Risks and Opportunities: Q4 2020

With just weeks to go till November 3, all eyes are on the upcoming US election.

At this time of writing, online prediction markets Iowa Electronic Markets and PredictIt respectively see an 80% and 64% probability that former Vice President Joe Biden will win the White House.

Media polls show that Biden has a decidedly similar advantage. Of course, polls and predictions can never be fully relied on, and there are market commentators who believe that President Donald Trump will once again come from behind to secure a re-election.

In the lead-up to Election Day, markets are bracing themselves for choppy trading and near-term volatility, especially in the event of a contested election. For investors trying to analyse how possible election outcomes could affect the market, the challenge is that it is difficult to put much confidence behind any likely scenario. 

Here’s a look at what a Biden / Trump win, or a contested election, could possibly mean for equities in Q4. 

If Biden wins

This is currently the most likely outcome if polls are to be trusted. Investors should however note that US presidents are elected based on Electoral College votes and not the popular vote. Should Trump emerge victorious in key battleground states, he could still win the White House even if Biden garners more popular votes. 

Some analysts see a Biden win as a potential counterweight to the market rally we have seen this year due to his proposed tax reforms. He has proposed to hike the US statutory tax rate from 21% to 28% on corporate income and increase the GILTI (Global Intangibles Low-Tax Income) tax from 10.5% to 21%. 

Such tax hikes could impact companies in the communication services, healthcare and information technology the most since they currently enjoy low tax rates and are large consumers of intangible assets. 

Furthermore, these sectors have driven the stock rally since March. Any tax change could reverse the momentum if investors seek to take profits before the tax hikes are implemented. That said, it remains to be seen how soon Biden might try to introduce such changes against a weak economic backdrop.

More regulations on Big Tech?

There is also a likelihood of heightened regulatory scrutiny over major tech and internet companies if Biden wins. This may ultimately hinder tech growth potential. Earlier this month, Democrats proposed an overhaul of US antitrust laws that could make it easier to break up corporate giants. 

That said, both Republican and Democratic states have been investigating several Big Tech companies on a range of antitrust allegations for some time now. On Tuesday, the Trump administration filed an antitrust lawsuit against Google. Should Trump be re-elected, the lawsuit is a concrete sign that his administration intends to place tech giants under closer scrutiny.  

There are upsides to a Biden administration as well. Green energy and infrastructure companies are likely to get a boost and US-China trade tensions could ease if Biden takes a more moderate approach. 

However, it is worth noting that even if Biden defeats Trump, he will be unable to pass legislation on key issues unless the Democrats simultaneously win the Senate, where the Republicans now have a 53-47 majority. Markets will be watching not just the presidential election but also how the Senate elections play out on November 3.

A Democratic clean sweep

A large Democratic Senate majority is likely to unleash greater fiscal stimulus. As it stands, the current stimulus stalemate is unlikely to be resolved ahead of the election. But more COVID-19 relief measures will almost certainly be passed in a Democratic clean sweep. 

For this reason, investors eyeing the Democrats’ proposed US$2.2 trillion stimulus package (compared to the US$500 billion put forth by Republicans) now favour a Blue Sweep at the elections.  

In fact, analysis from Goldman Sachs indicates that the boost to US economic growth from fiscal stimulus would outweigh the impact of tax hikes especially since the increased tax revenue will go towards spending on relief measures, infrastructure, education and healthcare. 

If Trump wins

A Trump victory is likely to benefit the stock market. We could possibly see the S&P 500 and other major indices in a relief rally given that there will be less uncertainty for the markets to process. 

In a status-quo scenario (Trump as President; a Republican Senate and Democratic House), deregulation and further tax cuts could continue, which would likely benefit the telecom, energy and financial sectors.

Trade tensions between the US and China may persist should Trump adopt a more anti-China stance – especially if he thinks there is greater US voter wariness of China. This could mean higher tariffs on Chinese goods and further restrictions on Chinese tech companies.

A contested election 

Such an outcome could happen if Trump loses the election and refuses to concede, or if he questions the legitimacy of the results. Trump has repeatedly questioned the validity of mail-in votes, and has declined to say whether he will accept the election results if he loses.

A contested election will mean that the eventual winner is not determined until days or weeks after Election Day on November 3. Markets dislike uncertainty, and a contested election will most likely dampen sentiment and the hopes of any fiscal stimulus. 

We could see a spike in volatility as well as a broad sell-off in the stock market. There could be a flight towards safe haven assets like gold and US government bonds. 

Although the risk of a contested election is still significant, recent polls showing Biden widen his lead over Trump suggest the odds of a decisive election outcome in November are improving. The final US presidential debate this week (Friday, 9am SGT) will be closely watched for assurances both parties will not contest the outcome.

Additional risks to watch out for 

The election is a key risk for the market, but two other major sources of uncertainty remain.

Progress of a COVID-19 vaccine. China’s Sinovac Biotech is the first drug maker to disclose late stage trial results for its coronavirus vaccine. Preliminary results indicate that the vaccine appears to be safe, giving rise to hopes that it can be approved by year-end and widely distributed by the first half of 2021. But even if effective vaccines can be successfully developed, mass produced and deployed, governments will still need to convince their citizens to accept these shots. 

Further stimulus for the US economy. It is increasingly clear that the US economic recovery is likely to be hampered if fiscal stimulus is delayed till 2021. For one, further support may be needed to bolster the labour market. Another 898,000 Americans filed first-time unemployment insurance claims for the week ended October 10 – an unexpected 8-week high. A deal on fiscal stimulus is still out of reach, but will be necessary to help keep workers on payrolls and support unemployed Americans.

What’s an investor to do?

Who wins the White House will have an immediate effect on the stock market, but analysis from Julius Baer suggests that there is no significant long-term impact. 

Data from 1928 to present | Source: Bloomberg Finance L.P., Merrill Lynch, Julius Baer Strategy Research

In the one year after a presidential election when the incumbent president (Trump) was re-elected or when a new president from the opposing party (Biden) was elected, the difference between the average annual return of the S&P 500 index has historically been relatively small.

An elected president’s policies will of course play a part, but there are many other factors that influence the stock market.

Political drama makes for good headlines, but remember, the underlying driver of stock markets is real corporate earnings growth, i.e. adjusted for inflation. If companies have robust fundamentals, continue to grow their profits, and inflation remains benign and supported by a low interest rate environment, the stock market will continue to do well.

So what should this mean for investors? While it can be tempting to de-risk and retreat to cash to wait out the uncertainty of the election, it is important to keep a balanced perspective with your big-picture investment goals in mind.

Case in point: the stock market after Trump’s surprise win in 2016. Analysts had predicted that a Trump win would be a bane for stocks and markets initially tumbled after his win. Near midnight, futures for the S&P 500 had fallen by over 4%. But the day after the election, the index was up over 1% by market close, and would continue to climb in the months that followed.  

The key takeaway is that political noise is just that. The best thing for investors to do now is tune out and stay the course.