Monthly Agenda July 2020 – 100 Days
This month we focus our attention on the upcoming US presidential election. This is timely for two reasons. First, we are now three months out from the election. This is typically the time markets begin to focus more on the outcome. Second, we now have the July consumer confidence reading for the US. Historically, the July consumer confidence reading in an election year has been statistically significant predictor of the election outcome.
We look at the current polling, what the data is suggesting the outcome will be, how financial markets react before and after election day, and what the key policy differences are between the two parties. We finish with some potential investment implications.
It will take 270 electoral votes to win the 2020 presidential election. Incredibly, there are no fewer than 39 different polling sources for this years’ election. The average of the five most recent polls has Biden ahead of Trump by ten percentage points.
This is consistent with President Trump’s low job approval rating (chart 1).
Chart 1. Trump Job Approval Rating (%)Enlarge Source: Bloomberg
A president as unpopular as Donald Trump has never won a second term. The average job approval rating for a two-term president is 53.2%. As the chart above shows, Trump’s job approval is currently sitting at 42.4%. Indeed, no other president has had an approval rating this low in modern history.
Consumers may already know the result
Predictions around election outcomes are difficult to make and, recently at least, have not been all that accurate. So it is with some degree of caution that we highlight an interesting relationship between consumer confidence and the election outcome. TS Lombard, an independent research provider, found that in election years, the result in November tends to follow the Conference Board Consumer Confidence Survey measured in the previous July.
On average, if consumer confidence in July is below 92, the incumbent party has lost the election; if it is above 98, the incumbent has won. In other words, a party in charge of a faltering economy has never been re-elected.
The July Conference Board Consumer Confidence survey was released last Tuesday. The result came in at 92.6, just above the 92.0 threshold.
The chart below shows the annual change in that same consumer confidence index when the incumbent was defeated. The current reading of -31.8% is significantly below the average when previous incumbents were defeated (chart 2).
Chart 2. July consumer confidence (yoy%) when incumbent defeatedEnlarge Source: Bloomberg
So while predictions are difficult to make, Trump’s current combination of weak consumer confidence and weak job approval does not bode well for the Republicans.
Financial market response
We look at what happens to US and international equities, US bond yields and the AUD/USD exchange rate before and after a presidential election. Our data set goes back to the 1936 election for US equities, the 1964 election for US bonds, and the 1972 election for international equities and the AUDUSD exchange rate.
Chart 3 shows how the US S&P500 performed in the 6 months prior to election day (ED) and in the 6 months following. The heavy black line is the average across the 21 elections studied and the red line is the tracking for the current election year.
Two things are clear from this chart. First, the average is weighed down by the 2008 global financial crisis. Excluding this, US equities tend to rise 4.5% in the 6 months leading up to the election and rise a further 3.1% in the 6 months after.
Second, the current market is tracking well ahead of the average of the previous election years. Indeed, just two years exceed the current trajectory – 1936 and 1980.
On average, US equities have performed better in the 6-months following election day under a Democrat victory. This is particularly the case when 2008 is removed from the sample (+4.0% vs +2.2% under a Republican victory).
Elections rarely are the sole key driver of equity market performance, however. The domestic economy and financial conditions in particular play a far greater role. This goes some way to explaining the outsize result for the current year.
Chart 3. S&P500 performance in previous electionsEnlarge Source: Bloomberg
Chart 4 shows the same analysis for global equities.
The lower bound of the dispersion is again captured by the performance in 2008 while the upper extreme, against which the current performance of global equities is tracking closely, was 1980. On average, global equities underperformed very slightly in the leadup to election day and outperformed by 3.6% in the 6 months after.
This outperformance was particularly apparent when the Democrats won (+6.2%). Digging deeper, the German DAX was up on average 7.3% following a Democrats victory while the Japanese Nikkei was up 17.3%. Under a Republican win, the DAX rose 3.6% while the Nikkei rose 6.7%.
Chart 4. MSCI global equities performance in previous electionsEnlarge Source: Bloomberg
Chart 5 shows the performance for the AUD/USD exchange rate.
The US dollar has tended to strengthen against the Australian dollar in the lead-up to the election by around 3.3%. This trend continues in the aftermath of the election with an average decline in the Australian dollar of 0.8%.
The current trajectory of the Australian dollar has it well ahead of any path taken in previous years. The weakest path was that taken in 2008 when the Australian dollar fell some 30% in the year-to election day. This highlights the importance of economic and financial factors as more important drivers of the currency than elections.
Chart 5. AUD/USD performance in previous electionsEnlarge Source: Bloomberg
While Joe Biden is a moderate, he is proposing higher taxes (reversing half of Trump’s corporate tax cut and returning the top marginal tax rate to 39.6%) and more regulation. Both Trump and Biden plan to spend around $1 trillion on new infrastructure over the next ten years.
On climate policy, Biden wants the US to reach net zero emissions by 2050 by raising the cost of fossil fuels and boosting the development of alternatives (possibly with a carbon tax). Biden also wants to strengthen Obamacare and limit drug prices.
Biden would likely de-escalate tensions with Europe and strengthen the alliance, work with international organisations like the World Trade Organisation, work to re-establish the nuclear deal with Iran and adopt a more diplomatic approach to dealing with trade and other issues with China (working with Europe and Asian allies in the process). By contrast a re-elected Trump is likely to double down on his trade war with China and possibly elsewhere including Europe.
If we have learnt nothing from recent history, it is the danger in trying to predict the outcome of an election. That is not the intention of our analysis. The point here is to show that the election outcome is finely balanced. Clearly, if the US economy and by extension the virus, continues to weigh, it will be very difficult for the already unpopular Trump to win a second term.
We would also caution on reading too much into past analogs of how financial markets have performed in an election year, particular in a crisis year such as the one we are currently in. There is no definitive heuristic that a victory by party X is good or bad for asset Y.
In that light, we prefer to offer observations rather than clear conclusions.
First, the study suggests that whoever wins on November 3rd, US equities perform well in the following 6 months. The performance is slightly stronger under a Democrat victory. This may be due as much to seasonality as anything political.
The six months from November are historically one of the best performing six months of the year for US equities (chart 6).
Chart 6. Avg S&P500 6-month return from:Enlarge Source: Bloomberg
Second, a Democrat victory also appears to be associated with a strong performance for international equities in the 6 months following the election.
US and global equities have already outperformed the average of previous election years. In our view, further significant outperformance is likely to be more reliant on the path of the coronavirus than the outcome of the election.
Third, the strength of the US dollar in the leadup to and following election day should be viewed cautiously given the evidence of seasonality. As we show in chart 12 on page 8, the last five months of the year tend to be associated with US dollar strength.
Finally, we struggle to find a statistically significant result for the direction of bond yields under a Democrat win. A win for the Republicans, on the other hand, has been associated with higher bond yields 75% of the time.
In our view, we believe both US and international equities can move higher from here, particularly if the virus case count is controlled. A Biden victory has the potential to add to that though much would depend on whether he passes legislation to raise taxes. We would suggest a Trump victory is most likely to see the US dollar strengthen given the likelihood of an escalation in the US/China trade war.
Chief Investment Officer