Investors should not let US election noise get to them

On November 5, the UK will celebrate Bonfire Night. There will be fireworks and, of course, bonfires with a ‘guy’ on top.

The origins of this are the Gunpowder Plot in 1605 when Guy Fawkes tried to blow up the House of Lords and kill King James I. He was caught after an anonymous tip-off to the authorities, convicted and then hung, drawn and quartered.

November 5 will also see the US Presidential election. Given what happened in January 2021, after the last US election, this seems ironic. The question is whether we will merely see entertaining fireworks, or whether there will be bonfires?

Fireworks are guaranteed. The election is close and, according to recent polls, getting closer. While both candidates are among the oldest ever to run for the US presidency, Republican nominee and former President Trump will try to induce a Biden ‘senior moment’ during the debates.

Meanwhile, I expect somebody is already making a market on how many times Biden will use the word ‘felon’ to describe his opponent following the latest court verdict.

The question for us, though, is to what extent should investors care. Let’s break this question down into two parts: before and after the election.

If we look at history, the second-half of an election year is normally still positive for the US stock market, despite the risk of increasing volatility. This suggests that significant political uncertainty is not normally the dominant driver for investors.

A cooling off for inflation

Hence, we remain overweight global equities and, indeed, have a preference for US equities. We see inflation moderating in the second-half of the year, with upside inflation surprises already starting to fade. This should allow the Fed to start cutting interest rates and bond yields to decline.

The US stock market has a high weight to technology and communication service, which are more resilient to a growth slowdown and benefit more from lower interest rates and bond yields. After stagnating in 2023, earnings are recovering strongly and outperforming expectations. All this suggests that equities are likely to grind higher in the coming months.

After the election, things get more complicated. At the risk of oversimplification, there are three main scenarios: a clear Biden victory, a narrow Biden victory and a Republican clean sweep.

Election scenarios and markets

In the first scenario, which we deem to be the least likely outcome, Trump’s 2020-21 ‘stolen election’ mantra is unlikely to gather momentum and political conflict is likely to ease, at least temporarily, as the Republican Party pivots away from Trump.

Assuming this brings with it a clean sweep of the House and the Senate, fiscal policy will likely remain tilted towards high spending and raising taxes on the wealthier segments of society. It would also signal strong support from Ukraine and continued sponsorship of the decarbonisation agenda.

A tight victory for Biden, on the other hand, would likely mean that the House and Senate are split. Arguably, from an economic perspective, this could be the best outcome as dramatic policy changes would be challenging to implement, probably resulting in the least fiscally-irresponsible outcome.

The political environment would be challenging. It is possible that the Republicans could formally endorse the ‘stolen election’ mantra, which could lead to significant clashes between ardent supports of both parties. Indeed, it is not beyond the realms of possibility that a state suggests it should cede from the union (although doing so is highly unlikely).

All of this would make it harder for the Republican Party to move away from Trump, potentially leaving the door open for him the run again in 2028.

Finally, a clean sweep for the Republicans probably minimises the political uncertainty, but leaves the door open for radical economic, trade, immigration and geopolitical policy shifts.

There is a sense that Trump did not have the machinery around him in his first term to drive his agenda efficiently. Many believe that it would be different this time.

Trade tariffs would likely be introduced, given cross-party support for greater protectionism. While China is the focus, tariffs and threats of tariffs are likely to extend to allies as well. Immigration would likely be sharply curtailed. Support for Ukraine would likely fall dramatically, while oil would be promoted over green energy.

Finally, fiscal policy is likely to remain very loose as the Trump tax cuts implemented during his first term are extended indefinitely.

So, what does all this mean for investors in the longer term? Making predictions based on political outcomes is always risky. Remember 2016 when the overwhelming narrative was that a Trump win would be bad for equities. On confirmation of his victory, the stock market dipped intra-day, but then rose over 30 per cent in the next 14 months.

Trump’s policy agenda, on the face of it, looks the riskiest. His fiscal, trade and immigration policies look inflationary. However, he is also likely to be more supportive of US business interests, especially for the traditional energy sector.

This means he will likely calibrate his policies to ensure they do not inhibit businesses.

Therefore, it is important for investors not to overreact based on personal political biases or rhetoric. Elections, especially emotionally-charged ones, make investment decisions more challenging. However, I believe the best approach is to stay invested through the uncertainty and look for opportunities to add to diversified portfolios if we see short term weakness.