US election: Certainly uncertain

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.

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.

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.