Well we don’t have to long to find out, the election is next Tuesday but with over 65 million Americans having already voted, early indications are that things are not looking good for Mr Trump! However, I seem to recall reading something similar 4 years ago and look how that turned out!
In this article from this morning’s Financial Adviser magazine, Ed Smith, Head of Asset Allocation Research at Rathbones makes some interesting points on what might happen whoever wins.
“Contrary to popular belief, elections rarely matter for financial markets.
Looking at 40 years of data, covering equities, the dollar, and bonds, we have found that presidential elections generate a little noise, but rarely any signals. Popular ideas such as ‘Democratic presidents being worse for investment returns’ do not stand up to scrutiny.
Even sectoral ramifications are often hard to identify. What were the two worst performing sectors during the Obama years? Financials and energy.
The worst under President Trump? Financials and energy. There were and are bigger forces at work, driving the underperformance of those assets, than the vagaries of politicians indulging in rhetorical flourishes.
Political polarisation means that the Republicans are now right-wing populists and the Democrats are touting more big government, even socialist policies. It is possible – though not certain – that it is different this time.
Preparing for what comes next
In mid-September, the betting markets re-evaluated the huge lead they had given Democratic presidential nominee Joe Biden during the summer.
What were the two worst performing sectors during the Obama years? Financials and energy. The worst under President Trump? Financials and energy
Nominally, Biden still had the edge, but, given the bookies’ track record, the odds suggested it was really too close to call.
We agreed with this. We do not pretend to be able to predict elections, but we do have the tools to help assess the spread of likely outcomes. “Prepare, don’t predict” is always a good mantra for investors regarding political matters.
Biden had a huge lead in the national polls, but not in key swing states, where in some cases he led by less than Hilary Clinton did this time four years ago.
Some political science models favoured Biden, but our own econometric model, suggested that Trump still had the edge if – and it is a big if – this election is a referendum on the state of the economy, which is what it usually comes down to.
But the betting markets have moved again. After the first debate and Trump’s Covid diagnosis, the odds present a greater probability of a Biden victory than ever: a 68 per cent chance.
The debate is a red herring: post-debate polling failed to predict Trump in 2016, Obama in 2012 and Bush in 2004.
We agree that Trump’s Covid diagnosis helps Biden, but not to the extent that the bookies suggest..
Analysis of myriad opinion surveys suggests that Biden’s chances are maximized if he keeps voter attention away from the economy and on the disease.
Trump’s economic track record is too strong (whether US economic strength had much to do with his policies or not is irrelevant).
Typically, more Americans approve of his handling of the economy than approve of him as their president.
But the US’s Covid second wave (and possibly now its third) impacted a disproportionate number of counties in swing states that Trump won last time.
Moreover, only 40 per cent of independent voters, who account for about 40 per cent of the electorate, approve of the way Trump has responded to the health crisis.
Fear of the unknown
Markets believe the worst outcome is no outcome at all.
November VIX futures – the price of volatility protection – are notably elevated, more so than usual for an election month.
A recent survey of 1377 institutional investors by Citi found that 45 per cent expect US equities to fall by more than 10 per cent if there’s no result by Thanksgiving (26 November), with another 30 per cent expecting markets to fall by a number in the 5-10 per cent.
Why are investors more fearful of this scenario than anything else? Some investors believe the hyperbolic articles which envisage Trump ordering the army to seize ballot papers, undermining the rule of law and democracy which have an important relationship with economic development and depth of capital markets.
But this may be a misguided fear. States run the election, not Washington, and the concession of the incumbent is not required for power to transition.
We think investors should be more fearful of a stimulus stalemate.
While the result is still contested, additional fiscal stimulus is unlikely to happen.
This would be risky even in the absence of any other bad news, but it could be very problematic if the economy or the virus took a turn for the worse during that time.
While a delayed stimulus increases the risk of harming the economy permanently, its long-term impact that will be minimal.
Moreover, while the fiscal backstop may be removed temporarily, the monetary backstop of very low interest rates and quantitative easing would remain operational, and supportive of stock markets and the economy.
A very long delay to the result is unlikely, but some judicial challenges could happen, delaying the result for a short period.
And while we don’t think it is a useful comparison, for reference, the S&P 500 fell by 4 per cent between election day 2000 and the 12 December, when the Supreme Court intervened to rule in Bush’s favour.
It underperformed the MSCI World Index by 0.8 per cent. But this decline coincided with the start of the dotcom market crash, so will not be a precise example of what may happen this time.
A Biden bounce
The second most adverse scenario for markets according to the Citi survey is a Democratic clean sweep – Biden in the White House, Democrats controlling both chambers in Congress. Some 23 per cent of respondents expect US equities to fall by more than 10 per cent, with another 25 per cent expecting a 5-10 per cent fall.
Of course, there are more investors who think Biden will win than there are those who think Trump will win. According to a Deutsche Bank poll from September, 40 per cent of investors thought Trump was either extremely or slightly likely to win, compared to 46 per cent for Biden.
