Positioning for the 2020 U.S. Presidential Election: An Update
23. Oktober 2020
Why investors should stay invested and allow the noise to pass? An article by Principal Global Investors
Undeniably, 2020 has been an eventful year and the fireworks are likely not yet over. Amidst rising COVID-19 infections and a stuttering economic recovery, investors are preparing for the U.S. Presidential election. While this election may be one of the most contentious in U.S. history, investors should remember that that once the elections pass, much of this noise typically quiets and risk assets are able to resume a trajectory dictated by fundamentals.
The latest election developments
The race for the Presidency
Since our last election update, much of the election-related news flow has been, perhaps not surprisingly, astounding. The dispute over a Supreme Court appointment; the release of some of the President’s tax information; a vitriolic Presidential debate; a positive COVID-19 test; family corruption allegations. Somehow, 2020 still has the ability toastonish.
Yet, in one key respect, not much has changed: the polls continue to signal a victory for Joe Biden in November. Even before the first debate and his COVID diagnosis, the RealClearPolitics average of the polls showed that President Trump was trailing by 6%-7% (EXHIBIT 1). As of October 22, according to FiveThirtyEight Joe Biden has an 9.9% lead over President Trump with the chances of a Biden Presidency at 88%. In fact, that same model predicts a double-digit percentage Biden victory in the popular vote is now more than twice as likely as President Trump being re-elected. With just two weeks remaining, it will undoubtedly be an uphill climb for President Trump –the only previous incumbent president to be re-elected with lower approval ratings at this point in office was Harry Truman (1949).
All eyes are on the U.S. Senate elections
The race for control of the U.S. Congress is more balanced, and this is where much of the post-election uncertainty is focused. As a reminder, in the House of Representatives, all 435 seats are up for re-election. Democrats currently hold 232 of those seats. In order to keep control, they must retain 218. Given the natural advantages incumbents enjoy, combined with favorable current polling numbers, that’s a likely outcome in November.
In the Senate, on the other hand, the Republican party has a majority, holding 53 of the 100 seats. During this election, 35 Senate seats are being contested, of which Republicans currently hold 23. To win a majority in the Senate, Democrats would need to win three of these Republican controlled seats (and retain their 12) if the new vice president is a Democrat, or four if not (EXHIBIT 2A & 2B). Democrats appear to lead the polls in enough states to make winning the Senate a realistic possibility. FiveThirtyEight’s model puts the chances of Democratic control of the Senate at 74%.
The past few weeks have seen markets price in a greater chance of a blue wave, with expectations for the Democrats to take control of the White House and both chambers of Congress. However, If Democrats do take control of the Senate, they’re most likely to end up with only the slimmest of majorities.
Don’t let political beliefs cloud long-term plans
Markets like certainty and when polls narrow, indicating less confidence in the eventual election result, markets usually respond negatively. Recently, polls have widened, suggesting the increasing probability of a Biden victory and as such, markets have rallied. This is not a demonstration of which candidate is better for market prospects but simply a positive response to greater election clarity and diminishing prospects for a contested election result. After all, the wider the eventual margin, the less credible any challenge to the election outcome.
While many investors may be quick to make portfolio adjustments, or even step away from markets, based on how they foresee an election playing out, our analysis suggests there is no statistically significant correlation between the political party in office and equity market performance. Median equity returns were no better or worse when previous elections resulted in a Democratic sweep, Republican sweep, or a split government – any political configuration (EXHIBIT 3).
Note that only 160 times since 1928 have the Republicans had full control of the U.S. government and 403 times for the Democrats. So had an investor only chosen to invest during years when one specific party were in full control, they would have lost out on multi-years of annual returns.
As the past has shown, polls do not have a perfect predicative track record, and neither do market expectations. Consider the overwhelming belief that a Trump victory in 2016 would be negative for risk assets. In fact, until the COVID-19 crisis, President Trump presided over one of the best market performances in decades, wrongfooting many investors who expected a catastrophic impact on the U.S. economy (EXHIBIT 4).
Ultimately, to reduce long-term investment allocations because of a particular political view is to take a stance against the ability of the U.S. economy to grow. We believe that an active, long-term approach is likely suited even for investors who may be worried about the outcome in Washington.
One issue that has received a bulk of investor attention is that the outcome of the race may not be settled for some time after Election Day. With more voters utilizing mail-in ballots then ever before, this could occur due to delays in reporting results (mail-in ballots take longer to count) or due to a contested election.
A predictable aspect of any election cycle is heightened volatility in the run-up to the vote, as markets continuously reprice the probability of the future administration’s policies, that returns to normal soon after there is a winner declared. However, the prospect of a contested election result potentially means that elevated volatility endures post-election day. In fact, this nervousness over a contested election can already be seen, with VIX futures pricing in higher volatility into November and only subsiding again in 2021.
Certainly, the current electoral polarization does suggest a greater-than-usual risk of post election unrest, and investors have inevitably taken note of President Trump’s remarks regarding the potential fairness of the election. Yet, it is important to recognize that the polls strongly indicate that a clear Biden victory is likely, suggesting that concerns over a contested result and extended election turmoil are likely exaggerated.
Looking ahead, heightened volatility in the run-up to the election and even, potentially, following the election will eventually subside and markets will soon reassert a trajectory determined by fundamentals, rather than election news flow. Case in point, the S&P 500 has registered positive returns in seventeen of the last nineteen presidential election years!
Elections don’t stop prevailing economic conditions from driving markets. Any lasting impacts are likely to come from policy changes over the course of the coming four years.
EXHIBIT 5 > Equity market performances in the two election years which recorded negative returns were driven by the prevailing economic and financial conditions at the time –the bursting of the tech bubble in 2000 and the Financial Crisis in 2008. Similarly, this year’s equity market returns will have been primarily determined by the COVID crisis and policymakers’ response, not the election.
