The US elections come around every four years, and the 2020 election will be unlike any other. For the last few months, we’ve been witnessing two grandads contesting to lead the oldest democracy in the world. The presidential election takes place with the backdrop of the coronavirus pandemic, a trade war with China and a less united European Union. That’s in addition to older issues, such as conflict in the Middle East.
Why should you care about US politics?
There was a time when the politics of one country did not affect another country. But we now live in a globalised world. The world is so interconnected and interdependent that in some cases, countries rely on other countries for even their most basic needs (including drinking water). For any given product or service you consume, you can be fairly certain that a mix of companies from around the world were involved in the chain linking production to consumption. Undoubtedly, the USA is home to the largest and most ubiquitous corporations in the world and if these corporations are affected by US politics, soon enough, you will be, too.
In fact, at Interactive Investor, one of the UK’s largest DIY investment platforms, customers hold ⅕ of equities overseas, of which, on average, 77% is US shares, reports the Financial Times.
People may observe the US elections for different purposes. An election can be fascinating in its own right as a political and historical event, but the focus for this article is purely a financial one. Whilst every election is unique, there are many patterns that can be observed, which may be useful to note as stock traders.
Analysts at U.S. Bank, which is the fifth largest bank in the states, studied market data from the past 90 years and observed patterns that repeated themselves during election cycles. This is by no means a guarantee that the same patterns will occur again, but more often than not, it does.
Generally speaking, equities provide gains as good as 8.5% over a 12 month period, — but in the year leading up to a presidential election, gains totalled less than 6%, according to the same analysts. Likewise, the bond markets provided similar results, with returns of around 6.5% in the year leading up to a presidential election, compared with their more typical 7.5% in any given 12-month period. Of course, bonds are totally forbidden for Muslims, but the point stands that during election years, returns are lower. After the election is over and done with, stock market returns tend to be slightly lower the following year, while bonds tend to outperform slightly after the election.
But if the Republicans (the supposed business-friendly party) take power, that’s better for businesses, and therefore the economy, right? No, not really, according to U.S Bank analysts.
You may find an article and graph published by City Index interesting on this point. It shows that overall, the stock market rises irrespective of the party. It also suggests that when the democrats are in power, the rises are slightly bigger.
It doesn’t seem to make much difference which party takes office, but it does matter whether control of the White House changes hands. The introduction of a new president tends to see a 5% gain in the stock markets, but if the same president is re-elected, returns were slightly higher, at 6.5% say the analysts.
On the point of the president, COVID19 complicates matters somewhat. Trump presides over the worst COVID19 infection and death rates in the world. At the time of writing this article, infection rates stood at 9.1 million cases while the death rate stood at 240,000. This introduces two themes into the elections. First, how well the virus was managed affects the economy; it affects how normally the economy can operate, which affects company profits. If voters believe Trump managed the virus well, his chances of re-election are boosted, according to the Economic Times of India. Second, while the virus is at large, many people may not be able to go out. So, postal votes have become an important mechanism in this election race. Trump has already cried (postal) fraud and in the event that he loses, he may not accept the election result. So we may not know the winner of the presidential contest immediately. This brings in an element of uncertainty, and every time we have uncertainty we have volatility.
In any case, the president is just one part of the puzzle and cannot introduce new ideas and laws (such as tax rises (or cuts) or infrastructure projects) alone. For that to happen, the senate needs to be convinced, which is not always an easy task.
There’s a famous saying that one man’s loss is another man’s gain. We certainly saw that in early-mid 2020 when leisure related stocks (such as holiday companies) took a battering while stay-at-home companies (such as Netflix) benefited massively. The economy may decline a little, but it doesn’t mean the whole economy will be down. It’s more likely that certain sectors will be affected and this point is particularly relevant for the Muslim investor. Put another way, if a Muslim cannot invest in Ladbrokes, would they be allowed to invest in Betfred? It would be impermissible to participate in that entire industry. Another example is the airline industry. There is nothing inherently haram about airlines, but given airlines’ high level of debt (which tends to be across the board), investing in the airline industry becomes problematic. It’s important to remember that presidential elections can have specific consequences for the market's various sectors, depending on each party's agenda and how much of Washington they control.
So, which industries might the US election results affect the most? We’ve seen what happens to the economy with Trump at the helm. But what if Biden was to take power?
According to Societe Generale, the French banking giant, the digital technology sector is in for a rude awakening because if Biden wins, he’ll look to push through greater regulation of how personal data is handled. In a similar vein, banks may experience greater scrutiny, too.
Another loser might be the pharmaceutical industry if Biden wins because he is likely to put controls in place for drug pricing, which will affect profits of big pharma.
Infrastructure, on the other hand, is likely to be a winner if Biden wins.
But perhaps the most upheaval will be seen in the energy sector. Biden wants to decarbonise the economy, instead opting for electric power with plans to spend £2tn within four years, according to news outlets such as the Financial Times and America’s CNBC.
A major talking point is Biden’s desire to raise tax from 21% to 28%. That’s a huge hike by any standard. If this were to materialise, one would expect some of this tax money to pay for big infrastructure projects. According to the Financial Times, if all of Biden’s tax proposals were implemented, it would reduce S&P 500 earnings by some 9%.
Another major talking point is trade. Biden and Trump have largely different approaches to trade. A Trump re-election means more trade friction and escalated commercial conflict with China, say analysts, whereas Biden is less confrontational and would seek to utilise multinational organisations like the World Trade Organization. This does not make Biden better or worse than Trump, it just makes him different.
All this will put pressure on the dollar, a key consideration for non-US buyers of American stocks. “Political risk is high, the dollar is weakening, interest rates are at rock bottom, so gold is attractive. Corporate debt is at an all-time high, government debt is high,” says Luca Paolini, chief strategist at Pictet Asset Management. “Everything is against the dollar.”
Finally, it turns out that the stock market has an uncanny ability to predict who will win the US presidential election. If the stock market is up in the three months leading up to the election, the incumbent party wins the election. Losses over those three months tend to usher in a new party, according to the Financial Times.
The statistics are compelling. In the 23 president elections since 1928, 14 were preceded by gains in the three months prior. In 12 of those 14 instances, the incumbent (or the incumbent party) won the White House. In eight of nine elections preceded by three months of stock market losses, incumbents were sent packing. That's an 87% accuracy rate. (Exceptions to this correlation occurred in 1956, 1968 and 1980.)
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