As investors confront the upcoming US Presidential election, we believe that, in terms of market impact, two uncertainties dwarf the obvious question of who will win the Presidency.
A smooth transition of power
The first question is whether there will be a smooth transition of power. In past elections, a predictable process was mostly taken for granted, but we should not do so this time given multiple red flags that President Donald Trump is prepared to contest the election. These include his refusals to commit to accepting the results, his claims of widespread voter fraud – and more tellingly, Trump’s prediction that the outcome will be decided by the Supreme Court.
Faith in US institutions and the stability of its democratic processes play a key role in underpinning investors’ confidence in its markets – and a chaotic and drawn-out contest would result in much anxiety.
To illustrate, the last contested election in 2000 between George W. Bush and Al Gore was relatively brief – starting from election day on Nov 7 and lasting till Dec 13 when Gore conceded. This episode ended more than a month before the planned inauguration of the new President on Jan 20, 2001; even so, we saw the S&P 500 fall more than 10% over that period, while the US dollar depreciated and safe-haven gold rose in value.
At the time of writing, Joe Biden’s average lead in the polls of about three percentage points in the six battleground states of North Carolina, Arizona, Florida, Pennsylvania, Wisconsin, and Michigan has significantly reduced, but not eliminated, the risk of a contested election.
Like the 2000 election, Florida is a wild card, given that Biden’s lead there is only 1.2 percentage points, which falls within the margin of error.
On election day, the focus will be on Florida, North Carolina, and Arizona, and if Biden builds a clear and early lead in these states, then Trump’s options to credibly contest the result would be curtailed. If Trump wins Florida and Ohio, however, the risk of a drawn-out contest rises precipitously.
Will Congress remain in gridlock?
The second question is whether the US Congress will remain divided after the elections, that is, the Senate controlled by a Republican majority and the House of Representatives by the Democrats.
If gridlock persists, then never mind who wins the Presidency – both Biden and Trump will find it difficult to expand government spending or implement their respective agendas to boost growth.
Since the 2018 mid-term elections when the House flipped to a Democratic majority, Trump has struggled to bridge the gulf between the two parties; and his surprising failure to pass a new pandemic relief package in the fourth quarter of 2020 that is so critical to sustaining the nascent US recovery reflects the negative effects of the partisanship in Washington today.
Scope for near-term turbulence
These two election-related risks signal scope for near-term turbulence for markets – especially if we also take into account the negative impact of new Covid-19 surges in the US and Europe as we head into the winter season before the widespread availability of vaccines, and the waning of the supportive effects of US fiscal stimulus over the next few months before a new package is delivered, likely in the first quarter of 2021.
Long-term market outlook is positive
Over the medium to long term, however, we believe the outlook for markets is positive.
While election uncertainties may loom large for now, polls suggest that the most likely outcome is a Biden win with a Democratic sweep of Congress. In this scenario, we expect Biden’s policies to result in higher growth, moderately rising inflation, and a weaker US dollar. This environment is favourable for equities, credit, commodities, and emerging markets.
Even if we see a contested US election or a gridlocked Congress outcome that hurts sentiment and growth for a period, it is key to remember that the US Federal Reserve is willing and able to employ its tools to bend the arc of the economy towards growth.
With rates near zero, the Fed’s most potent weapon is money printing. As seen in the aftermath of the 2008 Great Financial Crisis, this tends to exert upward pressure on financial asset prices over time.
Investors should approach periods of volatility ahead as opportunities to prudently buy sound assets with a patient, long-term view.
This article was published by The Straits Times on Nov 2, 2020, in its print and online editions.Disclaimer applicable to recommendation
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