US elections: the final stretch

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Personal Investing

15 October 2020

The global pandemic aside, our Global Equity Strategist believes the US presidential election looms as the biggest overall event for markets in 2020.

In any election, US or otherwise, the run-un up to such an important event is often filled with the odd moment of drama. This time round, some would argue that a president testing positive for one of the world’s deadliest viruses in history constitutes more than enough drama already.

But barring any further surprises, we believe it unlikely that either Republican President Donald Trump or Democratic challenger, Joe Biden, can build a large enough lead in the closely watched battleground states of Pennsylvania, North Carolina, Ohio and Florida for investors to feel confident of the outcome on election night. In short, we believe it may be be a tight race to the finish.

With the 2016 shock win by Donald Trump still fresh in investors’ minds, our view is that financial markets are unlikely to price a specific outcome confidently ahead of the election. All scenarios are therefore likely to result in some movement in the prices of US stocks and US government bonds once the winner is declared.

Potential outcomes

Just to be clear, we have no particular edge in predicting the election outcome on 3 November. Instead, we focus on the market implications of the four potential outcomes:

  1. A ‘Blue Sweep’ where Democrats control the White House and both chambers in Congress
  2. Joe Biden becomes president, but Congress remains divided
  3. Donald Trump wins a second term in office, but Congress remains divided
  4. A ‘Red Sweep’ where Republicans control Washington as they did in 2017 and 2018.

For those of us who don’t follow US politics that closely, blue is the colour of Democrats, red the colour of Republicans. A divided Congress – the part of the US government that passes laws and is made up of the House (lower chamber) and Senate (upper chamber) – would entail one party controlling one part of the chamber, while the other party controlled the other.

In the event of a ‘Blue’ or a ‘Red’ Sweep, we believe both scenarios would result in more money being injected into the economy. In the case of a Republican victory this could take the form of lower taxes. By contrast, an outright victory for the Democrats, we believe, could result in more spending in areas such as the environment and healthcare. That said, if Democrats were to make good on their promise of a rise in corporate tax (a tax imposed on company profits) then our belief is that the impact on the US stock market would be negative in the event of a ‘Blue Sweep’ victory.

The overall effect on the US economy of a ‘Blue’ or ‘Red Sweep’ is likely to be expansionary as both parties seek to inject more cash into an economy gripped by the pandemic. But that’s not necessarily a good thing for all investments. In the case of US government bonds in particular (a government bond is essentially an IOU whereby an investor lends to a government for a set time-period in return for a fixed rate of interest) they tend not to like this type of environment.

Remember, remember the 4th of November?

The final wildcard, of course, is what happens if there is no outright winner on the 4th of November. In the current environment, it may take several days to count the large number of mail-in ballots (postal votes to you and me). It may take even longer than that for either candidate to concede. But that does not mean financial markets won’t move on 4 November. Probabilities of the election outcome can shift significantly even without a confirmed result and the markets may not wait for someone to concede to price in a likely winner.

Remember, the value of any investment is not guaranteed. The value of investments and any income received from can go down as well as up and you may not get back as much as you had originally invested.