Implications of U.S. elections

The U.S. elections are now just a few months away and the rhetoric will undoubtedly pick up sharply in the weeks to come. This week, Democratic presidential nominee Joe Biden announced that California Senator Kamala Harris will be his running mate. Vice President picks rarely influence election outcomes. While there may be some incremental impacts at the margin from this week’s news, we don’t expect it to shift the narrative much.

The race for the presidency understandably gets most of the attention. But, the legislative branches of the U.S. government will also be elected in November. The U.S. Congress is made up of the Senate (currently controlled by Republicans) and the House of Representatives (currently controlled by Democrats). Within Congress, there are certain rules that require enough bipartisan support for a law to be passed. This important division of power acts as a guardrail of sorts, and ensures that any sweeping policy changes have enough support from both Democrats and Republicans. In other words, there are checks and balances in the U.S. political system that ensure a President alone cannot drive policy.

With respect to election outcomes, we see three plausible scenarios: 1) status quo; 2) Joe Biden as President while the House and Senate stay unchanged; and 3) sweeping victory for the Democrats (President, Senate, and House). This latter scenario may pose the most uncertainty for the market as it could increase the odds of higher taxes and more restrictive regulation in the future among other things. Nevertheless, we think the elections are unlikely to alter the course of fiscal policy in the intermediate term as both Democrats and Republicans are incentivized to help their constituencies through this period of economic malaise. Furthermore, accommodative monetary policy, which has helped ignite the economic and market recovery is unlikely to change any time soon regardless of election results.

Elections and the equity market track record

During an election, it can be difficult for investors to maintain a longer-term perspective, given strong emotions evoked by politics. Add to that the non-stop 24/7 coverage by the media, and it makes it all the more difficult to ignore. In our conversations with clients, we have been getting an increasing number of questions around the election. Most people want to understand the risk that it poses to the market.

The best way to answer this question is to look at a couple of charts that come from our investment partners at Capital Group. For long-term focused investors, which we all are, the outcome of the U.S. presidential election hasn’t mattered as much as staying invested and maintaining one’s investment discipline. As you can see from the chart below, markets have tended to grind higher regardless of the party under control.

We will look at one more chart that conveys a similar message. Consider the historical performance of the S&P 500 over the past eight decades. In 18 of the 19 elections, a hypothetical $10,000 investment made at the beginning of each election year would have grown in value ten years later – regardless of which party or candidate won. In 15 of those 10-year periods, a $10,000 investment more than doubled.

The only negative ten year period that followed an election was George W. Bush in 2000. During that decade, the market had to deal with two significant events – the dot.com crash and the 2008 financial crisis.

We will likely have a lot more to say on the election as we move closer to November. We thought that the above serves as a good starting point, and provide some context as to why we are not overly worried about the election.

A word on market resilience

Many investors remain concerned about the current backdrop. After all, we remain in the midst of a global pandemic, with an economy that is recovering after a multi-month period of forced shut down. Much uncertainty remains. Nevertheless, global markets have been resilient in recent months. The widely followed S&P 500, an index representing the U.S. equity market, is higher today than it was at the beginning of the year. Elsewhere, markets continue to claw back much of their losses, though they still remain below breakeven on the year. While this may seem incomprehensible, there are some justifiable reasons for the resilience. More specifically:

• We are learning how to keep an economy functioning with the virus lurking in the background.
• Containment measures, assuming they are followed – mask wearing and physical distancing – have proven to be an effective way of limiting the spread.
• Health care providers have learned how to better treat patients.
• Governments continue to buy time for more healing through substantial aid to businesses and consumers.
• Central banks have aggressively lowered interest rates, incentivizing borrowers to refinance or borrow for new spending or investment. Moreover, they have ensured the proper functioning of credit markets.
• The scientific community is closer today to finding a vaccine, though this cannot be guaranteed.
• Economic momentum is improving, rather than deteriorating.

We have been impressed with the recovery, but remain vigilant given the elevated level of uncertainty. As always, we don’t know what will transpire in the weeks and months to come but will remain focused on ensuring that our investment plan can deliver the required outcomes of our clients.