As the U.S. elections approach, I’d like to take a look at what the possible outcomes are and how the markets might react. Unlike in the past, when Wall Street favored the Republicans, it seems to me that they are more even-handed in this election, or even favoring the Democrats. That makes me think that both stocks and the dollar are likely to gain in case of a “blue wave” that brings the Democrats control of Congress and the White House. Many financial market professionals are still fundamentally Republicans, however, and so a Biden victory with Republicans retaining control of the Senate might be well received as well. On the other hand, a Trump victory represents a danger to the markets, while a narrow Trump loss could be the most serious danger – for totally different reasons.
There are four possible results, ranked in order of what I think is most likely to least likely:
- The Democrats win everything. A “blue wave” gives the Democrats control over both houses of Congress and the White House.
- Two out of three: Democrats win the House of Representatives and the White House, but Republicans maintain control of the Senate.
- Status quo: Democrats retain control over the House, but Trump wins re-election and the Senate remains Republican.
- Democratic Congress, Republican presidency: Democrats take control over both houses of Congress but Trump somehow wins the presidency. I consider this result unlikely, because I think if there are enough Republican voters to elect Trump, there will probably be enough Republican voters to vote in a Republican Senate
Implications for the markets: Probably good
Usually, the way we assess what might happen in the markets is by looking at what happened under similar circumstances in the past. This time, however, the past may not be a good guide to the future, because the current circumstances are unique, starting with the incumbent.
Wall Street tends to be pro-Republican, but not this time. According to The Economist newspaper, “Total donations (from large Wall Street donors) went mostly to Republicans in 2016, but are now evenly split….Strikingly, many appear to be sitting 2020 out; around a fifth of those who gave meaningfully in the last election have given nothing in 2020.This decrease is largely the result of a drop in contributions to the presidential campaign, particularly that of Donald Trump.”
According to the Center for Responsive Politics, Biden has raised almost twice as much from the finance, insurance and real estate industries as Trump has ($76.8mn vs $43.0mn), while overall giving from that sector has gone 72% to Democrats and 28% to Republicans. In the previous presidential election it was 36% to Democrats and 64% to Republicans.
There are two reasons. On the one hand, many people on Wall Street are tired of “government by Twitter” and the unpredictability of the Trump regime. For example, it hasn’t escaped anyone’s attention that many of Trump’s more optimistic tweets come out shortly before the stock market opens.
At the same time, Biden has for decades been the senator from Delaware, home to many financial and credit card companies (and one of the world’s last remaining offshore tax havens, but never mind). Until becoming Vice President, his largest single contributor over the years was credit card giant MBNA Corp. Wall Street knows that contrary to what Trump says, Biden is a centrist, mainstream Democrat. Besides, they’re relieved he’s neither Senators Bernie Sanders nor Elizabeth Warren.
Thus the usual stereotype that Wall Street will greet a Republican victory with a cheer and a Democratic victory with a Bronx cheer is probably unfounded in this case.
In any event, on average, the U.S. stock market has gone up after the last 11 elections. Of course, the “average” masks a lot of variety, as the range shows. But in general it has tended to trend upwards. (I exclude 2008, the year of the Global Financial Crisis, because the stock market moves that year were stunning and had little to do with the election.)
The two times an incumbent has lost, stocks have gained at least initially. They didn’t go down after those elections. It didn’t matter whether the winner was a Republican (Reagan) or a Democrat (Clinton).
We can also look at the same graph to see what happened when a Democrat followed a Republican – Clinton coming after Bush didn’t hurt stocks any. (Obama coming after Bush II was not really comparable as the Global Financial Crisis engulfed the world.)
The dollar shows an even more pronounced rising trend after elections. Here again there’s a wide range, but much less variation after the election than before, and most of the variation afterwards is on the upside, not the downside.
As for the specifics – an incumbent being defeated or a Democrat taking over from a Republican – the dollar did start coming off a month or so after Clinton came into office.
The markets are bracing for volatility around the election. Both the VIX index of implied equity market volatility and the implied volatility in the currency markets show a marked spike in expected volatility around the election.
USD/MXN would be the currency pair most at risk from a Trump re-election because of the continued friction between him and Mexico. The weekly Commitment of Traders report shows a big increase recently in long MXN positions – perhaps people preparing for a Biden win?
This time, I believe the markets would greet a “blue wave” with relief. As things stand now, the U.S. government is nearly incapable of any action. This makes life difficult during ordinary times but is a disaster during a crisis. In particular, the logjam in Congress that makes it impossible to pass any bills is endangering the economy. A moderate Democrat in the White House and a unified Congress would be able to pass the necessary fiscal programs to get money into the pockets of the unemployed and keep the economy going.
But what happens if the incumbent isn’t defeated? What if Trump wins? Or what if Biden wins the White House, but the Republicans keep the Senate?
I think a Trump victory would be taken badly by the markets. At this point, I think investors are fed up with the mismanagement and all the drama, and would like to see some stability, even if it’s not under the party they prefer. I think the dollar would weaken and markets would go into a general “risk-off” mood if Trump gets back in.
On the other hand, markets would probably be calm if Trump loses but the Republicans keep control of the Senate. I suspect a lot of people on Wall Street who still prefer the Republicans would consider this the best of all possible results – the notoriously unpredictable Trump out and the Democrats largely in control, but with the Republicans there to moderate their more extreme policies (which in the event I doubt Biden would put forward anyway). That is, after all, the way the U.S. government is supposed to work – the famous “checks and balances,” which the Republicans have shown themselves happy to exercise with respect to a Democratic president but remarkably reticent to enforce on a fellow Republican.
On the other hand, looking at how little progress Congress has made on the second round of the CARES act, some people are bound to think the new administration will be just “more of the same, but without the tweets.” That could temper the markets’ enthusiasm.
The biggest risk, though, is a narrow Trump loss that encourages him to contest the election. There are numerous scenarios in which a contested election could be manipulated in ways that would technically be legal but would plunge the U.S. into a constitutional crisis the likes of which hasn’t been seen since the 1800s. A contested election would have the potential to unleash chaos in the country. We could see millions of people from both sides take to the streets to protest. Violent clashes seem almost inevitable. The prospect of massive demonstrations, a government that a majority of the people consider illegitimate, and near-insurrection could send both stocks and the dollar plunging. It would be a massive global “risk-off” event. Just to gauge the extent to which this is possible: there has already been talk about the possible role for the U.S. military in managing the aftermath of the election (spoiler alert: they rejected any role.)
There is the possibility that like in 2008, a disaster in the U.S. could prove positive for the “international dollar” as the safe haven of last resort even as stocks plunged. Still, I can’t imagine that the total loss of faith in the U.S. government could be good for its currency.
Ian Bremmer of Eurasia Group, a political risk company, famously said, “Emerging markets are places where politics matter at least as much as economics to market outcomes.” I’m sorry to say that this holds true for the U.S. too at this juncture.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.