Economics & Markets

Markets may soon start to pay attention to the US election

By Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist, AMP Capital Sydney, Australia

Investor focus on the US election waned earlier this year after Bernie Sanders dropped out of the Democratic primary race in favour of Joe Biden. At the same time coronavirus became the main focus for markets. However, markets may soon start to pay more attention.

Though COVID-19 is a major focus, the election is rapidly approaching in the US. While Joe Biden is a moderate, he is proposing higher taxes and more regulation and President Trump is not having a good run. Trump’s re-election chances have fallen, with a majority of surveyed Americans disapproving of his handling of the pandemic and recent civil unrest, at a time when the US has plunged into its deepest recession since the 1930s. The historical record indicates incumbent presidents tend to lose when there is a recession in the two years before the election and unemployment has gone up.

Normally at this point past presidents seeking re-election have started to see an upswing in approval, but this is not evident yet for Trump. Rather, consistent with the above, according to Real Clear Politics’ average of polls Trump’s approval rating has fallen to 41.2% over the last two months, his disapproval rating is edging above its 2019 high, opinion polls have Biden leading Trump by around 9 points and Biden is ahead in all 6 “battleground states”, the ‘Predict It’ betting market, which had Trump ahead of Biden up until late May, now has Biden with a 23 point lead and also now has Democrats winning the presidency, the House and the Senate. The Democrats already have control of the House and are likely to retain that, but they need three seats to then along with the Vice President, gain a majority of the Senate. A clean sweep for the Democrats would remove the Senate as a blockage to higher taxes.

However, it would be wrong to write Trump off. Polls and betting markets were not so reliable in the 2016 election, there are still four months to go to the election and ongoing civil unrest could see him garner support as a “law and order president” as Nixon did in 1968.Trump rates more highly on the economy than Biden and this may get a boost if the economy continues to reopen and recover. A rebound in the economy is Trump’s best hope which partly explains why he cheered on reopening from the end of April. However, the rebound in US coronavirus cases in many states in the last few weeks puts all this at risk.

Likely market reaction

Firstly, despite the heightened policy uncertainty the election year is normally an okay year for US shares.

Since 1927, the election year, or year 4 in the presidential cycle, has had an average total return of 11.2% pa, which is only just below the average return for all years. Of course, this year is complicated by the coronavirus hit to growth and so may well be weak regardless of the election.

Second, the run up to the election could see increased share market volatility if Trump’s prospects look bleak for two reasons: investors may start to fret about the prospects of increased taxes and regulation under a Biden presidency, particularly if it looks like Democrats will win control of the Senate; and Trump may reason that he will have nothing to lose by seriously ramping up tensions with China (and maybe Europe) in a way that threatens the economic outlook, but with the prospect of shoring up his base and rallying Americans around the flag. However, while there may be short term jitters ahead of the election, there is no reason to expect a weaker economy and hence share market under a Biden presidency as increased infrastructure spending is likely to offset the negative of higher corporate taxes, he is likely to dampen down his planned tax hikes once in office anyway and he is likely to take a more diplomatic approach to resolving trade issues. In fact, investors may ultimately welcome more reasoned and predictable policy making under Biden.

Third, historically US shares have done best under Democrat presidents with an average return of 14.6% pa since 1927 compared to an average return under Republican presidents of 9.8% pa. This has been evident in recent years with good average annual returns under President’s Obama (14.8% pa) and Clinton (19.1% pa) versus terrible returns under President G W Bush (-0.6% pa) but strong returns under President Trump’s first three years (16.3% pa).

However, the best average result has actually occurred when there has been a Democrat president and Republican control of the House, the Senate or both. This has seen an average return of 16.4% pa. By contrast the return has only averaged 8.9% pa when the Republicans controlled the presidency and Congress.

Concluding comment

The run up to the US election has the potential to drive increased share market volatility if it looks increasingly likely that Biden will win and raise taxes and regulation and the risk is probably greater if President Trump decides he has nothing to lose and so ramps up tensions with China and maybe Europe. This would weigh on global and Australian shares and the Australian dollar given Australia’s exposure to China. However, 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.

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