This piece is not intended to endorse either candidate or contain editorial comment. It is merely an opinion piece on past market reactions and what many market commentators are expecting.
Well, here we are again…
On 3 November the Melbourne Cup is run, and US voters will choose the leader of the free world for the next four years.
For ease of reading, this article is set out in three sections:
A) Just the Bare Facts;
B) A Summary; and
C) All the details – we’ll give an in-depth analysis of Trump vs Biden policies here and their potential short-term impact on markets.
No matter what the outcome, the two questions we will address are:
- What will be the long-term effect on markets and my portfolio; and
- What are the short-term effects?
As Election Day nears and COVID vaccine trials continue, headlines may lead to volatility, but the economic rebound is expected to continue.
Just to digress, the greatest near-term market influence will be the announcement of a vaccine. Don’t underestimate what the market will do when it is announced. The markets greatest enemy is uncertainty and when COVID insecurity is removed, no matter how long manufacturing and distribution takes, markets will have already rebounded way ahead of the economy.
A) The Bare Facts
1. What will be the long-term effect on markets and my portfolio
None.
2. What are the short-term effects?
Expect some short-term volatility as Trump is seen to be more market-friendly and Biden less so, as he will increase taxes and will pour more money into Climate Change policies.
The market hates uncertainty and it could take longer than usual to get a result because of the record number of postal votes (it takes longer to process postal votes that those votes cast at the ballot box).
The worst outcome for sharemarkets would be a contested election. If a clear winner emerges, there shouldn’t be a contest, but if it’s close, expect a contest, which pushes a result further out and the market will be jittery until a result is announced.
That’s it.
B) Summary
1. What will be the long-term effect on markets and my portfolio
None. Don’t believe us read on…
There is no scientific data that shows any long-term impact on investment markets, and there’s lots of data out there. John Rekenthaler’s Report on Presidential elections don’t matter (for investments). Is referred to often and contains most of the stats.
History’s lesson
Conflicting headlines are hurled at us at an unrelenting pace. Yet, the performance for the Dow Jones during the first three years in office for each of the past 10 Presidents (excluding John Kennedy and Gerald Ford, who didn’t serve 36 months) ranked from best to worst is:
1. Bill Clinton (D)
2. Dwight Eisenhower (R)
3. Barack Obama (D)
4. Donald Trump (R)
5. George Bush Snr (R)
6. Ronald Reagan (R)
7. Lyndon Johnson (D)
8. George W. Bush (R)
9. Richard Nixon (R)
10. Jimmy Carter (D)
The effect that dominates this list is not party affiliation but instead the President’s timing. Aside from George W. Bush, who was unlucky enough to catch both the technology-stock decline and the 2008 financial crisis, the bottom performances all happened during the 1960s, 1970s, and 1980s, which were afflicted by global inflation concerns.
Headlines will try to shock us, but the long-term value of stocks don’t change that much. While uncertainly still surrounds COVID and the election, Morningstar’s outlook for the continuing economic recovery, and forecasts for individual companies, haven’t changed.
There is no scientific data whatsoever that shows that there is a link between the performance of the Dow Jones and the president/party. Markets and economies will cycle as they do. It is the president’s timing of election in this cycle that matters, not vice-versa. The market is the dog, the actual President is the tail.
The same applies to bonds, the economy and employment too!
Presidential elections don’t much affect the general economy.
As Mr Rekenthaler wrote:
The effect on stock market returns three years after a presidential election has been due more to broader economic patterns than the party affiliation of the winners.
2. What are the short-term effects?
The US presidential election has contributed to recent market volatility, however this year it has been less so, due to COVID-19 trumping the election (pun intended).
Interestingly, Biden’s lead in the polls seems to track new COVID cases. As cases lessen, so does his lead in the polls. As the US is now facing record-breaking numbers, we’ll see how this translates:
Markets are not political, but they are sensitive to uncertainly. Although we are expecting investors to be jittery, we find ourselves in a situation where the worst of the volatility (from the election) may be behind us.
How will markets react to a Republican or Democratic win? Here’s a brief summary but we’ll unpack more in Section C.
Likely market reaction
Since 1927, the election year has been reasonable for shares with an average total return of 11.2% pa.
Of course, this year is complicated by coronavirus and this election comes with greater than normal uncertainty. There are several points to note:
🇺🇸 If Biden wins, investors are likely to fret more in the short-term about the prospects of higher taxes and regulation, particularly if it looks like Democrats will win control of the Senate. After initial negative reaction, there is no reason to expect a weaker economy, and hence weaker share market, under a Biden presidency;
🇺🇸 If it’s close and contested it may be a while before the winner is known and markets won’t like the uncertainty.
