November’s US presidential election takes place in a country that is in one of the most divided periods in its 248-year history.
Such division creates uncertainty on so many levels. It also means the election is too close to call, which, from an investor’s perspective, presents numerous scenarios to consider. It looks like a labyrinth of uncertainty and major risk.
“This is going to be a knife fight in a phone booth. It is going to be an incredibly close election,” says Libby Cantrill, head of US public policy at Pimco.
For Ross Barr, senior investment strategist at Cardano, the US election is a key risk event. Assessing the situation, he says: “Harris is now the favourite in the prediction markets, overtaking Trump. In reality, we have gone back to when Biden and Trump were neck and neck only a few months ago. This will be a tight contest, dependent on a handful of swing states.”
Given the tightness of the contest, Barr raises the obvious problem for investors. “It will be di cult for markets to price until the event itself, allowing events such as the [September] first Fed cut to have more importance on a shorter-term basis,” he says.
“However, we have also observed that the ‘Trump trade’ has been faded by the market and in our view this may provide some opportunities in terms of effective hedges for the election,” Barr adds.
Fall and rise
One study examines the investment trends leading up to and after a US presidential election, with a focus on the close-run affairs. Research Affiliates studied the 24 US elections since 1928 and revealed that stocks in the S&P 500 tended to fall in the run-up to a close election, then surge in the final week of the campaign before continuing their upswing, although with a greater amount of volatility, after the election.
The study noted that in the lead-up to an election, growth and value stocks tend to exhibit a similar performance. Whereas after the election, value stocks tend to bounce back when Republicans move into the White House, while growth stocks typically rebound when the keys are handed to the Democrats.
And assessing the impact on investments and the president in office, Morningstar looked at S&P 500 returns over a 50-year period. It found that since 1953, $1,000 invested when a Democrat became president, sold when a Republican took office, then reinvested when a Democrat returned resulted in $62,000. A different strategy – only investing when a Republican is in the White House – only grew to $27,000.
However, and this is good news for long-term institutional investors, doing nothing and leaving the $1,000 where it was for the duration would have reaped investors $1.7m by the end of 2023.
Divided government
Looking at scenarios that could result from the outcome of the election, and one connected with the divided US electorate, is a truly divided government, with the presidency going one way and the House of Representatives and Senate going or holding another.
Looking at the house and senate: out of the 435 seats available, current consensus forecast points to 206 being allocated to Democrats, 207 to Republicans with 22 seats being a toss-up – out of which nine are Democratic seats and 13 Republican, according to analysis from Deutsche Bank.
Coming down to the Senate, 34 out of the 100 seats are up for re-election. Currently, the Democrats control the Senate by 51 to 49 and 28 of the Democrat and 38 of the Republican seats are not up for re-election.
“The base expectation is for a divided government with 50-50 odds for a Trump-Harris victory,” says Deepak Puri, Americas chief investment officer at Deutsche Bank.
This, paradoxically, might not be a bad result for investment risk and returns. “Investors often welcome a divided government because, perhaps perversely, it diminishes uncertainty,” says Stephen Dover, chief market strategist and head of the Franklin Templeton Institute.
“The scope for sweeping legislative changes to tax laws or regulatory policy is constrained by the need for compromise,” Dover adds. “The status quo persists, allowing firms and investors to make decisions without having to consider major fiscal or regulatory policy shifts.”
Dover makes another positive point about the divisions between lawmakers. “Divided government can even permit deficit reduction, as occurred from 1994 to 2000 and again from 2010 to 2016. Bond investors, therefore, may have grounds for welcoming it as an avenue to reduce deficit and debt burdens,” he says.
The one area of potential concern under a divided government, however, resides in political default risk, Dover says. “Government shutdowns and the potential for the treasury to miss interest payments on the national debt have been a concern when impasses led to an inability to increase the US debt ceiling.”
It should be noted that in all such cases since the mid-1990s, those near misses – but including US debt downgrades – have occurred with a Democrat in the White House and a Republican majority in the House of Representatives.
Democrats, thus far, have not engaged in similar political negotiating tactics under circumstances where they controlled the House of Representatives under a Republican president. “The implication is that default risk would be higher in divided government with Harris as president,” Dover says.
Changing dynamics
One of the reasons we are where we are with a tight election is there has been a shift in the presidential race. There is no doubt that in recent months the dynamics of the US presidential election, as well as the outcomes for control of the US Senate and House of Representatives, have shifted.
The decision in July by president Joe Biden to withdraw his candidacy in favour of vice president Kamala Harris has seemingly changed the trajectory of the presidential race, or, at the very least upset the momentum Trump seemed to have towards heading into the White House.
Polls have indicated tighter races across all levels of elected government. Initial polling and moves in political futures markets indicate that vice president Harris won the September 10 debate against former president Trump.
