“It’s the economy, stupid.” That famous line from James Carville – Bill Clinton’s chief strategist – vividly described what would matter most to voters during the 1992 presidential race. The same idea applies to investors today: it’s not so much the election that’s shaping the market, but the economic conditions surrounding it.
On the face of it, investors in the US stock market shouldn’t welcome presidential races. Research from asset manager T. Rowe Price finds that over the past 96 years, the S&P 500 index has delivered an average annual return of just 11% in election years, but 11.6% in all the others. Volatility also tends to be higher in the 12 months leading up to an election, the study shows.
And when you look beneath those headline numbers, the story becomes more nuanced. The health of the US economy plays a big role in whether a particular party remains in the White House. And, in turn, whether they stay in office helps influence trends in market volatility.
Generally speaking, T. Rowe Price found that the US market proved more resilient when incumbents remained in office – and generally speaking, incumbents remained in office if the election took place when the economy was performing well.
Thomas Poullaouec, head of multi-asset solutions at T. Rowe Price, says that for investors the big takeaway is this: “Focus on what ultimately matters over the longer term: the economy and business fundamentals.”
That’s sound advice but leaves investors facing something of a dilemma – the outcome of November’s election, after all, is bound to have an impact on both the economy and business fundamentals.
Calling that outcome is extraordinarily difficult. For much of this year, Donald Trump appeared to be heading for a return to the White House, consistently polling ahead of Joe Biden, particularly in key swing stages. But the president’s decision to stand down from the race has had a dramatic impact. Democratic nominee Kamala Harris is now nudging ahead of Trump in most polls.
A Harris presidency might prompt investor concern, at least initially. For example, Harris has suggested raising US corporate tax rates from 21% to 28%, which would reduce profitability. She is also widely expected to support increased regulation in many sectors.
On the other hand, investors might also regard Harris as a president with fewer uncertainties and fewer risks than Trump.
A win for Trump might potentially result in a few big economic changes, says Lisa Shalett, chief investment officer for wealth management at Morgan Stanley. First, a potential extension of 2017 tax cuts could contribute to higher interest rates – which would weigh on corporate profits and stock valuations. Second, the Republican candidate’s proposed tariffs could interrupt recent progress toward curbing inflation in the US – potentially exacerbating consumer price rises. And, third, a broad immigration crackdown could slow the recent run of US population gains that have supported economic growth and disinflation.
That’s not a particularly happy prospect, but Morgan Stanley sees potential for some specific sector plays if Trump takes office. Energy businesses could benefit from support for fossil-fuel sectors, for example. Defensive industries such as healthcare, industrials, and aerospace and defense could also bear fruit, along with Japanese stocks, gold, hedge funds, and investment-grade credit.
With the race so close, it’d be brave to invest specifically based on one side’s victory. So some fund managers are focusing on areas that are less likely to be impacted by the outcome. For example, the Biden administration’s foreign tariffs, infrastructure projects, and deficit spending will probably continue, no matter who wins, says Richard de Lisle, who manages the VT De Lisle America fund. And manufacturers and raw materials producers stand to benefit from that, particularly smaller US firms, as production is brought back from abroad.
On the flip side, big tech could be in a lose-lose predicament, with both candidates – for different reasons – calling for them to be reined in. de Lisle says he wouldn’t be surprised to see folks move out of pricey Big Tech shares and into cheaper small-cap value stocks.
Similarly, Olivia Micklem, co-manager of the Artemis US Smaller Companies fund, suggests looking at infrastructure. She expects Biden’s plans for improving roads and bridges, setting up semiconductor plants, and encouraging onshoring to carry on into the next administration. “You don’t find many politicians saying they don't want the bridges fixed or not welcoming the arrival of a big semiconductor plant that will bring jobs and millions in tax revenue, so infrastructure winners appear in our US portfolios,” she said.
Brad Weafer, who manages the IFSL Marlborough US Focus fund, says he likes credit reporting company Equifax, no matter who wins. (Trump could make credit regulation easier, but Harris’ policies on home ownership could increase the number of Americans who are able to buy a house. That’s good for Equifax, which profits from every mortgage application.
He also likes the energy sector, regardless of who wins the White House. That might seem counter to conventional wisdom because the common perception is that Democrats impose tougher earnings-sapping restrictions. But, as Weafer points out, energy has been the best-performing sector during the Biden presidency and was the worst-performing sector during the Trump presidency.
When in doubt, look past the election calendar and focus on stock fundamentals and portfolio diversification instead, says Steve Tong, a portfolio manager at the global equity Mid Wynd International Inv Tr Ord. After all, it’s the quality of a company – not politics – that creates investor wealth in the long run, he says.
And remember, says interactive investor fixed-income expert Sam Benstead, politics will only move shares so much: the Federal Reserve’s (Fed’s) interest rate decisions play a much bigger role in how the US stock market performs.
If the central bank feels it can cut interest rates without creating new inflation, shares will be cheering. But if interest rates stay higher than anticipated and inflation begins to rise again, they won’t.
So watch out for campaign promises from either side that appear too good to be true. Tax cuts, spending plans, and other goodies might give some folks a boost, but if they reignite inflation and force the Fed to hike interest rates again, that may undermine any advantages.
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