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The US election will officially be held on Tuesday 3 November, however given the challenges of in-person voting in the Covid era, many votes have already been cast. Generally markets loathe uncertainty, so the prospect of a potential change in President, and in the composition of the Senate and House of Representatives, the two oldest Presidential candidates on record and an ongoing pandemic may spook the hardiest of investors. But what is the likely outcome of the election, and how likely is it to affect markets?
Historically, a change in president, or in the party dominating the Congress, has not been an inflexion point for the US stock market, nor for the US dollar.
According to research from the NAB Markets Research team, US equities tend to perform better when the incumbent is elected for a second term. However, the correlation is relatively low, with most of the underperformance experienced in the months after the primaries leading up to the election (when it becomes apparent that the incumbent is less likely to win). In 2016, markets only started to reflect the likelihood of a Clinton loss after the debates and the Wikileaks’ revelations. The market rallied strongly post election in anticipation of significant tax cuts and infrastructure spending (much of which did not occur).
This year may be different. While Biden has consistently polled 7pts ahead of Trump, a greater lead than Clinton sustained during her campaign, this lead is insufficient to assume a ‘shoo in’. The shambolic first Presidential debate and Trump’s COVID diagnosis have already demonstrated the extent to which this campaign can change in a moment. In addition to the Presidential race, both the House of Representatives and the Senate may turn blue… or not.
Were the election held prior to the debate (and therefore Trump’s diagnosis), polls indicate that Biden would win the Presidency, and the Democrats would win both the Senate and the House of Representatives – what’s known as a ‘blue wave’. This would allow the Democrats to effect significant policy change, including appointing their own Supreme Court Justices (following the death of Ruth Bader Ginsburg and her replacement with the right-leaning Amy Barrett). In the event that Biden wins but the Senate remains dominated by the Republicans, it is likely that the Democrats’ policy agenda will be hamstrung. While many states remain uncertain, either outcome is a possibility. It may be significant that the seats that are least certain to be retained by their incumbent are all Republican.
A blue wave has the clearest implications for investors who wish to understand what key Biden policies are likely to affect markets. While markets have responded enthusiastically to the enormous fiscal stimulus rolled out to combat the economic impacts of COVID, they are also closely watching the significant proposed increase in government spending under Biden. This spending will be underwritten by an increase in corporate taxes (partially rewinding Trump’s tax cuts from 2017), higher payroll taxes for high income earners and a capital gains tax on amounts over $1m. At $US2.2trn, healthcare spending accounts for nearly twice as much as the next highest expenditure (infrastructure, followed by pre-K and primary education). The healthcare sector is likely to be affected, with pressure on excess profits in the sector; and green energy plans are likely to be unfavourable to the fossil fuel industry. Big tech may also be subject to antitrust and global tax treaties. Winners may include companies aligned to the proposed infrastructure investment and clean energy producers.
Should the Democrats fail to win the Senate, or the Republicans win the Presidency but not the House of Representatives, the benign scenario is that policy will likely remain stable. This means neither side is able to dominate votes and therefore pass their legislation without compromise. The more alarming possibility is a contested outcome, which last occurred during the Bush-Gore election in 2000. The contested vote (in Florida) was taken to the Supreme Court, which ruled that votes could not be recounted and Bush won the Presidency. In the Trump era, the outcome may not be so clear – Trump has already hinted at refusing to step down in the event of a Biden win, and rejecting the outcome of the election if it is not favourable to him. (Despite Trump’s attacks on mail-in voting, over 25% of votes were cast by mail in 2016 and 2018). In this scenario, markets are likely to be highly volatile.
Given the uncertainty remaining even post the election, US investors are taking steps to protect their portfolios, with hedging over the November period at record highs. Australian investors with international equity exposure may wish to prepare for additional volatility – although given the wild ride 2020 has offered so far, perhaps this will be par for the course.
For further analysis on the election, the potential impact on equities and the outlook for the US dollar, the NAB Markets Research team offers their thoughts here. Magellan’s Hamish Douglass discusses the US election, COVID recovery and the likelihood of a vaccine and global market outlook here.