What Washington Politics Mean for Investors

As the Middle East crisis escalates, there’s a brewing political storm in Washington. Notably, the Congressional House speaker’s position remains vacant following the exits of Kevin McCarthy and Steve Scalise. Upcoming Republican and House votes are scheduled to fill this leadership gap, but a cloud of political challenges hovers. For investors already navigating rising interest rates, Federal Reserve uncertainties, and stock market fluctuations, this political landscape adds to their complex tapestry. So, how can these investors stay focused amid these evolving dynamics?

The Impending Debt and Its Implications for Investors

The projected interest payments on the federal debt are set to surpass historical peaks, calling for a time of introspection. When it comes to financial planning and investing, it’s essential to separate political beliefs from investment decisions. As citizens, voters, and taxpayers, we express our political convictions through voting, campaigning, and community organizing – the mainstays of a thriving democracy. However, the impact of Washington politics on the stock market is often unpredictable. History substantiates that markets can flourish under varying political climates and leadership structures across the White House and Congress.

Investors should be aware that news headlines about Washington’s ongoing conflicts could magnify market uncertainty and heighten concerns. The government needs to agree on a new budget soon. Congress must pass a new spending plan annually to be signed into law by September 30th, marking the government’s fiscal year-end. This year’s budget negotiations resulted in a 45-day funding bill, essentially delaying the inevitable. The ticking clock amplifies the uncertainty of meeting a mid-November deadline without leadership and consensus in the House.

The Debt Ceiling Suspension Deal: A Temporary Solution?

A more urgent issue is the debt ceiling suspension deal struck earlier this year, which merely postponed the problem until January 2025. While budget establishment is critical for maintaining government services, not raising the debt ceiling could be catastrophic, risking a potential government default. Despite the U.S. never defaulting on its debt obligations, the procrastination in these negotiations is worrisome. A default on Treasury securities, though not the most likely scenario, would send shockwaves through the market and economy in unprecedented ways.
The national debt’s size is a mutual concern for investors and everyday citizens. With the debt exceeding the previous ceiling level of $31.4 trillion or 119% of GDP, this complex issue requires a thorough examination. It involves political preferences over spending and taxation, entitlement programs like Social Security, Medicare, and Medicaid, emergency spending programs like those enacted during the pandemic, among others. It’s worth noting that a more accurate measure of the national debt, known as “net debt,” excludes what the government owes itself. This measure has reached 94% of GDP.
Federal Interest Payments
This chart shows the level of interest payments that the federal government pays on the national debt each year. You can clearly see that it has risen in recent years, both because the national debt has grown and also because interest rates have risen.

The Rise in Interest Payments: A Cause for Concern?

The surge in interest payments is not solely due to accumulated debts but also due to interest rates reaching levels unseen since 2007. Interest payments have burgeoned in recent years to $476 billion in 2022, a record high. As a percentage of GDP, interest payments are still lower than in the 1980s and 1990s when interest rates were much higher. However, research by the Congressional Budget Office projects these interest payments could skyrocket above $1.4 trillion, or 3.7% of GDP, in ten years.
Unfortunately, there are no easy fixes to this issue, especially as fiscal discipline has been overlooked in Washington for some time. Despite the escalating debt level, the stock market has performed impressively throughout many of these periods. Reacting to news on the national debt could have caused investors to miss significant market upturns, such as the bull market beginning in 2009 and the strong rally that started in mid-2020.
While politics matter in many ways, investors should keep a balanced perspective when making investment decisions. In the coming months, it will be more critical than ever not to be swayed by Washington headlines. This introspective approach will prompt investors to question their beliefs and biases, especially when confronted with societal pressures.
Political Parties and Stock
History shows that the stock market can perform well in a variety of different environments, regardless of who controls the White House and Congress. Investors who made portfolio decisions based on politics over the past few cycles would have missed out on strong returns.

Disclaimer: This blog post is not intended to trivialize the humanitarian impact of the conflict but aims to address the financial concerns that investors may have in light of recent events.

The content on this site, provided by Able Wealth Management, is purely informational. While we aim for accuracy and completeness, we cannot guarantee the exactness of the information presented. The views and analyses expressed in this blog represent those of the authors at Able Wealth Management. They should not be considered as investment advice or endorsement of any particular financial instrument or strategy. Any references to specific securities and their performance are purely informational and should not be taken as advice to buy or sell.Before implementing any information or ideas presented, we strongly advise consulting with a financial advisor, accountant, or legal counsel. Investing carries inherent risks, including potential capital loss. Asset values can fluctuate over time and may be worth more or less than the original investment. Past performance does not guarantee future results, and Able Wealth Management cannot ensure that your financial goals will be achieved. Information from third-party sources has not been independently verified by Able Wealth Management. Although we trust these sources, we cannot assure their accuracy or completeness.

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Volatility Drag

Volatility drag, often unnoticed by many investors, plays a significant role in the performance of investment portfolios, especially in markets characterized by high volatility. Understanding volatility drag is crucial for making informed investment decisions and managing long-term investment performance.

Understanding Volatility Drag

Volatility drag refers to the negative effect of investment volatility on compound returns over time. It occurs because losses have a more significant impact on portfolio value than gains of the same magnitude. For example, if an investment loses 10% one year and gains 10% the next, the investment will not return to its starting value due to the mathematical asymmetry between gains and losses. This phenomenon underscores the importance of minimizing large fluctuations in investment value to protect long-term returns.

The Mathematics Behind Volatility Drag

The mathematical principle underlying volatility drag is relatively straightforward but profound in its implications for investors. The key concept is that percentage gains and losses are not symmetrical. A 50% loss requires a 100% gain to break even, not a 50% gain. This asymmetry means that volatility (up and down movements in price) can erode the compound growth rate of an investment, even if the arithmetic mean of the returns seems healthy.

Example of Volatility Drag

Consider an investment with the following annual returns: +20%, -15%, +10%, and -5%. While the arithmetic mean of these returns might suggest a modest positive performance, the compound annual growth rate (CAGR) would tell a different story, factoring in the volatility drag and showing a lower effective return than the arithmetic mean would suggest.

Implications for Investors

  • Risk Management: Understanding volatility drag emphasizes the importance of risk management strategies, such as diversification and the use of derivatives for hedging, to minimize significant downturns in portfolio value.
  • Investment Strategy: Investors might consider investment strategies that aim for steady, consistent returns over those with potentially higher but more volatile returns. Such strategies might include investing in low-volatility stocks, index funds, or using dollar-cost averaging to mitigate the impact of market fluctuations.
  • Psychological Aspects: Volatility drag also highlights the psychological challenge for investors who may overreact to short-term market movements. A long-term perspective is crucial for successful investing, as frequent trading in response to volatility can exacerbate the drag on returns.
  • Performance Evaluation: When assessing investment performance, considering both the arithmetic mean return and the compound annual growth rate (CAGR) can provide a more comprehensive view of an investment’s performance, factoring in the effect of volatility.

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