The Citi poll gave similar results – 41 per cent versus 46 per cent - as did a Goldman Sachs poll. We expect this has risen in October, and so some of this risk will be in the price of financial assets already.
What is more, there has been no correlation between changes in Biden’s polling numbers and US equity market performance.
The first full week in October saw a big increase in Biden’s election odds/polling and a rising S&P 500 and Nasdaq.
Perhaps that is because past elections have had limited impact on the broad market.
Or because history is on the Democrat’s side in terms of the economy. Pre-eminent economists Nouriel Rubini and Alberto Alesina have shown that the Democrats tend to preside over faster growth, lower unemployment, and stronger stock markets than Republican presidents.
Recessions are almost invariably caused by imbalances built up by Republicans loosening regulations. Nothing destroys stock returns like a financial crisis.
But Biden’s agenda is more left-leaning than that of most Democratic presidents.
Perhaps the lack of correlation is because investors do not interpret Biden’s strengthening polling numbers as a proxy for the likelihood of the Democrats retaking the Senate.
It is easier for Biden to take the White House than it is for the Democrats to retake the Senate, due to the seats up for grabs this year (100 Senators serve six-year terms, with a third of seats up for election every two years). Assuming the Democrats lose Alabama (a very red state), they need to win back four other states.
However, Democratic challengers have started to poll increasingly well since early September.
Arizona and Colorado look highly likely to flip. North Carolina and Maine are leaning that way too, and it’s really close in Iowa and Montana. The election forecaster, ‘FiveThirtyEight’ believes the Democrats are “slightly favoured” to win the Senate, a significant change from mid-September when their simulations suggested it was too close to call.
Again, despite these large moves, US equity markets appeared unperturbed.
It is entirely possible, therefore, that the institutional investors surveyed are not representative, and that equity markets will not fall sharply on a Democratic clean sweep.
After all, what has been driving markets this year?
The hope for a timely, effective vaccine;
Supportive fiscal policy;
Supportive monetary policy;
A levelling-off of previously escalating Sino-US trade tensions.
Are any of those four pillars likely to be undermined by the clean sweep?
A President is unlikely to alter the outlook for a vaccine. Fiscal policy is likely to stay very loose under both Trump and Biden - its distribution will change materially, but not its scale.
Historically, a presidential candidate committing to very loose fiscal policy would have caused markets to expect tighter monetary policy, that is, higher interest rates as the central bank decides the extra government spending will create higher inflation, so higher rates are required to counter this threat.
But this time the central bank, the US Federal Reserve has committed to holding interest rates near zero until the end of 2023, even if inflation rises above 2 per cent.
As such, is it as simple as the outcome with the most stimulatory fiscal policy is the most positive for markets?
The risk of intolerably high inflation is a little greater under Biden, but over the next couple of years we expect both structural and cyclical forces to be stronger than the effect of shorter-term factors.
Structural changes in society such as ageing populations, high debt levels and greater adoption of technology are all long-term trends that create disinflation. Despite the stimulus that was in the economy in September, inflation was very weak, which justifies our position.
As good as it gets?
An outcome where Biden wins the presidency, but not the senate, may be the best outcome for markets.
Institutional investor surveys suggest this outcome is also likely to cause markets to fall, although by a smaller amount than if the Democrats win big or the result is contested.
Contrarily, we think there is a strong argument to be made for this being a very market-friendly outcome over the medium-term.
Little changes on the fiscal or monetary policy fronts, while there is no chance that Biden could get any large increases in corporation tax through Congress, or any of his most redistributional agenda items that markets fear the most.
But foreign and trade policy uncertainty will ease significantly. The substance of Biden’s trade policy is similar to Trump’s, at least on China, but the style will change.
This change may benefit non-US equity markets more than US markets.
From a global perspective this election is about whether global policy uncertainty will continue its dramatic ascent in recent years.
Huge increases in uncertainty, particularly around what American protectionism/unilateralism means for foreign export-oriented economies, have augmented US equity outperformance and the US dollar bull market.
An approach that means America is more conscious of its impact on the rest of the world, would likely lift all boats.
That is because the US is a more insular economy, with a lower trade-to-GDP ratio, its stock market is less cyclical than many others and less sensitive to the global trade cycle, and the dollar is a safe haven currency
If Trump is elected, uncertainty will likely spike again – hamstrung by a split Congress he would focus more on trade, where he does not need Congressional approval, just as he did after the midterms. This would support US equities, relative to the rest of the world.
A Biden win is not a foregone conclusion but whatever the result, history would suggest we will not see huge market swings on the outcome.”
I thought this article was extremely interesting and I would echo Ed Smith’s comment that markets have probably already priced in (to a certain extent) the most likely outcome because that’s the way efficient markets work.
As always, if you have any questions about any finance related matter, please do not hesitate to contact me at any time.
With best regards,
Yours sincerely
