What to anticipate ahead of the US elections this year
US Elections have been and are always expected to be an extremely volatile event worldwide. Elections, similar to other political or banking sector events, are notably treated by market participants with anticipation and speculation.
Hence as the US election looms, today's article is not in regards to the outcome but in regards to current markets positioning just a week prior to the election as well as their future response to each possible outcome.
While we have been facing an overall weak Dollar in the second half of the year, the proclivity for capital being safe harboured in US Treasuries means this is hinged on the global growth outlook establishing a sustainable improving trend, and that in turn may hinge on the world getting through the Covid crisis. However, the upcoming US election presents risks too, particularly given the perceived chance of the election being contested.
Markets are anticipating another US fiscal package, although the timing remains uncertain, and the size and scope of it will be dependent on the election result. Wall Street narratives suggest that US stock markets are pricing in a blue wave on November 3, with Democrats sweeping the House, Senate and Presidency, which would result in many trillions of Dollars in fiscal support.
So far in October Biden's lead in the polls has deducted the risk of a contested outcome and hence supported the US Equity market to recover since September (after the 1st debate), but also drove the risk sensitive Yen. This comes in contrast with the historical reaction of Stock markets in prior elections.
Historically, the stock market slows down and shows a weaker performance in the period leading up to an election, according to a study from US Bank. On average, the equity market showed a less than 6% gain during election years compared with an 8.5% gain in any other given year.
How could the stock market respond to a Biden win (Democrats)?
In the short term a Democratic win would support optimism as it would reflect an additional huge stimulus package. However, a blue wave outcome could also signal the prospect of higher taxes on businesses and rich people, something that could lead to a potential Equity market pullback. Biden's tax proposals are a means of paying for some portion of his spending initiatives such as health plans, housing support plans, jobs creation in the American auto industry, sustainable energy infrastructure and rise of minimum wage.
Hence not everything is black and white, as tax proposals could boost economic growth while on a foreign level they would trigger a more stable foreign approach as he ambasses a more conciliatory agenda for global relations. Having all this in mind the US major indices such as USA500, for example, remain close to record highs despite Biden's tax policies, something that could imply that market participants are not necessarily sure that a Democratic victory would weigh on Equities. However, if markets fall on Biden's election this could in the near term boost the US Dollar into a rally.
How could the stock market respond to a Trump win (Republicans)?
History tells us that it is still possible that we will see a Trump win, even though it looks unlikely based on polls. Since 1928, the party that controlled the White House has won 90% of the time. The times that this happened the largest US stocks have risen in the 3 months prior to the election. Let's not forget that Trump's policies are geared towards American manufacturers and Wall Street (in contrast with Biden) - which could mean that Stocks could rise if the incumbent remains in office.
According to CNBC journalist Nathaniel Lee: "Across the last seven presidential election cycles, average gains for major indexes such as the S&P 500 and Dow Jones showed positive returns in the six months before Election Day. The only exception was the 2008 financial crisis that rocked the stock market just ahead of November." - despite that, the stock market tends to perform on average much better during Democratic presidencies than Republican ones.
As discussed in our HF Markets Q4 Outlook, markets look to have already priced in the possibility of Biden's victory even though they overall maintain an increasing cautious optimism, holding the US Dollar basket at 2018 low territory.
Election-year fund flows, 1993-2020
Historically, it has been noticed that during election years, heightened uncertainty leads market participants to shift their investments into money market funds instead of the safety of stock and bond funds, as they wait it out. The year 2020 is not any different but it's been a unique one as we have seen an extreme money flow into currency assets in comparison with past election years, due to the sluggish US and worldwide economic activity as the Covid-19 crisis resumes, the truce with China which is again under scrutiny, the lockdowns in several areas, the lack of additional fiscal stimulus from central bankers, Brexit frictions and the fear of a double dip recession in Europe.
That said, cash balance into money funds spiked to $980 in 2020 as of June 30, given the large risk premia. However, as soon as the uncertainty recedes, we might see the equity market's volatility and volume spike again since they are considered to be attractive and more stable assets in periods in which there are historically low interest rates. If we focus on the medium term though it is expected that if current conditions sustain, market volatility will extend beyond Election Day regardless of the outcome, i.e. a Biden win and Democrat majority in Congress, a Biden win but split Congress, or a Trump victory with split Congress.
Meanwhile, a chart from the Wells Fargo Investment Institute shows the USA500 implied Volatility index along with the USA500 index performance prior and post-Election Day based on every election since 1988, with the 2008 recession year excluded. This chart interestingly suggests that typically the USA500 tends to ease/consolidate a bit a month prior to elections despite extremely high volatility, while the USA500 price continues its upwards move after the election day even though volatility declines significantly.
This article was submitted by Andria Pichidi, Market Analyst at HotForex.