Delays in counting postal votes may mean it takes longer to get a result, Trump’s refusal to guarantee to go peacefully should be taken “seriously but not literally”. It’s hard to see him starting a civil war and senior Republicans have not supported him on this with Senate majority leader McConnell saying, “there will be an orderly transition just as there has been every four years since 1792.”;
🇺🇸 If ultimately Trump is the winner, US shares may initially celebrate and outperform global and Australian shares but would be vulnerable next year as the trade war with China ramps up again; and
🇺🇸 Interestingly, the best average market returns (16.4% pa) has actually occurred when there has been a Democrat president and Republican control of the House and/or the Senate. But ultimately, it’s all about broader market conditions.
3. So why aren’t markets fretting?
On the face of it, you’d expect markets might have been fretting more in the last few weeks with Biden being out in front and promising higher taxes and more regulation.
In addition to higher corporate and top marginal tax rates, an increase in regulation and a rise in the cost of carbon, which is expected to weigh on energy companies when they are already struggling, are negative for the growth outlook.
For example, the rise in the corporate tax rate would knock around 6% off earnings per share for S&P 500 companies. In particular, these measures may reverse some of the supply side boost provided by Trump.
However, it’s never that simple, especially with all the variables at play this year. From Dr Shane Oliver, chief economist at AMP Capital, here’s a few possible reasons why the market isn’t fretting:
- The negative impact of higher taxes and more regulation would be offset by more fiscal stimulus under Democrats. Increased infrastructure spending could also help here. Once in office, Biden may dampen down his planned tax hikes, particularly if the economy is still weak;
- A clear Democrat victory would avert a worse case contested election;
- Biden will likely mean more stable policymaking with less trade wars. Biden’s trade and foreign policy is focussed more on strengthening ties with Europe and a diplomatic approach to dealing with China. Remember that 2018 which saw trade wars escalate under Trump was not a good for shares; and
- Quite aside from the above – after 2016, where polling is generally seen to have got it wrong, many people may simply not be believing the current odds ie. they don’t believe Biden is a sure bet.
C) In-depth analysis
1. What will be the long-term effect on markets and my portfolio?
More lessons from history
We won’t repeat what we’ve already covered above but add:
Headlines have been screaming at us, but Presidential elections don’t much affect the general economy, bonds, employment nor markets overtime.
Many additional factors influence investment performances, including whether the markets had anticipated those economic developments, investor demand, and (for corporations) shareholder responsiveness.
Over the years, there have been countless economic predictions based on political beliefs, with claims made about the effects of tax-code amendments, changes to business regulations, trade policies, and so forth. None of those forecasts occurred.
Mr Rekenthaler suggests that the reason is that there’s no actual science behind such assertions.
He gives an example:
Consider US economic output from 2014 through 2019, which incorporates the final three years of President Obama’s administration and the first three of President Trump’s. It would be difficult to find two presidencies that were more adamantly opposed, with each candidate sharply criticising the other.
Their tax, regulatory, and trade policies were different, as were their foreign relations.
Yet, the annualised growth rate was 2.5% for the first three years and 2.4% for the second period.
Here is the nation’s gross domestic product during those six years, expressed in real terms:
So, too, for employment data. Every presidential candidate claims to have mastered the art of job creation, thereby bolstering the idea that presidents possess such abilities. Once again, Presidents Obama and Trump implemented opposing policies, which, if one believes that presidential actions matter, should have led to dramatically different totals.
Here are the US nonfarm employment figures, also from 2014 through 2019:
The job-growth rate under President Obama’s final three years was modestly higher than during the first three of the Trump administration at 1.8% annualised versus 1.5%. Although it may seem significant, in reality, it becomes more difficult to add jobs as the unemployment rate declines – which it continued to do, reaching a 50-year low in December 2019. Call it a draw.
Why then do claims persist about investments, the economy and the effect of Presidential candidates?
The immediate response is that persuasion wins elections, rather than facts; and that not only do presidential candidates prefer to believe in the myth, but so do reporters and their audience. There isn’t much demand for articles that read “No story here, look elsewhere.”
For all the ink that will be spilled reporting on the election, most market observers think that the election’s outcome will not impact the long-term future performance of the stock market for long-term investors. However, a COVID vaccine will be a game-changer.
2. What are the short-term effects?
While the consensus from journalists on Wall Street is that the market will be especially volatile, it could actually be relatively mundane.
On the policy front, attention has shifted from monetary policy (interest rates) to fiscal policy (government spending) and markets are looking to see to what extent government spending will continue to prop up economies across the world.
Likely market reaction
Since 1927, the election year has been reasonable for shares with an average total return of 11.2% pa.
Of course, this year is complicated by coronavirus and this election comes with greater than normal uncertainty.