But it remains premature to know whether the result was enough to firmly entrench her as the frontrunner. In this context, one has to remember in 2016 Trump was considered to have lost all three of his debates with Hilary Clinton, but of course went on to win the presidency.
The Trump risk
And when it comes to risk associated with the US election, there is none bigger than the concern about Trump himself. One big issue, among many, is that Trump will not accept a peaceful transition if he loses. This happened in 2020, with disturbing consequences. If Trump loses in November, will we see it again?
“This is a sign of a democracy in crisis, and the potential for this outcome to be manipulated and lead to more division is something we all should be paying a great deal of attention to,” says Ian Bremmer, president of Eurasia, a political risk consultancy.
Although when Trump took this approach after the 2020 presidential election, which led to the storming of the Capitol Building in Washington, the Dow, the S&P 500 and Nasdaq all closed on record highs on January 6. This though was the result of an upbeat economic outlook post-Covid, and possibly a nod to a Democratic Party victory.
There could also be said to be Kamala Harris risk. Questions still abound about what she believes in. Is she a leftist masquerading as a centrist, or is she an outright opportunist given that she seems to have discarded most of her beliefs from just a few years ago? Which raises an obvious question: what type of president would she be? Such uncertainty is not good for markets and investors.
Don’t panic
But in assessing the returns of stocks during presidential election years, Mark Peterson, director of market and portfolio insights at Blackrock, says there is no reason to panic.
That is because, on average, stocks have risen 11.6% during presidential election years since 1926, slightly better than the market’s average 10.3% return in all years.
Drilling down further, he reveals that stocks tend to follow a pattern during presidential election years: sluggish in the first half, followed by a big second half. Historically, the third quarter has delivered the strongest returns, with an average return of 6.2%.
“Many Americans have strong feelings – and genuine concerns – about politics, but history suggests that presidential election years tend to be pretty good for stocks, especially in the second half of the year,” Peterson says.
In other words, what happens in Washington DC largely stays in Washington DC. There’s no guarantee the market will follow the historic election year pattern in 2024, given the divisive nature of the election.
But Peterson is positive about the future picture. He therefore recommends investors should “tune out the political noise”. Although outsized market moves can sometimes present tactical investment opportunities near to, and in the aftermath of elections, says Peterson’s colleague, Blackrock portfolio manager Tom Becker.
“In the run-up to elections, we sometimes observe a more muted asset price response to growth or inflation data,” he says. “Though it is hard to know for sure, some sub-sets of investors may be more cautious to express active views based on fundamentals in the run-up to elections.”
But what about after the noise has subsided and the election has been held? “In the aftermath of elections or referenda, we have sometimes observed large asset price moves that feel out- sized relative to the potential impact on fundamentals. It is not uncommon for these market moves to be sentiment-driven over-reactions,” Becker says.
Comparisons in uncertainty
Looking at other major political events as a potential guide to the US election, especially those that were uncertain or unknown, the Brexit referendum in 2016 is an example of a national vote that catalysed large global asset price moves, Becker says.
Leading up to the vote, uncertainty about the outcome was high. Consistent with its general approach to binary risk of this nature, Blackrock did not position portfolios for either out- come. “However, in the hours after results became clear, Japanese equities sold o sharply, declining -7% in the overnight session,” Becker says.
“Viewing this as an overreaction, particularly given the limited economic linkages between the UK and Japan, we took advantage of the opportunity to tactically buy Japanese equities at attractive prices,” he adds.
A few months later, in the run-up to the 2016 US presidential election, Blackrock had an insight that US growth and inflation data were improving but the market was not fully pricing in these macro developments.
“We viewed the impending event risk as a potential reason for that disconnect,” Becker says. “By maintaining short US bond positions, founded on the growth and inflation data rather than any view on the election, we were rewarded with the swift repricing that occurred immediately in the aftermath of the election,” Becker adds.
More recently, leading up to the Taiwanese election in January of this year, the asset manager observed evidence inflows data that investors were taking with risk ahead of the election.
“However, we had a positive outlook on earnings growth prospects of listed Taiwanese companies,” Becker says. “With an expectation that less uncertainty following the election – regardless of the outcome – could bring investors back and drive market prices higher we utilised this opportunity for a tactical, active investment in Taiwanese equities.”
Politics is overrated
It is though, a re-occurring theme among many investors that politics and elections have little impact on shaping investments. A point made by Stephen Parker, head of specialised strategies at JP Morgan Private Bank. “I generally think politics is overrated in terms of its impact on markets,” he says.
“And trying to make any meaningful changes to your portfolio is a difficult game. You have to predict who is going to win and then predict how markets will react,” Parker adds. “It is an opportunity, as an investor, to stay disciplined and stick to a plan. The biggest risk is with those [investors] thinking about making drastic changes to their portfolios in anticipation of the election. Historically, this has led to bad outcomes.”
