Election Considerations & Potential Market Implications
As another election is upon us, more questions than answers and overall uncertainty fill the air. Harbor is committed to our clients and is providing them with the "Harbor Lens," a way to help focus on relevant insights, declutter some of the noise, and provide solutions to evaluate and implement as appropriate. We are in a unique position with access to both in-house investment expertise and strategic investment partners. As such, we have synthesized and curated thoughts around this election and its impact on markets. Without taking sides or predicting an outcome, we want to share some important considerations as clients think through their long-term portfolio implications.
Acadian Asset Management LLC
Neutralizing Risk, Focusing on Process
The outcome of the 2020 U.S. presidential election has the potential to result in financial market repricing, particularly at the industry group level among equities. Such risks fall outside the scope of traditional risk models. As such, we are carefully reviewing our portfolio exposures to election outcomes. We sought to assess the degree to which portfolio positioning may reflect undue sensitivity to a particular outcome, and neutralize this exposure by restricting the relevant active weights.
Our approach to managing election risk exposure considers three key scenarios and their likely effects on financial markets. In terms of market direction, we don’t believe that either a Republican or a Democratic victory would trigger a significant downturn in equity markets. Rather a definitive election victory by either side would remove material uncertainty. A Republican win would most likely boost markets, while a Democratic win may also result in positive outcomes, offering the prospect of improved trade relations with China and other countries, as well as $5-6 trillion of stimulus in the form of infrastructure spending and other initiatives. These considerations have the potential to outweigh concerns about higher taxes and greater regulation under a Democratic leadership.
At the industry level, a Republican win would be a boost for cyclical industries, and we would also likely see oil, gas, and coal companies outperform. A Republican win represents greater risk for big tech, though a Democratic administration is also likely to seek greater regulation of this sector. A Democratic win would favor defensives, particularly healthcare, as well as renewable energy. As noted above, under a Democratic administration, we would see greater infrastructure spending. Big pharmaceutical companies also face some risk of drug price regulation with a Democratic POTUS. In neither administration do we expect much change in monetary policy. There is also the potential for a third outcome, which is a too-close-to-call or contested election result. The futures market shows evidence of investors positioning portfolios for increased equity market volatility, something that was not the case in 2016. An unclear election outcome, and the resulting economic uncertainty, could lead to a protracted period of market volatility, though most political analysts are rating this at only a 20%-30% chance.
Portfolio Risk Mitigation
Acadian’s philosophy on risk control is to take risk where we believe we have skill, and to mitigate risks that are beyond the scope of our systematic investment approach. While risk management is typically handled seamlessly within our process, in infrequent instances — such as the current U.S. election — we make a carefully calibrated intervention to identify and minimize sources of uncompensated portfolio risk.
Using short- and longer-horizon return estimates in conjunction with election outcome probability data, we measured election value-at-risk for all portfolios. We then estimated the transaction costs and impact on exposure to Acadian’s return forecasts that would likely result from trading to limit election risk. Finally, for those portfolios that were determined to have higher exposure to election outcomes, we evaluated the cost necessary to mitigate this risk while maintaining a similar level of exposure to our return forecasts. Our analysis suggests that, in general, our portfolios do not have large active exposures to the most impacted industries, and thus, the trading that we are undertaking to adjust for the election is modest and is being handled as part of our regular rebalances on our standard trading programs. To the extent that trading is required in any portfolio, the necessary adjustments generally can be made in large, liquid stocks, with minimal market impact. We are not attempting to tilt any portfolio toward a specific election outcome, but rather, to mitigate directional election risk while continuing to focus on an attractive, diversified array of holdings. By ensuring that our portfolios are not excessively exposed to either a Republican or Democratic victory, we also protect against the possibility of a contested outcome and a likely associated period of heightened volatility.
Consistent with past work in the 2016 U.S. election and Brexit, we have studied the potential outcomes of the current U.S. election and have assessed how these would likely impact client portfolios. As a result of this analysis, we have taken action to limit uncompensated election-related portfolio risk. We believe that these actions have neutralized directional election risk, with minimal transaction costs and no meaningful impact on portfolios in terms of expected return.
