Today, I want to talk about how the looming Presidential election might impact small cap stocks, which are my area of expertise. But first, I have a quick anecdote about my experience with politics when I was young.
No Politics at the Dinner Table
We never talked about politics at the dinner table when I was growing up. My dad’s reasoning (which my mom shared) was that political discussions are almost always divisive. He said the point of family dinners was to enjoy the moments when everyone was together. His philosophy extended to gatherings with friends and co-workers for essentially the same reasons.
I know it wasn’t for lack of interest or passionate political views. Time spent watching the evening news and reading the paper was evidence enough that his mind was always engaged in the issues of the day. So while I do know the personality traits that led him to like and trust certain people more than others, I don’t know his voting record.
It was a good call on his part. There were plenty of issues beyond politics to debate with my parents growing up. And not having to factor in political bias eliminated any concern that their advice on college, friends, travel and other important matters wasn’t influenced by pre-existing party affiliations (as I know it was for some of my friends).
Stocks that React Favorably to Trump or Clinton
This year’s election is about as divisive as they come. Sunday night’s debate was uncomfortable to watch at times. My sense is that most Trump supporters can’t possibly imagine why anybody in their right mind would vote for Hillary. And Hillary supporters can’t fathom why any sane person would cast a vote for Trump.
With so much space between the respective sides of the table, it’s relevant to wonder what’s going to happen to the stock market in November.
There is some evidence to suggest that stocks do better when there’s a Democrat in the Oval Office. But depending on how you slice the data, that potential advantage can be reduced or even eliminated.
What we do know is that volatility, as measured by the Volatility Index (VIX), tends to spike when there’s a leadership change in the White House. In contrast, volatility has been much lower when the incumbent President remains in office.
That said, it’s not clear what causes the increase in the VIX. Is it the fact that there will be a different President or that the Presidential party will change? Since the last three elections resulting in a new President also included a change in Party Leadership (Bush to Clinton, Clinton to Bush, Bush to Obama), we don’t know the answer. And there could be other economic factors in play too. In 1992, there was considerable economic uncertainty under George H. W. Bush, and Ross Perot jumped back into the race in October. In 2000, the Tech Bubble had just burst. And in 2008, we were in the midst of the financial crisis.
In any event, what we do know is that Obama will be handing the keys to somebody in November, and that there is considerable global economic and political uncertainty right now. So the pragmatist in me thinks it’s fair to assume we’ll see volatility increase, at least for a few months.
But volatility doesn’t last forever, and it can work to the advantage of informed investors. Stocks have survived all Presidential leadership changes to date. So what stocks should we buy if Trump wins? And what should we buy if Hillary wins?
So far it looks like health care and financial stocks react better to increases in Trump’s popularity. That could be because he’s viewed as being lighter than Clinton from a regulatory perspective. Generally speaking, investors might want to increase exposure to pharmaceutical, biotech and health care equipment and services stocks if it looks like Trump will win.
On the other hand, it looks like consumer discretionary and industrial stocks favor Clinton. Credit Suisse analysts think that’s because Trump’s stance on trade is leading to a lot of uncertainty. Many of these stocks have a high mix of international revenue. So they could have some obstacles to overcome if Trump wins and he follows through on promises to be tougher on trade deals. In particular, stocks with exposure to Mexico and Canada tend to suffer when Clinton falls in the polls and Trump rises.
One Stock to Buy Now
So where does this leave us? Are there any stocks that could do well regardless of who wins? I think so. Technology stocks are looking great. And it should come as no surprise that I like small cap stocks.
Small cap stocks have two potential advantages relative to large caps during this election year. First, they tend to have lower international exposure, so they should be less impacted regardless of who’s in the White House. And second, their valuation is less expensive than large caps. Both of those factors suggest that small cap stocks will post relative outperformance over the coming year. And given the strength in technology, it makes sense to me to focus on small-cap tech stocks.
There is one in particular that looks good to me right now. It’s a small-cap tech stock that sells software to regional banks, community banks and credit unions, all of which are expected to enjoy a better environment under either Trump or Clinton. And with interest rates likely to go up, banks should be able to generate greater profits, which can be invested back into critical software they need to compete in the digital banking age.
This is what I wrote about the stock to Cabot Small-Cap Confidential subscribers:
“While regional community banks and financial institutions (RCFIs) still offer the best person-to-person service, the harsh reality is that they need to modernize their technologies in order to compete in the global virtual banking market. Many of their systems are old and clunky. They aren’t particularly secure. And the patchwork of solutions from different vendors offers a user experience that’s about as smooth as a cobblestone road.
“This company has developed a virtual banking platform that supports dozens of different products. It lets account holders move securely and effortlessly between the digital and brick-and-mortar locations of their community bank or credit unions. Its platform was purpose-built to deliver a secure and consistent user experience across online, mobile, tablet, text and voice channels. And it can replace almost all of the disparate software solutions that many RCFIs are currently struggling to maintain.
“The company makes money from every one of the solutions it sells. It also makes money each time a transaction is performed on one of its solutions. Most importantly, it’s growing like a weed.”
This company is exactly what I look for in every Cabot Small-Cap Confidential stock: rapid growth from unique products that meet a large and growing market demand. Annual revenue growth has been 38% or higher in each of the last three years. And I don’t think future growth will be derailed, regardless of whether Hillary or Trump wins the election!
Shares have been in a consolidation pattern right above at their 50-day moving average since late August. And I’ve been telling subscribers it’s one of my top small cap stock picks to buy now. You should consider it too.