As the presidential election season heats up, I often find myself thinking, How could the outcome affect different areas of the market? You've probably asked yourself the same question at some point over the last few months, too.
Before you get the wrong idea, no, I'm not about to wade into politics. That's not my focus.
And I'm sure you'll be bombarded with political messages over the next few months. So I'll spare you my personal thoughts.
But as investors, we have to stay on top of how different administrations could influence the stock market. With that in mind, I will share one election prediction with you.
There's one sector that I believe will trade sharply higher during the next administration regardless of who wins in November.
Last November I issued my annual investment forecast for the coming year, which I said at the time was sure to be full of wild cards. But as I explained, increased U.S. military spending was all but guaranteed, given the ongoing war in Ukraine and the then-recent conflict in Israel.
Yes, disagreement over how much spending was appropriate nearly led to a government shutdown last year. But it seemed unlikely that the U.S. would meaningfully reduce its defense budget with two ongoing conflicts requiring the country's military support.
Now roughly nine months after my annual investment forecast, does the presidential election change anything? In a word, no; all signs point to even more spending on defense. Allow me to explain...
Investors typically view the Republican Party as more favorable toward defense spending.
That's because conservative politicians are usually more outspoken on topics like border security, national defense and military assistance for our allies.
But these views have blurred over the past few years. Under the Biden administration, our military resources have been used excessively. In supporting both Ukraine and Israel, the U.S. has supplied munitions and defense systems to the tune of tens of billions of dollars. And the more resources we send overseas, the more that needs to be replenished back here in the United States.
Meanwhile, the political sphere is a minefield elsewhere in the globe, including a possible need to defend Taiwan against China or escalating violence in the Middle East. So if Kamala Harris has a shot at winning the presidency or even taking over Biden's position ahead of the election we can only assume that her policies will follow Biden's.
In other words, it means sending billions of dollars in military support overseas and then spending billions more at home to bolster our own resources. This strategy is certainly good for defense contractors and paints an optimistic picture for investors in this area.
But would a Trump presidency or Republican sweep of Congress lead to a different outcome?
Trump pointed out that there were no new wars during his presidency and has proposed to negotiate a quick end to the Russia-Ukraine war if elected.
You might think that the end to this war would lead to less military spending and be a negative for defense contractor stocks. But the truth is that Trump (and other Republicans, for that matter) tend to lean toward the classic Roosevelt ideal of "speak softly and carry a big stick."
While political and economic negotiations may keep the U.S. out of a hot war under a Trump administration, peace through power would still continue to drive military spending. So for the foreseeable future, military spending is likely to be robust, regardless of who wins the next presidential election.
What about the overall economic picture heading into the election? Next month, the Federal Reserve is finally expected to start cutting interest rates. In anticipation, yields on everything from savings accounts to Treasury bonds are starting to slide.
For income-focused investors like myself, this presents an obvious challenge. And I've gotten questions from readers, friends and family about what to expect.
But as I’ll explain in a moment, this seasonal change actually creates an opportunity in one of my favorite areas of the market dividend stocks.
Let’s start with the problem at hand. When interest rates fall, the yields on “safe” investments like money market funds, CDs and government bonds tend to follow suit. For example, let’s say you have $100,000 parked in a money market fund yielding 5%. That’s $5,000 in annual income. Not too shabby.
But what happens when rates drop and that yield falls to 3%? Suddenly, your annual income has shrunk to $3,000. That’s a 40% pay cut!
This is the predicament many income investors find themselves in during a falling rate environment. The steady stream of income they’ve come to rely on starts to dry up. This is the harsh reality that many income-seekers are about to face. But that's when dividend stocks really start to shine.
Unlike the roller coaster ride of interest rates, dividends from strong companies tend to be remarkably stable - and often grow over time.
Many quality dividend stocks have solid track records of steady, growing payouts. It’s like having a raise built into your investment. These stocks tend to hold their long-term value in any interest rate environment, assuming their underlying business remains healthy. And lower interest rates can act as an additional tailwind for these companies.
For one thing, falling rates will lower borrowing costs, which should help stabilize profit margins and free up more cash flow for dividends. Management teams that prudently hoarded cash during uncertain times may decide to reward shareholders with higher payouts once the coast is clear.
Better yet, as interest rates fall and yields on “safe” investments like bonds and money market funds shrink, yield-hungry investors start looking elsewhere. Where do they turn? You guessed it dividend stocks.
This influx of investors can drive up the prices of dividend-paying stocks, leading to significant capital gains on top of your dividend income. It’s a double boon of returns that can really supercharge your portfolio. So what should you do as we head into this new season?
Consider shifting some of your assets to high-quality dividend stocks with strong fundamentals and histories of dividend growth. Above all, be patient. The true power of dividend investing is revealed over years and decades, not weeks or months.
It’s not about getting rich quick. It’s about building a steady, growing income stream that can support you through all kinds of market conditions.
As the Fed prepares to pivot and the income landscape shifts beneath our feet, dividend stocks are poised to shine. They offer a perfect combination of steady income, potential growth and a hedge against falling interest rates.
So don’t wait for the Fed to make its move. The time to position your portfolio for the coming low-rate environment is now.
The Daily Reckoning