can affect those components, or how the Federal Reserve can affect those components as well.

Once again, this is Chris Perras, Oak Harvest Financial Group, Keeping You Connected to Your Money. If you want to know more about Oak Harvest, please contact us. Feel free to reach out to us by phone or go to our website. Reach out. We’re here to talk to you about your investments, here to talk about financial planning, here to educate you, and help you in any way possible. Many blessings.

Voice-over: Content contained within this Oak Harvest podcast is for informational purposes only, and is based upon information current as of the time of recording. It should not be considered an offer or solicitation to buy or sell securities, nor is it tax or legal advice. Investments involve risk. Unless otherwise stated, particular investment returns are not guaranteed.