Interactive Investor

What are markets telling us about the US election?

29th October 2020 10:41

Hannah Smith from interactive investor

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Is a victory for Trump or Biden being priced in? Hannah Smith looks for stock-market clues.

With less than a week to go until the US presidential election 2020, Democratic candidate Joe Biden has what looks like a reasonable lead in the polls. But, as we know from last time when Donald Trump won a shock victory over Hillary Clinton, the polls are notoriously unreliable. So what are financial markets telling us about what could happen on 3 November?

Schroders global strategist Sean Markowicz says that markets are sending mixed signals, suggesting the contest could be very close.  

He explains that, over the long term, the stock market has had a reasonable track record in correctly predicting election results. Generally, whenever US equities were up in the three months leading up to election day, the incumbent party won and, whenever they were down, the incumbent lost. Since 1932, this methodology has correctly picked the winner 86% of the time, that’s 19 out of the last 22 presidential elections.

That would mean that, with the S&P 500 very slightly up since August (0.7%), the market is pricing in a victory for Trump. The performance of the index over this period, however, was much more favourable for Trump prior to yesterday’s sell-off (28 October), in which the S&P 500 dropped by 3.5%.

Moreover, until mid-September, US stocks were moving roughly in line with Trump’s re-election odds as measured by election betting markets. Now, these indicators are moving in opposite directions, so equities go up as Trump’s re-election odds go down. Betting markets now are not convinced of a Trump win – as of 27 October, his chances are down to 35%, so how can we reconcile these two measures, asks Markowicz?

He suggests one possible explanation is that Biden’s widening lead in the polls has reduced the possibility of a contested election, which is perceived as more negative for stocks, at least in the short run, than fears of higher taxes or regulation under a Biden presidency.

At the same time, stock prices do not just give a possible indication of who might win the presidency, but also the state of the economy, which has been recovering from the fallout of Covid-19.

Another possibility is that the betting markets have placed too much confidence in a decisive win against Trump. In 2016, betting exchanges assigned Clinton an 80% chance of winning the presidency. In comparison, the stock market was down 3.5% in the three months preceding the election, meaning equity investors had actually predicted that Clinton would lose, says Markowicz.

The ‘Biden trade’ has started to outperform   

So, although on the surface the market may be pointing to a second term for Trump, there are some other signals to consider. There are several market rotations taking place that point to a Biden win – stocks that are expected to benefit from a Biden presidency have surged as he has pulled ahead in the polls.

Small vs large caps: US small companies have trailed their larger peers since the pandemic began. However, since September, small caps have outperformed by 4.4%, as Biden’s chances of taking the White House have increased, as analysts hope for higher economic growth and a larger fiscal stimulus package that would lift small caps.

Emerging markets vs US equities: emerging-market stocks have suffered as a result of recent US-China trade tensions. But, under a Biden administration, analysts expect relations to be less fractious. With emerging-market equities up 5.9% versus the US since the beginning of September, investors may be pricing in this outcome.

Value vs growth: value stocks have taken a huge beating this year, as investors sought refuge in fast-growing technology stocks. However, following a major sell-off in tech in September, value has started to gain the upper hand. But will this last? Many investors expect the Big Tech stocks that have powered the market rally this year to come under stricter regulatory scrutiny under a Democratic president. Meanwhile, banking stocks, which represent a large component of value indices, should profit from a stronger economy, especially if accompanied by higher interest rates. But they may also be subject to a tougher regulatory regime, and it is unclear if one factor will outweigh the other.

No silver bullet

So which indicator is right? There’s no “silver bullet” and, with such mixed signals, we can expect a close-run race to the White House, says Markowicz. Whatever the outcome, what does it mean for your portfolio?

“Regardless of who wins, history tells us that, in the long run, neither political party is better or worse for your investments. Presidents do not operate inside a vacuum and there are many other factors that can influence markets such as valuations, interest rates and inflation, among other things,” he adds. “It is generally held that investors should avoid knee-jerk reactions once the winner is declared.”

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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