With less than two months before the US presidential elections, attention is turning to what effect different election outcomes may have on the US equity markets.
If we believe the polls, then a new President will be seated in the White House come January. Joe Biden appears to lead Donald Trump by about 8 per cent, as swing states take on a blue hue.
But as we learned four years ago, the predictive power of polls is far from absolute and, after the Republican convention, betting markets have dramatically shortened the odds of a Trump victory.
History favours Trump: about 75 per cent of sitting presidents have been re-elected. Declining numbers of new Covid-19 cases would boost Trump's chances of a second term and, with that, improve the prospects for the stocks perceived to lose the most under a Biden win, which include the big domestic taxpayers, the managed care organisations, and the traditional automakers.
A Democrat win is widely perceived as negative for the stock market, with the prospect of higher corporate taxes taking centre stage. A Trump win is regarded by many equity strategists as a positive for stocks, with a continuation of the status quo preferred to the uncertainty attached to a Democrat win.
The Democrats' main policy priorities seem to be the medical and economic response to Covid-19; addressing climate change; increasing spending on infrastructure/green infrastructure; and criminal justice reform (important to V-P nominee Kamala Harris).
To pay for it all, a corporate tax rate of 28 per cent (up from 21 per cent) has been mooted, alongside other tax increases on both corporates and higher-income households. This could cut earnings across S&P500 companies by up to 12 per cent, with a disproportionate impact on companies with a US-domestic focus including parts of health care, financial services, and construction including the homebuilders.
However, implementation may be challenging (most tax proposals were released prior to the pandemic). Any tax headwind should also be weighed against the likelihood of higher government spending that should help corporate earnings and employment in some industries including construction and clean energy.
In the short-term, investors may need to brace themselves for increasing volatility, both around the time of the election itself and in any transition to a Democratic government. Trading at 24 times 12 months forward earnings, the S&P500 is not cheap in absolute terms. Nor is the US market cheap relative to other global markets.
Covid-19 has disrupted the campaign, while state voting policies, including the use of mail-in ballots, may increase the chances of a contested election. Markets dislike uncertainty.
Remember Gore v Bush? In 2000, the S&P500 dropped 5 per cent in the five weeks between election day and when the outcome was resolved. Could a defeated Trump throw us all one last presidential surprise in his final days of power before a Biden inauguration? I wouldn't rule anything out.
Ultimately, these sources of short-term volatility are likely to be noise that resolves itself within any reasonable investor's time horizon. Whatever the election outcome, markets will, over time, come to terms with whatever the election process provides. Different industries will feel the weight of policy to different extents. There will be winners. There will be losers.
Betting on the result is foolhardy.
The most radical result?
The US Constitution created the United States Senate with equal representation — two senators — from each of the country's states, irrespective of each state's population. In both the 2016 elections and the 2018 mid-term elections, the Democrats' success in terms of total vote numbers did not translate into senate seats.
In the 2018 mid-terms, Democratic Senate candidates collectively were some 20 percentage points ahead of their Republican opponents. The Republicans increased their majority by two seats. (The indirect method Americans use to select their president has produced similar results of late, with both Trump in 2016 and George W. Bush in 2000 gaining office despite winning less of the popular vote than their opponents.)
Article IV Section 3 of the Constitution gives Congress the power to admit new states, subject to a presidential veto. A blue wave that places Biden in the White House and the Democrats in control of the Senate could see the creation of two new (likely Democrat-voting) states, which would lower the chances of future minority rule and reshape American politics for decades to come.
• Alexander Whight is a portfolio manager at Milford Asset Management.