Keeping an eye on policy decisions
Attention has been heavily focused on the presidential election but, when it comes to policy decisions, it’s the outcome of the Congressional elections, in particular the Senate, will matter significantly.
The relationship between the U.S. and China
One of the key policy focus points for the next administration will be its relationship with China. Having escalated the hawkish rhetoric over the last few years, an administration led by Donald Trump would inevitably be tough on China, potentially doubling down of the “America First” stance on trade and immigration.
While a Biden administration may take a different approach, resuming a more predictable foreign policy, within the structures of domestic and international rulemaking, he too will inevitably continue to take a hard stance on China. Therefore, no matter who wins, the economic relations between China and the U.S. will likely remain confrontational. Being tough on China appears to be one area where there is bipartisan support.
For investors, the market impact of U.S.-China tensions is difficult to quantify. While a Biden victory may trigger a positive reaction from Emerging Asian assets, this likely would happen even with a Trump presidency. After all, despite ebbing and flowing trade-war concerns and continued geopolitical frictions, markets have moved notably higher over the past four years. Between November 2016 and September 2020, the MSCI China index and MSCI U.S. index each equally rose 70% (EXHIBIT 6).
As long asearnings growth holds up and monetary and fiscal policies remain easy, markets may very well continue to shrug off persistent anti-China rhetoric.
Tech companies, notably—Apple, Amazon, Alphabet, Facebook, Microsoft, Intel, Netflix and Nvidia—have driven U.S. equity returns both during the pandemic and in the years leading up to it. Add in Tesla, and combined, those companies make up the BANG+US Index, a proprietary index created by Principal Global Asset Allocation in 2017. Given that BANG+US stocks account for almost over 26% of the S&P 500, U.S. equity market success largely rests on their shoulders (EXHIBIT 7).
Big Tech has been a focal point for the U.S. government for some time, and faces multiple federal, state and congressional antitrust investigations. In recent weeks, U.S. Congress has upped the ante. A House of Representatives subcommittee on antitrust law published a large report accusing Facebook, Amazon, Apple and Google of abuse of market power, while the Department of Justice launched an antitrust lawsuit against Google this past week. Increasingly, this appears to be a broad-based government campaign that promises to disrupt Big Tech.
We expect the assault on Big Tech will continue regardless of any political changes in Washington. Concerns around data privacy, censorship and market dominance have made tech regulation an area of growing bipartisan concern and as such, a potential blue wave in November wouldn’t necessarily darken the sector’s outlook any more than a red wave would.
Yet, the outlook for Big Tech might be sturdier than it appears. Despite the concentration in investigations, it seems there is little chance of actual action soon. Drafting and passing legislation to curb Big Tech’s market dominance will be a process measured in years rather than months.
In recent weeks, markets have become increasingly preoccupied by the outlook for additional fiscal stimulus. While the prospects for a new package before the U.S. election have faded, markets have been somewhat reassured by the growing odds of a Democratic sweep, believing that this would result in a significant positive fiscal stimulus package over the coming years.
If policies are enacted as planned in Biden’s platform, a Democratic sweep would see front-loaded spending in the early part of his term, followed by longer-term spending increases in infrastructure, climate, healthcare and education. Although taxes would also be increased, there is reason to believe spending would be prioritized (EXHIBIT 8).
By contrast, it has been widely believed that a second Trump administration would result in no major changes in tax or spending policies –which would imply reduced fiscal stimulus as the boost from the CARES Act fades.
A third possibility –a Biden victory where the Senate remains controlled by the Republicans –would potentially result in a policy gridlock, with much less ambitious fiscal stimulus and infrastructure, and no major tax changes. The U.S. would be facing the same fiscal pressures that weighed on the economic recovery post-GFC.
What’s more, although the recent debate around additional stimulus may have emphasized the Republican party’s more stringent attitude towards fiscal discipline, the economic backdrop may leave Congress with little choice but to enact a new stimulus plan. Indeed, our outlook is for a slow and protracted recovery, marked by continued pandemic uncertainty and economic scarring. Against that backdrop, the new President –Trump or Biden –may decide that additional fiscal support is necessary to deliver an above-trend expansion.
Implications for investors
Against an economic backdrop scarred by the ongoing pandemic, the market would be significantly disrupted by a prolonged bout of political uncertainty, so it is little wonder they have embraced the greater odds of a convincing Biden victory and even a Democratic sweep during the 2020 elections. Indeed, concerns around a contested election have been replaced by a more constructive baseline involving greater market certainty and potentially material fiscal stimulus.
Yet, investors should remain alert to the fact that pre-election polls do not have a perfect predicative track record, and neither do market expectations. As history shows, election night shocks are not unusual, so adjusting portfolio allocation in order to position for who is most likely to win is a dangerous strategy.
Today, extremely easy financial conditions, driven by historically accommodative monetary policy and ample liquidity remain key supports for markets, driving them to new record highs even as the U.S. suffers one of the worst social and health crises in history.
Positioning for modest global reflation should remain priority for investors – whichever way they think the election will pan out.
Investment horizons outlast election cycles and elections do not stop prevailing fundamentals from driving markets. Therefore, while election-related noise may be disruptive we do not believe that any of the potential election outcomes should be reason to go against these fundamental drivers of the market and significantly change portfolio allocations. Remember, neither the political party in the White House nor the majority in Congress will alter the direction of the Federal Reserve.
Ultimately, investors should be focused on fundamentals and remain fully invested through the election. Actively positioning for a slow and protracted economic recovery, backed by continued central bank liquidity, as well as being sufficiently diversified to withstand the pandemic-related challenges ahead should remain investors main priority.
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