Would a Trump win make you think twice about your investment portfolio?
Updated: Dec 21, 2020
Yifan Shen explores the effect that a second term for President Trump will have on the stock market.
The stock market and the political environment have always been closely interrelated, and therefore it is essential to keep a close eye on the Presidential elections this year. If we take a closer look at the market, we can see that the months leading up to Presidential elections usually consist of high volatility due to uncertainties on the winning party (Republican or Democrat). This is shown in the CBOE volatility index (Fig. 1), an index used to gauge the market's fear, which has sparked to above an index of 80 this year in mid-July and fluctuated significantly between the forthcoming months1. This is normally the case due to each candidate’s policies having their own (and often opposite) effect on the market, for example, the Republican’s encouraging decreases in tax under Trump’s rule which has fueled corporate earnings as well as confidence in a more bullish market. Meanwhile a Democrat win would see the market go in the opposite direction.
This uncertainty in market direction has proven to be the case in many pre-election months where investors are caught up in predicting which party will be in office next term, and hence which policies will be enacted that will shift up the market.
This year however, uncertainty is further aggregated by the report of all 3 major US indexes (DOW, S&P 500, NASDAQ) experiencing their first loss since the beginning of the pandemic in March. The fall in the US stock market normally occurs when investors speculate a Democrat win as, in this case, Biden’s intention to raise taxes will hinder corporate profits and therefore prove to be negative for the stock market. However, historically markets slow down and show a weaker performance in the lead up to the election anyway which in the end suggests that nobody can predict the election's direction. For example on average, equities showed less than a 6% gain during election years compared to an 8.5% gain on normal years.
The election can further impact the stock market when looking at past data through a newcomer loss phenomenon. This is seen in the market gaining an average of 5% in growth when a new party comes into power, compared to a 6.5% growth when an incumbent president is re-elected for a second term. This can be explained by consumer behaviour as a new party in their first term would still create uncertainty as to the outcomes of their policies.
However the most concerning aspect of an election’s impact on the stock market is the result of a contested election. This is where the degree of victory for the winning party is low, for example a win of 1 majority. This creates further uncertainty after the elections as voters and investors start doubting the transparency of the win. This uncertainty depresses valuations and eventually leads to even lower returns before the election occurs. Consequently we need to question how an investor's portfolio should be reconstructed depending on whichever party’s win.
Biden V Trump
In the past, it has been noted that under a Democratic president, the economy is likely to outperform those under a Republican president. For example, Clinton’s 1993 win (Democratic win) saw a nearly 4% rise in US real GDP, while Bush’s win in 2001 only saw a 1.5% rise in GDP - a 1.6 times faster growth under a Democrat president! This trend in higher growth rates under Democratic rule has proven to be consistently accurate over the last 75 years, as shown in figure 22.
Under Biden’s rule the economy would see an increase in corporate tax as well as harsher regulatory measures, particularly on fossil fuels and non-renewable energy. This would see a sharp fall in a lot of commodity stocks as oil regulation is likely to drive up prices and therefore decentivise consumers. Although this does prove to have a positive impact on international suppliers as they see oil to be an attractive investment as prices fall. Meanwhile Trump’s ‘pro-business’ policies sees a cut in corporate taxes from 35% to 21%.
Opposing Biden’s policies is Trump’s compliant and more lax policies which the majority of the economy actually roots for. J.P.Morgan expects the S&P 500 index to surge 3,900 points if Trump gets re-elected next term as his victory would be seen as ‘orderly’ and less uncertain for the market. This outcome is most favourable for the stock market because the current market is circulated around his policies already and thus him being in office next-term again would not create as much of a stir and uncertainty for investors since they already know the outcomes of his policies.
Although whether Trump’s win is the most favourable outcome for the stock market or not is not up to what investors desire the most. In October Trump’s ‘surprise’ announcement of a positive Covid test decreased hope and incentive for investors as they saw markets immediately dip on the news. Even though this dip leveled off afterwards, volatility levels have been raised as investors become more unsettled, with ‘concerns over Mr Trump’s capability to deal with the currently troubling and economic challenges over the next few weeks, says Richard Hunter, head of markets at Interactive Investor.
The Long run
Whoever comes out as the victor of the elections does not actually sway the market as much as the degree of the victory. A contested election result would further complicate market forecasts. For example, in the 2000 elections where Bush only won by a marginal degree (0.0009%), the S&P500 index fell more than 4%. This is often due to feelings of confidence in the market being shifted by people’s perceptions of risk. When your candidate wins, you act more bullish and are more likely to take risks as you are more confident in the policies put in place.
However as economies become increasingly interconnected and global, ‘investors should not base their optimism on a single political leader’. Since no one can predict the market with full accuracy, the current stocks and likely the ones a few months after the election will be purely driven by speculation. Although over the long-term no matter who wins and what policies are put in place, markets will recover and go up again.
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