Aristotle Capital Management, LLC
U.S. Elections – They aren’t Perfect, but They are All We Have
The U.S. presidential elections are here. Unlike Parliamentary elections, U.S. elections seemingly last for years. During this drawn out process, candidates traverse the country (although less so this time due to Covid-19) making promises and shouting why the other candidate’s election will result in the death of the Nation. History as a guide, very few of those promises ever become law and the Nation continues on.
We believe there are two factors that need to be considered when analyzing elections. First, the Founding Fathers gave us a system (albeit imperfect) that is designed to get little accomplished. We have three equal branches of government often working at cross purposes. The result is most of the more extreme policy positions fail to become law. George Washington famously said at a breakfast with Thomas Jefferson that: “We pour our legislation into the Senatorial saucer to cool it.” Meaning, that the more extreme positions coming out of the House of Representatives rarely pass Senatorial muster.
Second, quality businesses adapt. Political winds blow from all points on the compass and have since our founding. We believe good businesses can adapt and prosper regardless of the prevailing winds.
We at Aristotle Capital spend little intellectual capital trying to predict the unpredictable. We instead spend the bulk of our energies understanding the long-term secular trends that all businesses are subject to; some positive and some negative. Focusing our attentions on those factors that are analyzable while others chase the prevailing political winds, we feel is a distinct competitive advantage.
Baillie Gifford Overseas Limited
Beware of Misplaced Overconfidence
Our style of investment has always been led by individual company analysis, where we think we have a greater chance of doing something different and adding some value, rather than by making top down calls on macroeconomic or political events. We think it’s important, and absolutely in our clients’ interests, that we retain discipline and stick to that approach. But we recognise that the companies we invest in cannot operate in a cocoon from the prevailing environment around them.
So what should the bottom up stock-picker do when faced with such a dilemma? Our view is that it is better to appear slightly feeble than to fall into the trap of misplaced overconfidence in predicting the unpredictable. The problem as an investor is being asked to work through multiple layers of uncertainty. It sometimes feels akin to tossing a coin and calling the outcome. Except it’s even harder, since the coin toss needs to be done several times in a row and all correctly.
- First, one has to develop conviction on the outcome of the vote itself.
- Second, and possibly more important and more difficult, one has to develop conviction on the impact of that outcome. Would it be good or bad for the economy or for individual companies, both within the U.S. and beyond?
- Third, even if you could predict both the outcome, plus the impact of that outcome, one also must then decipher what may or may not be reflected in the starting prices of equities and other assets already.
The point here is that to identify cause and effect in the short-term behaviour of financial markets, and to boldly proclaim what is already discounted, is fraught with danger. To borrow from King Lear, ”that way madness lies.”
We would note the following feature which we hope is an interesting illustration. Based on the S&P 500, the Energy sector was amongst the lowest returning sectors during Barack Obama’s second term, returning c. 21% over four years. Under Donald Trump’s presidency through October 2020, the energy sector has been the worst performing sector, returning -45% since the start of 2016. Information technology was amongst the best performing sectors in Obama’s second term, returning 113% in four years. Under Trump, it has been the best performing sector, returning 182% since the start of 20161.
At first glance, these valuation moves might appear to be in direct contradiction to the stances of the two administrations. However, it makes sense to us as we believe there are deeper structural reasons for this repricing which are taking place outside, and irrespective, of political cycles. Technology is redrawing the corporate landscape and the shape and wealth of the global population is changing. Companies which are drivers of these changes, or are at least beneficiaries of them, are likely to prosper and those attractions are at best weakly linked to the prevailing political environment. When we find businesses with durable growth prospects then we often don’t see the value of that opportunity reflected in the current share price. We think that it is precisely because of a focus on news events like elections that stock markets fail to recognise the long-term value of exceptional companies.
In contrast, the long-term relationship between delivered earnings and revenue growth and returns to shareholders is a consistent one. Companies which grow deliver superior returns to those who are patient and committed enough to hold their shares for several years. As strange as it seems, we have a much higher conviction in our ability to predict which companies are likely to do well over several years than we have in our ability to guess what will happen in the coming weeks.
