The run-up to a United States election is traditionally a volatile time for markets, but this year is looks set to be more volatile than ever. The COVID-19 pandemic is causing economic and increasingly political chaos around the world, but in the US, which might normally be expected to be strong enough to better withstand such a crisis, the large death count and often unpredictable behaviour of the president are causing uncertainty on an unprecedented scale.
Markets have already been showing signs of stress, particularly after president Donald Trump’s announcement that he and his wife had both tested positive for the disease and then just days later he pronounced himself cured and immune. Equities immediately dipped on the news, and although they later rallied, the episode raised volatility levels and left investors nervous.
The election is preying on investors’ minds even more than COVID-19. A survey by RBC Capital Markets of more than 100 institutional investors found that 73% were worried about the election against just 68% about a second wave of coronavirus, and 63% about more job losses.
Races for the Senate and Congress will also be watched
There is more to consider than just the outcome of the contest between Donald Trump and Democrat contender Joe Biden. The race for the Senate, where Republicans currently dominate, will also be closely watched, as will that for Congress, now controlled by the Democrats. A Democrat victory on all three fronts could lead to greater regulation of business and higher taxes, which would weigh on stock markets, just as Trump’s win last time round and his promise of early tax cuts sent US shares higher. A mixed result on the other hand might also be a negative for equity markets as it could threaten gridlock on crucial measures, such as economic stimulus packages during the pandemic.
The nervousness on markets will only be exacerbated by the COVID-19 crisis as deaths continue to mount in the US and the incumbent president seems to many unwilling to do enough to combat it. Polls suggest around two-thirds of Americans are highly critical of both Trump’s handling of the COVID-19 crisis and of his own illness. And this is on top of other mounting concerns, such as relations with muscle-flexing competing powers such as Russia and particularly China, and the growing divisiveness of US identity politics.
This all leaves investors with the question of how best to manage their risk profiles.
Markets largely bullish on a Trump victory
The first outcome to consider is an outright victory for president Trump. In 2016, his surprise victory led to an initial rapid sinking of US stock market future, in line with widespread fears before the election that he would cause the economy and markets to tank. The S&P 500 dropped more than 5% in pre-market trading, triggering a circuit breaker to halt trading. But the market dive was short-lived as investors began to consider what benefits a Trump presidency might bring, such as tax cuts, and by the time the market closed the day following the election, the index was up more than 1%.
Market players this time around are generally bullish on a Trump victory and have suggested that markets will stabilise should he win a second term, partly as markets don’t generally like change and partly as he has shown himself to be pro-business.
The focus would quickly turn to stimulus negotiations with the Democrats and from then to the longer-term issues of China and the European Union. The market is also likely to remain pessimistic regarding the economy as COVID-19 continues to spread and corporate and government debt pile up, and these pressures could continue to weigh on the US dollar and interest rates. The likely outcome of all this is that although the market might stabilise or even rally a little in the event of a Trump win, money is still likely to continue being moved into safe havens such as gold, treasuries and the yen.
As of 22 October, Joe Biden still commands a comfortable lead in national opinion polls, however.
Traders assume a Biden win would be bearish for markets
A Biden victory would likely be immediately negative for US equities because of his stated intention to raise taxes, and a slide in the market over the middle of October suggests investors think a Biden win is increasingly probable.
A Biden government is also expected to look at antitrust laws, particularly where the tech giants are concerned. Although this, too, would normally be expected to be a negative for investors, Trump too is concerned by antitrust issues and the US Justice Department’s case against Google is already underway.
It is also the case that markets always expect business and the economy to go awry under a Democrat government, but this does not happen. Also, if Biden’s green outlook bodes ill for fossil fuel share prices, it bodes equally well for renewables.
The survey by RBC cited above found that if Biden takes the White House and Democrats win control of both houses of Congress, analysts see this as bearish or very bearish for 58% of the industries, neutral for 27%, and bullish or very bullish for 15%. A president Biden would be bullish for utilities, neutral for real estate investment trusts, communications services and consumer staples, and bearish for technology, energy, consumer discretionary, industrials, and financials.
A Biden result could present positives for the market
Yet Biden as president may not be so radical as some fear. He might increase taxes and regulatory oversight, but he might equally lead a more stable government than Trump’s, and markets if anything like stability. If Biden can calm tensions over China, work more closely with Europe and ease up on tariffs, then this would inject a little predictability into global affairs and this too could be a big positive for markets.
But however bearish on Biden markets may be, once the election is over, economic rather than political considerations will return to precedence as markets over the long course of history have shown no clear bias towards either party. Ultimately, the opinions of the president are less of a concern to the market than those of the chairman of the Federal Reserve. Markets crashed when states began imposing lockdown measures in March but bounced back when the Fed and Treasury stepped in with promises of trillions of dollars of aid to stricken businesses.
On an economic basis, history suggests Trump may not be returned to office. In the past 100 years, each president who avoided a recession in the two years leading up to an election was voted back in. But the electorate will be well aware that the COVID-19 pandemic is the cause of the economic downturn and are thus much more likely not to punish the president for negative growth results. If Trump is voted back in, it is also the case that markets have performed better over the course of a first year after a president’s re-election than when a new president takes office. Markets like the familiar. But the past doesn’t guarantee the future, and this year is as different as any most of us can remember.
A contested election result would be the worst outcome
The worst-case scenario would be a contested result, which seems a real possibility given concerns about voting by mail as the pandemic keeps voters at home. The five weeks of wrangling over the 2000 election outcome saw the S&P 500 reverse its upward trend of the month prior to the vote and then fall 12% to its late-December low, and a dispute over the election result this year could be even more ill-tempered.
David Kostin, chief US equity strategist at Goldman Sachs, has written about the possibility of a disputed election in 2020 and warned that because of this, volatility is “extremely high compared with prior cycles”. Goldman thus advised clients to hedge their market exposure going into December in order to lessen any losses an indecisive result causes.
“I would very much expect that if we don’t have a concession speech right away, either by the challenger or incumbent, it will be bad for the markets… it will be really bad,” agrees Charles Lemonides, chief investment officer at ValueWorks. Stocks will fall if there isn’t a clear winner on election day, he says, and it will be a “bad outcome for America.”
Markets can be expected to calm after the event
Either way, COVID-19 cannot last forever, and next year or the following there is every possibility of a steep economic recovery. The end of COVID-19 could see a shift away from the technology sector that has benefitted most from the crisis and back to more cyclical sectors that have suffered more than others.
In the meantime, any volatility ahead of the election is likely to calm after the event, as it almost always does once the outlook clears and the more excitable media headlines give way to some other topic. Although many investors are increasing weightings in relatively safe assets, to precipitate a flight to safety could miss opportunities that present themselves in certain sectors depending on the overall outcome.