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US election: Certainly uncertain

Uncertainty usually rises leading up to elections, but the actual result may help to reduce investor anxiety and market volatility. Portfolio Manager Oliver Blackbourn provides historical context showing that markets tend to shift to a more risk-on mode following the result, as moving past the uncertainty allows investors to latch onto the positives.

Oliver Blackbourn, CFA

Oliver Blackbourn, CFA

Portfolio Manager


28 Oct 2024
5 minute read

Key takeaways:

  • The lack of clarity surrounding the 2024 US presidential election is creating near-term uncertainty, but politics tend to move more slowly than the day-to-day shifts in global markets, with the actual election result reducing investors’ focus on imagined worst outcomes.
  • Markets have tended to shift into a more risk-on mode after an election as uncertainty fades, with equities generally rallying, US small caps and non-US stocks historically outperforming, and US Treasury yields rising following the result.
  • Despite some fragile areas, the US economy appears to remain on the narrow path to a soft landing, and we would encourage investors to focus on this underlying economic health given it will likely matter far more for markets than the near-term result of the election.

The one certainty about elections is that uncertainty rises ahead of them. In most cases, this has rapidly reversed as the market moves from worrying about its worst fears to accepting the new reality.

So far, this election cycle is looking no different, with the common theme being a lack of clarity, even if there are clear differences between both presidential candidates. It is important to note that, with the exception of those leading into recessions, most recent elections have generally presaged improved returns for risk assets.

Clear signs of investor fretting can be seen in the recent shift upward in the VIX Index of implied equity market volatility and a rising gold price, despite sharply higher bond yields. High yield credit spreads have also tended to widen historically but have continued to grind tighter so far this time around.

The potential for change always creates uncertainty among investors, but politics tend to move a little more slowly than the day-to-day chopping and changing of global markets. Within democratic political systems, we tend to see more extreme policy proposals ultimately watered down as compromises are made. An actual election result tends to make it easier for investors to see this path, reducing their focus on the imagined worst outcomes.

Focusing on the presidential level to start, there is a clear split between the candidates on areas such as immigration, tariffs, and taxation. However, understanding the realistic scale of what will potentially be implemented is muddied by soaring rhetoric and a lack of clarity on exact proposals. In addition, looming after the election will be questions around the sunsetting of the Tax Cuts and Jobs Act in 2025 and whether a rising government debt level actually matters for the time being. These areas concerning spending are perhaps where the final composition of Congress will be most important after the election.

A split government will likely see smaller shifts, with the odd one out among the House, Senate, and President in terms of the party in control more likely to take up the debt burden as a cause, given it can be framed as taking a responsible position but also a reason to frustrate adverse policy implementation. Therefore, while both sides in a particularly divisive election may worry about more extreme policy outcomes, these are unlikely to be realised.

Markets tend to shift into a more risk-on mode after an election. Uncertainty fading into greater clarity about the future allows investors to latch onto the positives. With the exception of recessions and the bursting of the Tech Bubble, we have generally seen equities rally, high yield credit spreads compress, and US Treasury yields rise following recent elections. In the pro-risk vein, US small-cap stocks have tended to outperform following the result, and non-US stocks have often outperformed the S&P 500, helped by a tendency for the US dollar to weaken.

S&P 500 performance around recent US elections

Source: Bloomberg, as at 25 October 2024.

These last two points are perhaps among the most relevant as we think about this coming election. In 2016, Donald Trump stood on a similar platform to his current proposal, and the result saw a stronger dollar and underperformance of non-US equities, but a sharp jump in smaller companies. In 2020, when Joe Biden won the election, smaller companies outperformed, but this was over a longer period and at a steadier pace, and non-US stocks outperformed for a few months as the dollar weakened.

We would encourage investors to look past election-related anxieties and focus more on the underlying health of the US economy as a medium-term indicator for markets. Despite recession fears over the summer, the Atlanta Fed GDPNow estimate of growth is suggesting that the US economy grew 3.3% over the third quarter of 2024. The last US labour market report showed an improvement after two months of slower jobs growth and the unemployment rate reduced.

While we can identify some fragile areas of the economy, such as manufacturing, we have yet to see widespread evidence of cracks. We are monitoring areas where we see strain closely, but so far the economy appears to have remained on the narrow path to a soft landing. This will likely matter far more for markets than the near-term result of the US election.

Cboe Volatility Index® or VIX® Index shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500® Index options and is a widely used measure of market risk. The VIX Index methodology is the property of Chicago Board of Options Exchange, which is not affiliated with Janus Henderson.

Credit Spread is the difference in yield between securities with similar maturity but different credit quality. Widening spreads generally indicate deteriorating creditworthiness of corporate borrowers, and narrowing indicate improving.

Risk assets: financial securities that may be subject to significant price movements (ie. carrying a greater degree of risk). Examples include equities, commodities, property lower-quality bonds or some currencies.

S&P 500® Index reflects U.S. large-cap equity performance and represents broad U.S. equity market performance.

US Treasury securities: Debt obligations issued by the US government. With government bonds, the investor is a creditor of the government. Treasury Bills and US Government Bonds are guaranteed by the full faith and credit of the United States government. They are generally considered to be free of credit risk and typically carry lower yields than other securities.

Volatility measures risk using the dispersion of returns for a given investment.

Yield: The level of income on a security over a set period, typically expressed as a percentage rate. For a bond, this is calculated as the coupon payment divided by the current bond price.

IMPORTANT INFORMATION

Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.

Fixed income securities are subject to interest rate, inflation, credit and default risk.  The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.

High-yield or “junk” bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings.

Smaller capitalization securities may be less stable and more susceptible to adverse developments, and may be more volatile and less liquid than larger capitalization securities.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.

 

Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

 

The information in this article does not qualify as an investment recommendation.

 

There is no guarantee that past trends will continue, or forecasts will be realised.

 

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