Income Research + Management
Sectors to Watch and Potential Fixed Income Implications
Election uncertainty rests not only on the ultimate voting results, but also the timing around when it will be final and what the process could look like if contested. The full economic impact of election depends on potential Presidential and Senate combinations driving taxing and spending decisions as well as regulatory changes. There are four key areas we believe election results may impact:
- Health insurance
- Environmental regulation, and
- Financial regulation
Continued Republican control would likely maintain status-quo in these areas. Given the level of current Federal Reserve (Fed) intervention in the markets, Investment Grade spreads have continued to remain well supported despite uncertainty. Higher corporate taxes are a potential headwind if Democrats win the presidency and senate majority. Expected changes to capital gains rates could cause some elevated year-end activity. Additionally, how fiscal stimulus is targeted will also be influenced by election results, with state and local aid likely differentiated based on control. Under any election scenario, deficit spending is expected to continue which will likely put upward pressure on U.S. Treasury supply and could impact interest rates going forward.
Marathon Asset Management LLP
Markets are Notoriously Fickle about What They Want
As we get closer to the election, the market seems to have pivoted to accepting a Blue Wave as a realistic outcome. Initially, that might have been expected to be a bad thing – higher taxes etc. – but markets now seem to be focused on the larger stimulus that it would probably entail and perhaps regarding that as more than offsetting the increase in corporate taxes. This seems to be an optimistic view. In any case, at some point there will need to be a reckoning for all the stimulus dollars spent, whether it comes in the form of higher taxes or higher inflation, a weaker dollar or higher interest rates.
Sector-wise, a Democratic win is viewed as worse for financials, energy, big technology (due to more regulation,) climate change policy and higher taxation, and better for healthcare with the potential for more spending. However, a Green New Deal would boost certain sectors of which many of these have already been bid (should this be built) up.
A Republican win would be viewed favourably by markets from a taxation and regulation viewpoint, though with less stimulus. A Republican win also tends to be viewed as better for financials, energy, with support on big technology which has bipartisan support. There is also a foreign policy question as Republican leadership is often seen as volatile and unpredictable in international relations, which we believe is worse for international trade. We don’t know how the Democrats would handle China relations. With the Democrats, perhaps we might see an end to protectionist policies, which we feel would be better for markets.
We are concerned about the outcome for markets should we see a split house/senate. We think it would be difficult to pass a large stimulus, as taxes move higher. Additionally, a contested election result would most likely result in greater volatility which adds market uncertainty.
Given the uncertainty, we continue to stick with our investment process around focusing on individual companies and the supply side of their industries.
Robeco Institutional Asset Management U.S. Inc.
U.S. Elections: Weighing the Odds
Even with indicators as much as one month, two weeks, one week, prior to the election, we believe there is still a chance of a surprise. History has shown that even with 48 hours to go, key events occurred in the 1968 (Vietnam ‘Halloween Peace’) and 1980 (the final debate) presidential races. The past has already seen the death of one Supreme Court justice and the adding of a replacement, rancorous debate, POTUS being hospitalized with Covid-19, and speculation regarding Democratic affiliation in various overseas business deals with potential conflicts of interest.
While derivative markets have been pricing in somewhat higher volatility around 3 November, until recently, equities and credit spreads have not factored in any meaningful potential risks. We think the U.S. presidential election – and, perhaps more importantly for the U.S. Treasury market and dollar, the Senate elections – are just one of a cluster of highly volatile events.
Betting Odds and Polling Swing in Favor of Democratic
Since the summer, our view has been that voting momentum will follow the path of the pandemic and the economic recovery. Trump’s handling of the coronavirus pandemic has been compared to George W. Bush’s mishandling of the disaster response to Hurricane Katrina, which coincided with a fall in the then President’s polling and approval ratings. The Democratic party had a strong lead in betting odds and national polls and, appeared ahead heading into the election in key battleground states such as Pennsylvania, Wisconsin and Michigan.
The recent Democratic surge has led markets to price in a base-case probability of Democrats gaining control over both houses of Congress, the Senate and House of Representatives, in a so-called ‘Blue Wave’ scenario. According to our research, with the vote for the House expected to remain more than 90% probability for the Democrats, the vote for the Senate is key. To gain control, the Democrats need to flip three Senate seats if we elect a Democratic president, four if we remain status quo.
