What might the US election result mean for investors?

One of the questions investors are asking right now is “Does the US election matter for markets and if so, what should I be doing about it?” Obviously the policies implemented in the US are hugely important for investment markets around the world. But perhaps even more so in the coming years when markets are likely to be more driven by political policy than by macro-economics. The extent of the fiscal stimulus deployed in the years ahead, how it is financed, and where it is targeted, will have a very direct bearing on which companies fare best.

Conventional wisdom generally holds that investors favour a Republican victory. Yet this time around, might a ‘blue sweep’ of Democratic victories be what investors want to see?

What does history tell us, if anything…

Since 1932, no sitting US president has lost an election unless a recession occurred during their time in office. Love him or loath him, President Trump faces the challenge of having one of the deepest recessions of recent times sparked by the Covid-19 pandemic. But it’s also the case that the performance of US markets, in the three months before Election Day, predicted 20 out of 23 elections since 1928 – with a positive performance supporting the incumbent. Hard to know which way that will land right now.

As for the impact that the result might have on stock markets, history doesn’t tell us quite as much. US markets tend to be bit bumpier in election years as markets reprice the impact of changed policies – although that has been far less the case this time with Covid-19 as the main driver of uncertainty. History also suggests that markets tend to react better to a Republican victory as they are seen as more market friendly. That said, the presidencies since Jimmy Carter are pretty evenly split between Republicans and Democrats in terms of equity market performance. When market performance over the term is measured, Bill Clinton’s presidency was the strongest and George Bush Jr. was the weakest. Excluding Bush Junior (given 9-11 attacks and the ensuing war), the parties are tied at 3 each. Not much to guide us there.

Two main scenarios

The polls continue to call a Biden victory although all pundits are chastened by 2016 election. There remain lots of uncertainties – including the impact of the larger postal ballot, Republican Electoral College advantage, and lingering concerns of a contested result. But given Biden’s persistent 7-8% advantage, investors are focussed on two main scenarios:

The first is a divided government. We may see a Biden presidency with a Democratic House of Representatives and a Republican Senate. Or it could be a Trump presidency with a Democratic House or Democratic House and Senate. Either way the outcome will be gridlock and a more constrained presidency. Markets will probably respond positively to this, because it means less dramatic policy shifts and therefore less uncertainty. History suggests that markets tend to perform at their best when Congress is split and makes it is more difficult for politics to become policies.

The second scenario is the so-called ‘Blue Sweep’ – a Democratic victory in the presidency and in both houses of Congress. This would open up potentially more significant policy shifts to which investors will be highly attuned. It does seem likely that in this scenario there would be a somewhat larger fiscal stimulus including significant investment in infrastructure and green energy and it might also herald a rowing back on Trump’s corporate tax cuts.

A Democratic government probably hastens the pace at which the US markets make the shift from monetary policy being the main engine to fiscal policy becoming the driver. In that case inflation expectations and bond yield may begin to shift upwards. In such a scenario, there is a stronger case for a broadening of the recovery in equity markets and for the baton of leadership to shift from the big tech stocks.

Why big government spending might change the winners

The reason behind this is the current super low interest rate environment is disproportionately supportive of high growth companies – such as technology companies. This is because, right now, interest rates are forecast to remain so low so far into the future. If however higher economic growth rates spark an increase in inflation expectations, which in turn will increase long dated interest rates (e.g. the 10 year US bond yield), that starts to favour companies which have stronger near term earnings certainty – many of which are in sectors that have so far not recovered or have seen weak recoveries thus far. In the jargon this is the so called “steepening of the yield curve” and while it could play out under either candidate, a Blue Sweep might accelerate it.

Investors can sometimes pay too mention attention to the importance of US Presidential races – which are only one amongst many factors driving investment outcomes. This time around, given the nature of the shifts happening in US policy and their potential for ever greater impact on equity markets, the focus seems justified. Regardless of the election outcome the two key priorities are economic recovery and jobs. Democrats have indicated a tougher stance on large cap tech and drug pricing with a more conciliatory approach to international relations particularly with China and therein are the types of changes that investors may focus upon. Investors will eagerly await the election result.

Kevin Quinn, Chief Investment Strategist, Bank of Ireland