How the outcome of the US elections could affect the global stock market

The Covid-19 pandemic didn’t leave much space for other talking points in the markets this year, but with the outcome of the US election imminent, investor attention will inevitably shift towards how different outcomes could impact the performance of the US stock markets.

Historical data shows that stock market volatility tends to increase in the months before a US election, thanks to political uncertainties and the continuous re-assessment of poll results and market expectations.

As a rule of thumb, a Republican lead is supportive of stock prices as Republicans tend to favour policies which boost company earnings and shareholder profits. Alternatively, a Democrat lead would have the opposite impact on equity prices as Democrats would concentrate on redistribution of wealth, and social rights and benefits.

In addition, markets tend to perform better when the sitting president stays in office for a second term. It is, again, a matter of more certainty, and a switch from a Republican to Democrat government could have a negative impact on stock prices as investors factor in business-unfriendly changes such as tougher regulation, higher corporate taxes and so on.

However, this time it is different. The US economy has been struggling with an unprecedented recession due to the global pandemic that has ravaged all layers of businesses across the country. Donald Trump has been criticised for his poor management of the public health crisis that resulted in the US being the worst-hit country by the pandemic worldwide.

With roughly 15 million unemployed and a skyrocketing government debt, the US economy is not out of the woods just yet, even though the V-shape correction in the US stock markets distorts the perception of the underlying fundamentals and paints a drastically different picture compared to what’s really happening on the field.

The stock market and the economy are key indicators of who wins a presidential election, according to Forbes, with ‘avoiding a recession’ in the two years leading up to an election a key indicator of re-election. In the past century, presidents who averted a recession during this two-year period have always been re-elected.

Likewise, a positive performance in the S&P500 during the three months leading up to an election has been a major sign that the sitting president would be re-elected and a negative performance in the S&P500 would hint at a new government taking over. According to Forbes, the S&P500’s three-month performance has predicted up to 87 per cent of the election outcomes since 1928, and 100 per cent since 1984.

But in the past, the stock market performance has been at least somewhat in line with the underlying economic situation. This is clearly not the case this year. Donald Trump has constantly demanded a loosening monetary policy of the Fed, and this policy has been the main reason behind record US equities.

Massive monetary and fiscal stimulus pumped a gigantic amount of liquidity into the financial markets, triggering the fastest rebound in equity prices following a bear market. Meanwhile, the real economy has been left behind the market euphoria, and saw only a moderate recovery.

So if we look at the actual state of the economy, Donald Trump is in a difficult position, as he has been the victim of the worst economic recession of our lifetime, and the situation will unlikely get any better by the time voters go to the ballots. If he is re-elected, Wall Street is likely to celebrate in the short term, however in the long-term, the macro-environment will determine the effect.

The 2020 elections will show what matters the most to American voters: the stock market performance, or the real economy.

The election polls showed up to a two-digit advance for Joe Biden over Donald Trump, even though the latest polls hint that Biden’s lead significantly narrowed since June. But there is no sign of stress regarding the Biden-lead across the US equities. Given the cataclysmic economic conditions, Democrats are unlikely to risk harming the financial markets, fearing that any weakness across equities would have broader implications for the economy. So, investors are convinced that the pandemic will somehow protect their capital gains even under a Democratic government.

On the other hand, even though a handover to a Democratic government might have an early negative reaction of some 2-3 per cent drop in major US indices, historical data reassures us that knee-jerk sell-offs have been short-lived and the stock prices recovered the year following an election, regardless of who was elected.

Gold’s momentum has started to weaken, so although we don’t expect a big drop, trading may remain choppy. With regards to the USD, while we don’t expect any change in US monetary policy, it may start regaining trust if Biden wins and US yields start attracting investors again.

The worst case scenario will be if Trump loses the election but doesn’t accept the results, in which case a huge amount of the US government’s time, attention and political capital is going to be sucked into the constitutional crisis that will ensue. A turbulent political and legal drama such as this engulfing the world’s biggest democracy and economy is likely to rattle global markets, as the world holds its breath to see where the chips will fall.

Our preference is to diversify the portfolio to avoid being over-exposed on one asset or market. A portfolio consisting of gold (both physical gold and gold ETFs), short term bonds (1-3 years) and high-quality equities is a good investment selection. It will be better to focus on the realistic returns and hedge positions on USD and gold before the election if investors have considerable exposure.

The impact on USD and gold will not happen immediately in any of the possible scenarios, and the election outcome will only be one factor among many others influencing investments. Whether Trump wins or loses, we recommend that a 10-15 per cent cash (of the total portfolio) is maintained in case any opportunities emerge.

Chaddy Kirbaj is the vice director at Swissquote Bank’s Dubai Representative Office