It is hard to believe that Election Day is just days away. This election season has certainly been unique, occurring in a year that has been characterized by a painful global pandemic, a short but deep recession and continued social unrest. Yet, the surprises keep coming. The events of the past few weeks — the death of Supreme Court Justice Ruth Bader Ginsburg, a contentious first presidential debate and President Trump and several administration members contracting COVID-19 — have added to the layers of uncertainty of this election season.
With so much uncertainty, it is unsurprising that investors consistently ask whether their portfolios are properly positioned for the outcome. As we've learned from the 2016 presidential race, it can be difficult to predict a winner. Furthermore, history tells us that the outcome won't have a significant impact on stock market performance. Thus, as an investor, it's better to stick with your long-term investment strategy and avoid making emotional decisions based on who you think may win the White House.
THE MARKET'S MIXED MESSAGE
The former Vice President and Democratic nominee Joe Biden continues to maintain a high single- to double-digit lead in the national polls, according to polling aggregator sites such as RealClearPolitics and FiveThirtyEight.
But leads in national polls aren't always accurate at predicting a winner as we saw in 2016, when Hillary Clinton's lead in the national polls won her the popular vote but not the electoral votes. It's also important to monitor statewide polls in key battleground states. Currently, as illustrated in Figure 1, Biden remains ahead of the president in key states like Arizona, Pennsylvania and Florida, and has a stronger lead than Clinton had at this point in 2016.
Markets are not quite as convinced about Biden's lead and present a more mixed message. The stock market and the U.S. dollar, which have been fairly good predictors of who will win the election, are suggesting a tighter race. The general rule states that if the S&P 500 is positive in the three months leading up to the election, the incumbent party will win the White House. If returns are negative, the incumbent party will lose. Similarly, if the U.S. dollar is down in the three-month period before the election, the incumbent is predicted to win.
This time around, the S&P 500 is up modestly since August, perhaps representing a slight advantage to Trump. Meanwhile, the dollar is up 0.5% since August 3, a slight advantage to Biden.
WELL-POSITIONED AND PREPARED
As an investment strategist, it's important to look beyond these political headlines and help navigate investors through election cycles. But rather than relying solely on election outcomes, it is important to consider where we believe the global markets and economy are headed when making asset allocation decisions.
Today, we have positioned portfolios for a mid-cycle bull market of modest equity returns, lower-for-longer yields given the accommodative policies of global central banks and a pickup in volatility. Yet, we constantly monitor for new information that may influence how we position investor portfolios moving forward. This may include developments around a potential second wave of the virus, the pace of economic recovery from here and of course, the U.S. presidential election.
Regardless of who gets elected, the ultimate policy landscape will depend a lot on the makeup of Congress. And, often what becomes law is very different (and watered down) from what is proposed during a campaign. While Biden has campaigned on raising taxes, expanding Obamacare and funding clean energy, much of this agenda may be postponed given the focus on containing the virus and the economic recovery.
With that said, the following provides a look at how client portfolios are positioned today and offers some perspective on the types of changes we may consider making in the event of a Biden win. We have not yet made any asset allocation changes solely in anticipation of the election outcome, but continue to base our decisions on fundamentals — not who wins the election.
Large Cap vs. Small Cap: Our portfolios have had a U.S. bias with a tilt to large cap equity over small for a number of years. Regardless of who wins in November, we believe the trend to bring manufacturing back to the U.S. and to shorten supply chains will benefit larger companies. However, under a Biden administration, large cap stocks may fare better than small cap given they are tied more to the global economy, may benefit from a weakening dollar and may be better positioned to realize profits under a higher corporate tax environment.
Non-U.S. vs. U.S.: We currently favor U.S. equities given the Federal Reserve's accommodative policies, signs of a strong consumer and the economic rebound underway. Expectations for more multilateral trade policies under a Biden administration could weaken the U.S. dollar as well as the potential de-risking of U.S.-China trade tensions. This result may cause us to invest more in non-U.S. equities, a move we began in August given the relative attractive valuations, weaker dollar and strength of the economic recovery outside the U.S.
In addition, a potentially higher corporate tax rate in the U.S. could hurt domestic companies' earnings. Although Biden has proposed increasing this to 28%, up from the current 21%, the extent of the increase may be limited under a divided government.
Emerging Markets: A less protectionist trade policy may stimulate growth for many export-driven, emerging market economies. Countries most dependent on exports, including Mexico and Canada (both with about 70-80% of exports to the U.S.), may be hurt, while other emerging markets with fewer exports to the U.S., such as Russia (<5%) and China (20%), might do quite well in comparison. Look for us to remain neutral in this asset class if Biden gets elected.
Exposure to Diversifiers: We currently have a small overweight to diversifiers, which are designed to help buffer swings in the market. The recent equity market volatility in September, with a rotation from technology names that have led the rally to more cyclical names, shows how quickly market trends can shift. Thus, it is important to have asset classes that are less correlated to stocks and bonds. While a Biden victory could increase market volatility, at least initially, we may recommend increasing exposure to strategies that benefit from increased volatility.
WAITING AND WATCHING
Over the next several weeks there will be much to contemplate. In our view, the market may have already priced in a relatively high probability of a Biden victory. In the event of a contested outcome, where we don't know the winner for weeks or longer, markets may become more volatile. However, it appears as if the chances of a contested election are waning as Biden continues to widen his lead in the polls.
Given that asset allocation is the biggest driver of long-term returns, try and resist making investment decisions based on politics and stick with your well-thought-out plan. Engage in the political process and let us help you navigate this election season.