US Presidential Election 2020: Understanding the Market Signals

While the stock market has a good track record of "predicting" the outcome of the US presidential elections, the signals this time around are mixed. There has been a great deal of interest in alternative methods of forecasting the outcome of the election, and many are turning to financial markets for guidance.

The Stock Market Indicator versus Election Betting Odds Since 1932, the stock market has had an 86% accuracy rate in predicting the winner of the presidential elections. Whenever US equities were up in the three months leading up to election day, the incumbent party won, and whenever they were down, the incumbent party lost. This year, however, the signals from the stock market are mixed. The S&P 500 Index has gone up around 4% since August, suggesting that markets may be pricing in a Trump victory. But on 27th October, Trump’s chance of winning re-election was only 35%.

Market Movements: The "Biden Trade"

Although the stock market may be indicating a Trump win, beneath the surface, it is sending mixed signals. Stocks that are expected to benefit under Biden have surged as his lead in the polls has widened. Small-caps have outperformed by 4.4% since September, as Biden’s chances of taking the White House have increased. Analysts expect a larger fiscal stimulus package under Biden and potentially higher economic growth as well. Emerging market equity performance has suffered immensely as a result of recent US-China trade tensions. Under a Biden administration, analysts expect relations to be less fractious and for alliances to be restored with US' allies. This improvement in international relations and its positive effect on global trade activity should support emerging market equities.

Value stocks have taken a huge beating this year, as investors have sought refuge in fast-growing technology stocks. Following a major sell-off in tech in September, value stocks have started to gain the upper hand. Many investors expect the Big Tech stocks that have powered the market rally this year to come under stricter regulatory scrutiny under a Democratic president. Meanwhile, banking stocks, which represent a large component of value indices, should profit from a stronger economy, especially if accompanied by higher interest rates. The issue is that banks are likely to face a tougher regulatory regime under the Democrats as well.

Conclusion: The Investment Approach

Regardless of who wins, investors should avoid knee-jerk reactions once the winner is declared. The long-term returns of equities have very little difference whether the Republicans or Democrats are in power. Presidents do not operate inside a vacuum, and there are many other factors that can influence markets such as valuations, interest rates, and inflation. Investors should look beyond the election outcome and focus on the fundamentals of the market. They should consider diversifying their investments across various asset classes and adopt a long-term investment strategy that aligns with their risk tolerance and financial goals.