2020 Foresight: A U.S Presidential Election Blog Series from TDAMPublished: 6/10/2020
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"Winning or losing of the election is less important than strengthening the country"
~ Indira Gandhi
With the 2020 U.S. Presidential election mere weeks away, the final stretch of the campaign promises to be full of rhetoric, twists, turns and plenty of surprises - for both voters and investors.
Making predictions on not only who will win, but how their win will affect the world is not easy.
As investment professionals, anticipating what will happen in the markets depending on the various outcomes of the election is a challenge. There are many possible outcomes that can have different ramifications on various asset classes and the economy. Regardless of the outcome, financial markets are always best viewed through a long-term lens. Short-term events can certainly cause market swings and it is very important to monitor for major policy shifts. But barring dramatic swings in policy, these events become less impactful when making decisions for longer-term goals.
While we are not in the business of predicting the election outcome, we decided to create a weekly blog for the month of October leading up to election day, that will feature a snapshot of our current thoughts on how various asset classes and markets may react to the possible outcomes of the election.
In our first blog of the series, Michael Craig, Managing Director and Head of Asset Allocation and Derivatives at TD Asset Management Inc. ("TDAM"), provides his thoughts about the potential election outcome scenarios and what they could mean for markets. These insights can also be found on a recent episode of MoneyTalk where he had a chat with Kim Parlee.
Do elections matter for financial markets?
Many of us will be glued to election coverage over the next month, but what does that mean for an investment portfolio?
Pundits often think of elections as having binary outcomes, however the impact on a portfolio is anything but. First, let's consider how politics and markets interact with one another, and the answer is relatively straightforward - it's all about policy. Not just about what politicians want to do, but what they can do. Often the world of policy is one of incremental change, however, occasionally, we see radical paradigm shifts.
Things have started to radically change under Donald Trump in terms of economic impact, particularly concerning free trade and globalization. Years of capital gaining at the expense of labour has led to extreme levels of inequality in the U.S not seen since the 1920s*. Inequality leads to a whole host of societal problems that ultimately lead to political and policy shifts. No matter what the political outcome is, we are at the twilight of the last regime. The reversal of globalization, a green energy revolution and increased corporate oversight are all on the table.
For this year's election, there are four primary potential scenarios which investors should consider. Remember, what matters is not just what politicians want to do, but what they can do, and this will depend on control of the U.S Senate. The four possible outcomes are:
Scenario #1: Joe Biden wins the presidency, but the Senate stays Republican
Expected Result: Positive. In this scenario, it would be very hard for Biden to get his most disruptive policies through. The divisions between Republicans and Democrats are at a fever pitch, so we're unlikely to see bi-partisan support for major policy change. This situation would likely be positive for markets because of limited policy risk and Biden's more traditional and multilateral approach to foreign policy compared to Trump.
Scenario #2: Joe Biden wins the presidency, and the Senate goes Democrat
Expected Result: Sector Winners and Losers In this scenario, there would likely be a major shift in policy. Proposed policies include: higher corporate tax rates, increased taxes for higher income earners, higher minimum wage, regulating drug prices for pharmaceutical companies, and more regulation on energy and financial services. The positives in this scenario are likely large infrastructure spending, major investment in green energy industries, and an expansion of health care.
Scenario #3: President Trump wins the presidency, and the Senate stays Republican
Expected Result: Status Quo. This outcome would be similar to what we have today. Trump's policy has been limited – so we could see another round of tax cuts, and a continued push for de-regulation. Any real benefit would come from policy continuity, which means the markets will likely continue to move higher. We could see more geopolitical uncertainty as a second term President, without control of Congress, tends to focus more on foreign policy, which they can control. As a result, we can expect more tension with China.
Scenario #4: A contested vote
Expected Result: Negative. Given the high number of expected mail-in votes, a tight election could lead to either side challenging the results. This is a worst-case outcome for markets, which never like uncertainty, and it could drag on for weeks. In the 2000 U.S Presidential Election, the U.S Supreme Court settled a recount dispute in Bush v Gore. During that time the markets sold off 8%. We'd expect anywhere from a 5% to 15% selloff if the markets were made to cope with the uncertainty of neither candidate conceding.
How can you position portfolios at this juncture?
At TDAM, our investment teams don't believe that positioning portfolios for election outcomes is a sustainable investment process. However, we keep a keen eye on policy as it can have a major impact on economic growth, capital markets and companies. Ultimately, our goal is to build robust multi-asset portfolios that can withstand and thrive in a range of future scenarios.
When faced with many uncertain outcomes having optionality is ideal. We believe this is where tactical asset allocation becomes valuable because this strategy seeks to generate value in volatile markets. Optionality can also be in the form of options or simply having some cash available and a plan based on the outcomes of the election.
For additional insights, check out the latest Market Perspectives from the TD Wealth Asset Allocation Committee. Also, be sure to visit the TDAM Views Blog next week for our second installment of the series which will focus on equities.
*Source: Bloomberg L.P, GINI Income Inequality Index of United States. From January 1, 1973 to December 31, 2019.
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