Stephen Dover agrees with such a view. “Despite shifts in polls and other indicators, our primary investment conclusion remains unchanged. Investors should stay focused on long-term objectives and not overact to US politics and election outcomes,” he says.
In this way, politics is a big circus that investors are not clownish enough to participate in. “Markets have thrived, paused, corrected and rebounded under Republican and Democratic presidencies, as well as under various constellations of power in Congress,” Dover says.
“The broad contours of the stock, bond and even currency returns are typically dictated by fundamentals determined outside the sphere of politics.”
Ready for regulation
This does not mean there are no concerns for investors. It is more of a case of the devil is in the detail. “The more important consideration for equity investors is regulatory action, which resides chiefly with the president,” Dover says.
A point shared by Wei Li, global chief investment strategist at the Blackrock Investment Institute. “A Trump win could mean some deregulation, including the rolling back of regulation for banking in particular. Big tech may still be a target for bipartisan anti-trust measures,” she says.
“By contrast, a Harris win could reshape the healthcare landscape through expanded Medicare or drug price caps.” There are other takes on this theme from the Harris and Trump camps.
“Harris and the Democrats are apt to push for greater regulation of fossil fuel energy and the pharmaceutical industry, that is further caps on prescription drug pricing, while promoting alternative energy,” Dover says. “The opposite would be true in a Trump presidency.
“Accordingly, we think those sectors are likely to react more to the presidential outcome than the broader market,” he adds.
Risk and reward
So what in this more focused picture could a Harris victory mean for the market? “Anti-trust policy is worth watching,” Dover says. “The Biden administration has taken a tougher stance against large capitalisation technology companies, led by Federal Trade Commission chair Lina Khan. A Harris administration could also pursue that approach.”
There are other aspects to a Harris presidency, says Deutsche Bank’s Deepak Puri. “Overall, the Harris-Walz ticket is based on creating a ‘care’ economy from day one and extending many of Biden’s Build Back Better plan initiatives.”
And in the same way, what could a Trump victory mean for the market? “The wildcard for the dollar and capital markets would be a Trump victory followed by the imposition of large, across the board tariffs,” Dover says.
“If countered by other countries, the risk of trade wars could push up risk premiums, leading to sharp falls in equity markets and a surge into traditional safe-haven currencies – Swiss franc, Japanese yen – or gold and crypto-currencies.”
Looking at what to expect from a Trump presidency, Puri also adds: “The Trump-Vance ticket is expected to create stricter control on illegal immigration, use deregulation and focus on imposing tariffs to maintain domestic competitiveness.”
Another point Puri identifies about a Trump presidency is a possible unpredictable Fed policy shift with Jay Powell potentially being replaced, which could create huge uncertainty for investors.
Of course the only certainty about this election is its uncertainty. And we are likely to see more twists and turns before election day.
“The sharp shift in the polls over the past two months is a reminder that a lot can still change. Relatively few voters may remain undecided, but US elections – at all levels – are often decided by swings in relatively few votes in just a few states,” Dover says.
This is a good point. The outcomes of the 2016 and 2020 presidential elections hinged on less than a million votes cast in six key swing states – out of about 150 million votes cast.
The swing states are now Arizona, Georgia, Michigan, Nevada, North Carolina, Pennsylvania and Wisconsin. It is here where the election will be won and lost. It remains too close to call in all of them.
An indication of this, are the numbers, as they currently stand in each of the swing states. In Nevada, Michigan, Wisconsin and Pennsylvania Harris is up, but only between a mere 0.2% in Nevada and 1.7% in Michigan. Trump is up 1.6% in Arizona and 1.7% in Georgia with North Carolina tied.
It is though important for Puri that investors stay focused amidst the din of all the election coverage. “While short-term volatility is common in markets leading up to election season, it is important to separate the noise from the long-term drivers of equity market performance which depend on sound fundamentals,” he says.
“Retrospectively, stock markets appear rather unimpressed in the medium term by who moves into the White House, which confirms the old stock market wisdom that political bourses do have short legs.”
And he adds that although meaningful tactical calls can be undertaken, investment portfolios should be constructed to outlast an election cycle. “In most cases, a well-diversified, multi-asset portfolio is the best way to navigate political and macro-economic events and investment strategy should continue to be tailored towards personal timelines, liquidity needs and risk tolerance levels,” Puri says.
But at the same time, the most divided election could cast a shadow of uncertainty over the investor and political landscape for some time. “US politics has been, and remains, closely divided. It is therefore still too soon to draw firm conclusions regarding the outcome in political or market terms,” Dover says.
Comments