US stock markets are shaping up for a volatile October and November as the presidential election enters its endgame. Angry debates, accusations of mail fraud and now the coronavirus have seen the US election become anything but predictable, even by Donald Trump’s standards.
Anyone doubting the impact of politics on US stocks right now only has to look at how the US stock markets reacted to news Trump has tested positive for COVID-19. The S&P 500, Nasdaq and Dow all ended last week down following the announcement.
What followed was an extraordinary 48 hours, with Trump admitted to the Walter Reed hospital for treatment, conflicting reports about the president's health and a televised address from Trump himself on Sunday.
What happens next in the election battle could well have a bearing on US stock markets up to, and even after, Americans go to the polls on 3 November.
US stocks are in for post-election volatility
Trump’s diagnosis sent Wall Street’s Volatility Index (VIX) up half a percent on Friday — implying increased volatility in US stock markets. This is only likely to increase in the coming months, especially in the event of a disputed election.
While in previous contests this would have been unthinkable, President Trump has continued to cast doubt over whether there would be an amicable handover of power should Democratic Party challenger Joe Biden win.
Future contracts on the VIX — which is used to forecast upcoming trading volatility — point to heightened movement around October and November. Jason Goldberg, a portfolio manager at Capstone, told the Financial Times that potential volatility for the end of the year is above average, indicating that markets are expecting a messy, prolonged election.
“What is interesting isn’t the election peak but the fact that it doesn’t come down quickly after the election. The market is saying that we might not get a clean election.”
“What is interesting isn’t the election peak but the fact that it doesn’t come down quickly after the election. The market is saying that we might not get a clean election” - ason Goldberg, portfolio manager at Capstone
What a Trump or Biden victory means for US stock markets
Polls suggest that Biden is on course for victory. However, over the recent month, odds of a Democratic victory have been slashed as the contest becomes increasingly fraught. Even if Biden wins, anything other than a clear-cut victory is likely to result in prolonged litigation similar to the disputed 2000 election.
Analysts seem split on what a victory for either candidate would mean for US stock markets. In a CNBC poll of 20 analysts, 14 predicted a Biden victory. Only 3 expected a clear victory for Trump.
However, half of those polled predicted the S&P 500 will decline in the first month after the election, with eight saying they expected a decline of more than 5%. Of the rest, 5 thought there'd be a rally, 4 a range-bound market, and one analyst chose not to offer a prediction at all.
Biden has suggested taxing dividends as ordinary income. That could put US stocks, especially the tech sector, under pressure as investors look to lock-in gains.
“If you have enough people looking to harvest gains, that has an impact on the stocks that have led the market, and the big tech stocks could be where people choose to sell at the end of the year,” said Eddie Perkin, chief equity investment officer at Eaton Vance.
“If you have enough people looking to harvest gains, that has an impact on the stocks that have led the market, and the big tech stocks could be where people choose to sell at the end of the year” - Eddie Perkin, chief equity investment officer at Eaton Vance
In theory, a Trump victory should be beneficial for US stock markets. 11 of the analysts polled by CNBC thought that the S&P 500 could rally by 5% if Trump wins. However, some of those polled said that any gains could be capped in 2021 due to Trump's economic policies.
Where's the opportunity?
Uncertainty around the election creates a unique challenge for traders invested in US stock markets. One possible strategy is to avoid US stocks altogether.
"If your baseline assumption is that there's going to be a contested election ... recognize that this is a US-specific event and therefore that argues for underweighting US assets versus other assets," a JP Morgan strategist told Bloomberg.
“If your baseline assumption is that there's going to be a contested election ... recognize that this is a US-specific event and therefore that argues for underweighting US assets versus other assets” - JP Morgan strategist
Another possible move is hedging bets through a diverse portfolio. If Biden wins, clean energy, healthcare and infrastructure stocks could do well. Biden has promised to pump money into clean energy initiatives. Likewise, a Trump victory could be good news for tech stocks, especially if there is a tail-off in US-China rhetoric.
The real opportunity might come with investing in the long-term, though. A contested victory is likely to see the S&P 500 slump between 5-10% according to 11 analysts in the CNBC poll. Another 5 said that the selloff could be worse than 10% in this scenario.
If this happens, then investors with a longer-term timeframe could pick up a bargain, especially in sectors that have seen outsized growth this year.