How will the 2020 US election impact the stock market?

Investing knowledge

On November 3rd, we’ll finally get an end to the Trump vs Biden soap opera! (Or will we?…) The 2020 US election has been one of the most divided in modern history, with both candidates proposing radically different political programs. The polls are still tight, and the backdrop of Covid-19 is bathing Wall Street in uncertainty – which is enough to give investors a cold sweat! Let’s take a closer look.

Does Wall Street Prefer Red Or Blue?

The popular belief is that Republicans are more ‘market-friendly’ than Democrats. Why? Democrats usually come along with higher taxes and tighter regulation – not something investors like to see.

But history tells us the reality is actually quite different. Indeed, when a Democrat president is elected, the market usually plunges in the short term, but performs much better in the long term. Democrats are surprisingly efficient at managing the economy, if you look at the data. Since 1947, the American economy has grown by an average of 3.6% with a Democratic president, and 2.6% with a Republican in the White House.

2020: the year when anything can happen (literally)

Every election is different, but 2020 is a special vintage year! Who can ignore the Covid-19 crisis at the centre of every debate during this contest?
And this is where it gets tricky. The Republican party has played down the pandemic and encouraged people to get out and go to the polls. Democrats are more cautious and are calling for people to vote by mail to promote social distancing.

This could lead to a big delay in counting on the evening of November 3rd. All the mail votes won’t be counted yet, so it will take some time to get the true result. Inevitably, the markets risk getting a heart attack during the agonising wait. Expect volatility!

What happens if Biden gets elected?

Okay, let’s move onto the two different scenarios. If Joe Biden and running mate Kamala Harris win the 2020 US election, the market could experience losses of 6-10% in the short term. As we explained, investors could get scared about higher taxes.

Indeed, Biden is expected to tax capital gains and dividend payouts as ordinary income, pushing the tax rate from 20% to 39.6% for those in the highest tax bracket. This could lead some investors to lock in their profits and sell before Biden’s new rule kicks in. The dollar could also fall around 0.45% against the euro.

BUT… on the other hand, Biden is more inclined to approve a new stimulus plan, which is currently blocked in Congress. The money could help out families and save certain sectors hit by Covid, like airlines and aerospace. That would be a good thing for the markets. But the adoption of this stimulus package will also depend on who wins a majority in the Senate and the House of Representatives, and that’s a whole other story.

Finally an anecdotal element (but still!): Joe Biden’s running mate, Kamala Harris, recently came out in favour of decriminalizing cannabis at a federal level. Inevitably, the news has reached the ears of investors, so watch the pot stocks if Biden wins the vote.

If Republican Donald Trump is re-elected

The stock market has been on a rollercoaster ride since Trump was first elected, what with all the official statements and unofficial tweets. First there was the trade war with China, then the Covid crisis which injected plenty of volatility in the stock market.

However, investors do like the ‘pro-business’ side of Donald Trump. A gigantic tax cut and deregulation during his tenure saw stocks go sky high. So if Trump wins, we can probably expect a 4-6% bump in the short term and some strength in the dollar. The oil sector could also get a boost with some support from Trump.

In the long run, it could be a different story. Second-term presidents have a difficult record with the stock market. Nine presidents have served a second term… and eight of them experienced lower stock market gains in the second innings compared to the first.

What if Trump refuses to accept a Biden victory?

We warned you that 2020 could be a spectacular year… and this would really finish it off! For the first time in history, the president has hinted that he may not leave office peacefully.

Trump has openly said he might not admit defeat if Biden wins because of unreliable postal votes. If this chaotic scenario plays out, things will get very complicated for the stock market. This could get bogged down for weeks. The Supreme Court might have to get involved, thereby lengthening the period of uncertainty. Not good for investors.

This reminds us of the 2000 election when Democrat Al Gore contested George Bush’s election victory. Gore called for a recount in Florida. For a month, no-one really knew who won the election until the Supreme Court ruled that Bush should get the keys to the White House.

During this period of uncertainty, the S&P 500 and Dow Jones indexes fell 4.24% and 3% respectively.

How to invest during an election period?

History tells us that, no matter what happens, elections cause a big spike in volatility, which is measured by the ‘fear index’ or VIX. It makes sense… The closer we get to the 2020 US election, the greater the uncertainty, the more volatility in the market.

So you have to be prepared to trade and invest prudently, not just in the US markets, but also in Europe, where there will be an obvious ripple effect. But rest assured, volatility can also offer new opportunities if you are prepared to take the risks.

The stock market predicts the future

The New York Stock Exchange’s main index is a great crystal ball. It has accurately predicted the election outcome in 87% of the results for more than 100 years. Effective. How does it work? If the index suffers losses in the three months leading up to the election, the sitting president usually loses. If the index is positive, the ruling president should win again.

Watch for the movement of stocks

Historically, US stocks and bonds tend to perform better during an election year… but that’s not the case abroad! In international markets, returns are better the year after a presidential election. And when a new party comes to power, stocks gain an average of 5% compared to 6.5% if the party stays the same.

And what about the dollar?

The greenback is currently getting beaten down in the run-up to the 2020 US election. It’s lost 3.4% since the start of the year… which is unusual because election years tend to strengthen it. This has more to do with the Covid-19 crisis than the election, however.

Either way, whether a blue wave hits Wall Street or Trump renews his White House lease, the stock market will always adapt. Also, this is not the usual Republican vs Democrat fight. This year, the markets might care more about who handles the pandemic better. So buckle up, watch the news, and get ready for some thrills in the markets in the coming weeks.

All views, opinions, and analyses in this article should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.