Thrust of Democratic Policy and Potential Democratic Blue Wave
The Democratic election platform is more progressive and liberal than what investors would have historically expected from a moderate candidate. The proposed spending plan of over USD 6 trillion for the next 10 years includes infrastructure (USD 1.3 trillion), climate change (USD 1.7 trillion), healthcare (USD 750 million) and higher education (USD 1.5 trillion). The plan suggests these elements will be mostly financed by increases in income tax, capital gains taxes and corporates (28% tax rate) as well as closing tax loopholes. However, legislating these changes could be difficult in practice. Even if the Democrats win both the presidency and the Senate, any legislation would need to gain approval from the moderate Democrats in Congress as well. In addition, some of the proposed measures will require a supermajority of at least 60 seats in the Senate or face a difficult approval process.
Heading into the election, the recent positive response to the probability of a Blue Wave suggests the market has endorsed the view that a large stimulus plan, along with less foreign policy uncertainty, should offset the negative effects of higher taxes and more financial regulation. This is a change compared to several months ago, when the Blue Wave scenario was viewed by the consensus with risk-off concern over higher taxes.
Implications for Fed Policy and Interest Rates
Whether an additional fiscal stimulus deal is agreed upon ahead of the elections is, in our opinion, a key current driver of rates markets. A deal is much needed, as was underlined in the minutes of the September FOMC meeting. We believe a pre-election deal would lead to higher Treasury yields and a steeper curve. If no deal is reached before the elections, we still expect one but only after a clear election result. In that scenario, uncertainty will prevail in the near term on both the fiscal and electoral fronts. We give a probability of 70% to no fiscal deal before the elections.
We also believe a contested election is the main risk to fiscal stimulus in the short term. There is only one scenario (Republican, split Congress) where we don’t expect a meaningful stimulus deal in the longer term either.
Heading into the election, the risk of contested election and/or delayed results with legal challenges and unrest has become underappreciated in markets. This scenario would certainly be a risk-off event in the short-term with possible increased volatility. History will tell if the coronavirus is to Trump what Hurricane Katrina was to George W. Bush’s legacy.
Wellington Management Company LLP
Pandemic, Policies, and Legislation Important Considerations
Covid-19 brought forth an unusual recession. While many recessions are associated with the withdrawal of capital from the economy, this one is about the displacement of a very large number of workers, and predominantly those in low-paying service industries who have been sidelined by the economic shutdown. The impact on blue-collar labor stands in stark contrast to the impact on highly skilled labor, which is seeing losses more typical of a recession.
This blue-collar distress has been met with large-scale support from the fiscal authorities thus far. But if the support falters as the shutdown continues (or as some states renew restrictions following a surge in cases), we would expect discontent to grow over time. Given that the demographic cohorts most impacted are largely affiliated with the Democrats, this could raise the odds of a “blue wave” of victories for the party in the upcoming election, and potentially a sweep of the White House and Congress. In this note, we briefly outline the potential election outcomes and the implications for policy, the economy, and the markets.
The Blue-Collar Vote Impact
We believe the current economic downturn and the ongoing malaise make redistributive fiscal policy most impactful. At U.S.$2.9 trillion, the government spending thus far is large and the efficacy has been evident in the unusually strong level of activity, relative to other recessions.
Congress has provided robust income support for some of the hardest-hit industries. Under the CARES Act, the average weekly unemployment benefit exceeded the average weekly earnings in retail, leisure, hospitality, transport, education, health services, and other service industries. A June study by the Congressional Budget Office estimated that if those benefits were extended through January 2021, five out of six recipients would receive benefits that exceed the weekly amounts they could expect to earn in their jobs.
With this election, the calendar demands that both parties demonstrate the types of policies they will pass if elected — and blue-collar workers will be watching closely. We expect they will find a lot to like in the proposals of the Democrats, who envisage a large infrastructure spending plan, including physical infrastructure but also green investments and broadband. Democrats are also emphasizing worker retraining, free community college, forgiveness/refinancing of student debt, and a higher minimum wage.
