Director of Research Matt Peron says when it comes to the U.S. election, the biggest risk for equity markets is not which party gets voted into office but whether the outcome is contested. So far, equities expect a clear winner on or near Election Day.

Key Takeaways

• For equity markets, one of the largest risks surrounding the U.S. election is a contested outcome – particularly one that leads to a prolonged and uncertain battle for the White House and/or control of the Senate.
• In recent weeks, U.S. stocks have climbed on optimism that there will be a definitive winner on or shortly after Election Day on Nov. 3. Such a result would provide clarity on potential policy going forward, helping reduce uncertainty.
• Markets are also weighing the trajectory of the global pandemic and prospects for additional fiscal stimulus, which could lead to volatility. Longer term, however, we believe the resolution of the U.S. election, monetary and fiscal policy, and progress on COVID-19 vaccines could support equities.

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Matt Peron: Markets have been rallying in the past few weeks because there is a sense that the election results will be quite clear and uncontested. There was a fear earlier in the summer that the election would be so close, that it would be a prolonged and contested election and that would bring a significant amount of uncertainty and volatility to the markets. So, having now a better sense of how the election might shape up, at least in the market’s view, that brings about two important items: one is the reduced prospect of heightened volatility and second, a clearer path on the policy front.

So, in the case of a blue wave, which is to say both the Senate flips to Democrat as well as the presidency flipping to a Democrat, then the thinking in the market is that that will be a backdrop for very stimulative policy; for example, a large stimulus program for infrastructure and clean energy, and that would be a boost to near-term profits for the markets. So, the markets think that is a relatively benign and good outcome, actually, for the markets.

Of course, if there isn’t a blue wave, then there are a few other possibilities. One is a split government, where we have the Senate staying Republican, for example, and a [Joe] Biden presidency. That also would be okay for the markets because what that means is that there is probably more policy gridlock, but the status quo is maintained. And from a market perspective, that is an acceptable outcome. There is an unlikely situation, we have more of a red wave, which is to say the Senate and the presidency stays where it is and that also would probably, in the end, be okay for the markets because, again, we will have a stable policy backdrop. But the risk really is if there is a contested election where the results are prolonged and drawn out, and that would introduce quite a bit of volatility into the markets, depending on how that gets resolved.

While we think in most election outcomes the market will eventually find its footing, the different outcomes could have different implications for the sectors. So, for example, in the case of a blue wave, one might expect more stimulus, more infrastructure, more spending on green energy, and that is going to benefit certain sectors; and yet, higher tax policy could adversely impact other sectors. So, there are going to be different outcomes underneath the market in terms of the sectoral differences between different administrations and how that plays out.

It is said that the markets climb a wall of worry, and certainly this is no different. There are risks that we have to keep an eye on as we move forward. Certainly, a contested election is one of them, as we referenced earlier, but also the concerns about possibly further problems with coronavirus and the economic impact if the virus were to get out of hand in the coming months. So, that is certainly a risk. But put it all together and we feel pretty constructive about the outlook for the next 12 months. There could be bumps along the way, but our view takes the half-full approach, which is to say that the positive will outweigh the negatives and we will continue to heal and recover, especially after the election is resolved.

And in fact, when you look at history, the 12 months after an election are usually quite strong. We don’t expect this time to be any different, given the new optimism of a new administration regardless of which administration it is; potential stimulus coming, a large amount of stimulus, both fiscal and monetary; as well as we hope a resolution of the coronavirus crisis in due time. All of that together should conflate to push markets higher in the coming months.