3. Summary of key policy areas: Biden vs Trump
As it stands, here is what we know about some key policy areas. Keep in mind that whoever takes office may need to react to a weaker economy than when this election race started:
- Taxation: Biden plans to raise the corporate tax rate to 28% (reversing half of Trump’s cut to 21%), return the top marginal tax rate to 39.6% (from 37%) and tax capital gains and dividends as ordinary income;
- Infrastructure: Biden plans to spend $1.3trn over 10 years;
- Climate policy: Biden aims for the US to reach net-zero emissions by 2050 by raising the cost of fossil fuels and boosting the development of alternatives (possibly with a carbon tax);
- Regulation: Biden is likely to end the era of deregulation;
- Healthcare: Biden wants to strengthen Obamacare and limit drug prices;
- Trade and foreign policy: Biden would likely aim to de-escalate tensions with Europe and strengthen the alliance, work with international organisations like the World Trade Organisation, work to re-establish the nuclear deal with Iran and adopt a more diplomatic approach to dealing with trade and other issues with China (working with Europe and Asian allies in the process);
- By contrast, a re-elected Trump is likely to double up on his trade war with China and possibly elsewhere including Europe and
- Budget deficit: For the near term, the budget deficit is likely to remain high whoever wins, but historically they have fallen under Democrats after rising under Republicans. That said, if the economy proves slow to recover Biden may be more likely to respond with large public sector spending programs aided by ongoing Fed quantitative easing in order to deal with ongoing high levels of spare capacity and unemployment.
4. Trump vs Biden and what it means and the likely short-term impact of possible outcomes
A Trump Victory
A Trump victory will mean more of the same and would likely initially be more positive for the US than global and Australian shares.
If President Trump were to be re-elected, we don’t foresee any significant policy changes and would expect the status quo.
History indicates incumbent presidents tend to lose when there is a recession in the two years before the election and unemployment levels rise:
But we all know that Trump has bucked trends before.
The US share market is sending a more positive signal for Trump and it has been one of the best guides to election outcomes:
If the S&P 500 is up over the 3 months prior to the election date the incumbent party tends to win and vice versa if it’s down. This has been 87% accurate since 1928 and 100% accurate since 1984. Right now, it’s up 1.2% since August 3rd!
A Biden Victory
If former Vice President Biden were elected, but the Senate remains in Republican hands, we think he would be able to implement some of the policies he has advocated, but the scope would be limited.
If there is a Democratic sweep across the presidency and Congress, then the Democrats would have wide latitude to implement the key Democratic priorities within their platform.
Economic impact of a Biden victory:
Higher tax rates and more regulation under Biden would be negative for the growth outlook on their own. However, as with all things economic, it’s never as simple as that.
- The negative impact of tax hikes and increased regulation in the short term could be more than offset by increased infrastructure spending;
- Once in office Biden will likely delay or dampen down his planned tax hikes, given the weak economy;
- Raising taxes on top earners, while a negative for incentive, may help reduce inequality;
- Biden’s trade and foreign policy focused on strengthening ties with allies and a diplomatic approach to China will reduce a source of angst and uncertainty under Trump (which will likely intensify if he is re-elected); and
- More stable and predictable policymaking under Biden may provide a more certain environment for business and so result in increased business investment.
So, most economists see no reason to expect a weaker economic/investment outlook under Biden beyond near-term uncertainty.
It’s interesting to note that Biden’s poll lead over the last six months has been more stable and wider than Hillary Clinton’s was during the 2016 presidential race. However, as 2020 has taught us, don’t bank on the polls!
So… three possible scenarios:
Scenario 1: The ‘blue wave’ – a Democratic sweep of the White House and Congress
Scenario 2: A divided government – a Biden White House and Republican-held senate
Scenario 3: Status quo – a Trump administration with control of the Senate
For more see Betashares take here. Although they are trying to sell you their ETFs, it’s a pretty good overview.
5. Psychological Need
Elections ARE significant, but not as far as market movements nor economies are concerned.
But could there be a psychological need?
The immediate response is that persuasion wins elections, rather than facts; and that not only do presidential candidates prefer to believe in the myth, but so do reporters and their audience. There isn’t much demand for articles that read “No story here, look elsewhere.”
However, there may be a deeper reason, which is that attributing power to presidents brings order to chaos.
If the harvest fails, one could investigate if the soil was adequate, the crops appropriate, and the cultivation suitable. Unfortunately, doing so requires much effort and might not yield a simple answer. Easier to blame the gods. Then all will quickly make sense. Which is fine. Blame the gods, if you wish. But exclude them from your investment and economic analysis.
Tip to reduce stress in your life
What if for one whole week… you did a media fast? Too long? Then scratch that, make it three days. THREE DAYS. That’s just a long weekend!
No screens, no devices, don’t even pick up a newspaper! No. Media. Period.
Give it a shot. And when you do, pay close attention to your emotional state. How does it make you feel? Better? Happier? Sad? Energised? Exhausted?
Concluding comment
The US election has the potential to create further volatility in investment markets.
A Trump victory will mean more of the same and at least initially would probably be more positive for US shares than global and Australian shares (all other things being equal).
By contrast, a Biden victory may add to short-term volatility but this is likely to be short-lived as there is no reason to expect a weaker economy and hence share market under a Biden presidency and he is likely to take a less disruptive approach to trade and foreign policy issues.
Bottom line: Biden might be ahead but it’s premature to write Trump off.
Don’t make short-term investment decisions based on media frenzy. Stick to your long-term plan and stay invested.