The US election: Too close to call?

In a week that saw the Presidential debate between Donald Trump and Kamala Harris, it seemed a good time to discuss potential market scenarios as we approach election day and beyond. 

If the polls are to be believed, the Presidential election is too close to call. FiveThirtyEight.com, a branch of ABC News in the US, estimates that Kamala Harris would win 56 times out of 100 at the time of writing. That’s hardly conclusive. The other complexity is that both Houses of Congress will also see elections—albeit not in every state. For instance, the Democrats have a very slim majority in the Senate, and that could be at risk. That increases the number of scenarios we might need to consider. 

We should ask if the historical pattern is relevant this time around. Some analysts have noted that US equities typically perform better if the incumbent party wins. But that might not always be the case, nor is it clear why it should be.

It’s also worth stressing that, while elections may cause some short-term volatility, over the long term, the overall health of the US economy – growth and inflation – matters more than which party is in power.

As we think about potential policies, the usual caveats apply. We don’t really know what the candidates might do as President, nor do we know if the Congressional results will allow them to implement their plans. There’s some data to suggest that US equities perform best (just about) when Congress is divided, suggesting that investors don’t want to see too much policy intervention from the government.

But, if we take their comments at face value, there are a couple of points to make. 

Kamala Harris has been talking about raising corporate income tax in the US, while Donald Trump has promised to lower it. All things being equal, we think investors will look more favourably on lower tax rates – in theory meaning more cash flow ending up in the hands of investors. We’d argue that the equity rally following Trump’s victory in 2016 was, to some extent, a consequence of lower expected taxes. You’d also guess that a Republican administration might try to reduce regulation. Investors often look favourably on that, at least in the short-term, even if the long-term impact might be less clear. The important caveat here is that the US fiscal situation is not great, and isn’t expected to improve significantly no matter who wins. The two parties might approach this in different ways – lower taxes and lower spending for Republicans, higher taxes and more distributions for the Democrats – but the US deficit probably won’t improve, and could increase further. For now, we think that financial markets will look past that, but it remains a longer-term question.

The second point is around trade tariffs. Trump has argued in favour of increasing (aggressively) US tariffs on foreign goods. Trade policy is an area where Presidents typically have a lot of discretion and it’s a policy that could be implemented relatively quickly. All else equal, we’d expect investors to take that negatively. We’d argue it’s likely to result in higher prices and slower growth over time. But, it might also mean we should favour US financial assets over the rest of the world. The US is a relatively more closed economy and might be better able to weather an overall increase in trade barriers compared to, for instance, the Eurozone. 

Finally, there’s the question of interest rate policy. At various points, Republicans have argued for reducing central Bank independence – giving the President or their government more scope to intervene in interest rate decisions. Again, it’s unclear if this plan would really move forward, and it could take time, but we still think eroding central bank independence would probably make investors nervous.

So, there’s still some time to go before the elections, and the outcome remains very unclear. But we’re wary of getting too focused on the minutiae of the opinion polls. In the long term, a solid macro background will probably be the biggest driver for returns in US financial assets.