We also communicated in previous content about another likely source of support for Democrats: the millennial generation, with its increasingly important role in the economy. This young and engaged cohort is particularly focused on social concerns including income and wealth inequality.
Weighing the Implications of Potential Election Outcomes
This election has shown that a lot can happen, especially with mail-in ballots and additional complication that may affect results. With that in mind, there are a couple of key points around how policies could change under the various election scenarios, including the potential impact on different sectors.
A sweep by either party would allow for more legislative action
In the event of a Democratic sweep, the legislative agenda would include higher taxes on corporations and on high-income earners. At the same time, the Democrats would seek to ramp up spending — on infrastructure, health care, and climate change. Importantly, we would expect the economic benefit of the spending to outweigh the harm of higher taxes, yielding a net positive effect for growth. At the same time, the tax hikes would hurt corporate earnings and likely be a headwind for some equity sectors. Also of note, the Democrats’ focus on fiscal policy would reduce dependence on monetary policy in coming years, implying that interest rates could start to normalize more quickly than the market currently anticipates. In the event of a Republican sweep, the legislative focus would likely be on extending tax cuts, a net positive for growth and the equity market.
With divided government again, the path to change would be regulatory rather than legislative
A Democratic administration would, for example, likely focus on pushing a green energy agenda via regulation, including reversing some of the easing of fracking rules approved by President Trump. On the executive side, a Democratic POTUS would also likely rejoin the Paris Agreement. For its part, a Republican administration would likely continue its support of fossil fuels. In the event of a split Congress, two likely areas of common ground would be a boost in infrastructure spending (though the specifics would vary greatly) and reduced dependence on China. The latter is also an objective that either Republicans or Democrats would likely pursue through executive-level changes. Aside from China, there could be some improvement in trade relationships with the rest of the world under a Democratic administration.
Westfield Management Company, L.P.
Election Results Mirroring the Covid-19 Pandemic Progression
- The likelihood of a Democratic presidency has mirrored the perceived severity of the Coronavirus pandemic – a reflection of the general public’s disapproval of the current administration’s handling of the crisis.
- Leading up to the election, we have seen a Democratic consensus front runner; however, the lead began to shrink as infection rates have fallen over the summer. Heading into the fall, they’ve increased significantly in several states, and sentiment is uncertain.
Biden vs Trump: who fares best under election scenarios? We believe that certain sectors have the potential to benefit or decline based on the outcome of the election
Democratic Beneficiaries: hospitals and volume-based health care providers, alternative energy, construction materials, infrastructure, discount retailers
Republican Beneficiaries: industrials and materials, banks and consumer finance companies, aerospace & defense, oil & gas, media/telecom
A common theme among our strategic partners is that attempting to predict the outcomes and implications of near- term events like elections, is extremely challenging and potentially perilous. In addition, the market’s tendency to dwell on and over-extrapolate the effects of these near-term events is precisely what can create long term opportunities for disciplined and patient investors that are primarily focused on individual company fundamentals. While we have seen some consensus among our strategic partners that a democratic wave would at the margin be better for the Heath Care and renewable energy sectors (as well as bad for the Financials and Oil and Gas industries), the desire to act on this consensus, which remains highly outcome dependent, has been less prevalent.
At Harbor, we recognize that it’s impossible for our clients to insulate themselves from daily news events related to economies, politics or financial markets. However, we believe that it is important not to place too much emphasis on elections as a basis for investment decisions and that adhering to a long term strategic asset allocation plan, focused on active management and regular rebalancing practices, remains a prudent course of action.
Legal Notices & Disclosures
1Baillie Gifford Overseas Limited, October 2020
Past performance is no guarantee of future results.
The information shown relates to the past. Past performance is not a guide to the future. The value of an investment can go down as well as up. Investing involves risks including loss of principal.
The views expressed herein are those of Harbor Capital Advisors, Inc., Acadian Asset Management, LLC, Aristotle Capital Management, LLC, Westfield Management Company, L.P., Marathon Asset Management LLP, Baillie Gifford Overseas Limited, Robeco Institutional Asset Management U.S. Inc., Income Research + Management, and Wellington Management Company LLP investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice.
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