Presidential nominations are all but secured for Donald Trump and Joe Biden to re-contest for the U.S. presidency. As such, investors will begin to extrapolate the results to financial markets, says a report from iCapital.
The firm specializing in alternative assets says it is early for markets to reflect a possible outcome, but certain equity baskets are already showing election-related divergences. Perhaps most important is recent data indicating that the economy may be operating at a “sweet spot,” which should further support U.S. equities regardless of the outcome of the election, summarize analysts Anastasia Amoroso, Peter Repetto and Nicholas Weave.
President Biden and former President Trump dominated their respective Super Tuesday races on March 5, securing enough delegates to win their parties’ presidential nomination and setting up the first rematch since the 1956 election. This result had largely been expected by the markets, particularly as PredictIt odds on the morning of Super Tuesday indicated a 92% likelihood of Trump securing the Republican nomination and a 77% likelihood of President Joe Biden retaining the Democratic nomination.
Indeed, the market’s subdued reaction to this development also underscored the widely expected nature of this outcome. As the November election approaches, PredictIt odds now show former President Trump with a slight edge, with a 47% chance of winning to President Biden’s 45%.
While it may still be premature for markets to worry about the presidential election, scheduled for November 5, iCapital notes that U.S. equities are beginning to price in the potential election results.
The report released in early March focused on three main points: 1) taking stock of which sectors are showing or are likely to show election-related divergence, 2) noting how volatility spikes associated with elections tend to be short-lived and occur much closer to the election, and 3) focusing on how fundamentals and renewed “economic enthusiasm” should support overall equity returns regardless of the election outcome.
Certain Sectors May Be Starting to Price in Potential Election Outcomes
With eight months to go before the U.S. presidential election, it is early for markets to reflect the likely outcome. However, looking at the performance of certain policy baskets, it appears that markets are beginning to price in a Republican victory.
In fact, since the end of September 2023, the Morgan Stanley Republican basket is up 22.4%, which has not only outperformed the Morgan Stanley Democratic basket, which is down 30%, but has also outperformed the S&P 500’s 18.4% rise. The outperformance of the Republican basket has coincided with a 10 percentage point (ppt) increase in the former President’s PredictIt electoral odds, while President Biden’s odds have only increased 3 ppt.
In addition, iCapital also believes that the Republican basket has benefited from Trump’s lead in virtually every swing state. In fact, if we look at Real Clear Politics’ top battleground states, the former President has an average lead of 4% in these key states. The only battleground state where Trump does not currently have a lead is Pennsylvania, where President Biden holds only a 0.8% lead.
Similar to the outperformance of the Morgan Stanley Republican basket, the Goldman Sachs Republican basket has also outperformed the S&P 500 since September 2023. Indeed, the Goldman Sachs Republican basket is up 21.4% which compares to the 20.3% gain for the S&P 500. Even on a YTD basis, the Goldman Sachs Republican basket has performed in-line with the S&P 500. The outperformance of the Goldman Sachs Republican basket has been more pronounced when you compare it to their Republican underperform basket. Indeed, since September 2023 the underperform basket has lagged by seven ppt. This underperformance has continued into 2024 as it has lagged by five ppt on a YTD basis. Similar to the composition of the Morgan Stanley basket, the Goldman Sachs Republican basket has a cyclical bias and should benefit from financial deregulation, onshoring, construction, energy, coal and steel production, in addition to companies that have their sales coming from small businesses.
iCapital says these baskets will be important to watch as they will eventually provide more insights into what outcome financial markets will price in. For example, in looking back at the 2016 election the Goldman Sachs Republican basket was up 14% from Jan. 1, 2016 through the November 2016 election. This outperformed the S&P 500 by 6.6 ppt.9 Conversely, heading into the 2020 election the Republican basket underperformed the S&P 500 by roughly 11 ppt, indicating that markets were pricing in a Biden victory.
Looking abroad, the analysts that certain international financial markets could be impacted by how polling data and election odds evolve throughout the year, specifically China. Even though Chinese equities have recouped their YTD losses, benefitting from policy easing announcements, Chinese equities were particularly sensitive to trade rhetoric when former President Trump was in office. Indeed, when former President Trump first started mentioning the potential for tariffs, Chinese equities were almost 9% lower, significantly lagging the 18.5% gain for the S&P 500 from January 2018 through December 2019. Given former President Trump continues to tout the potential for further tariffs, we think Chinese equities could become increasingly more sensitive to such announcements.
Spikes In Volatility Will Likely Take Place Closer to The Election
Another reason iCapital believes it is too early for markets to focus on the election is that, historically, the S&P 500 begins to factor in election results in the period between August and October, which is one to three months earlier. In fact, according to the firm’s research, markets tend to experience more volatility in the months leading up to an election. This view is also corroborated by the current time structure of the CBOE Volatility Index (VIX), where the October contract trades much higher than other contracts, indicating that markets are beginning to assign some risk to the election.
Markets Broadly Are Benefitting from the “Economic Enthusiasm”
Even with the increase of the former President’s election odds and polling data, the Republican baskets have also been benefitting from the “economic enthusiasm” given the pro-cyclical composition of the basket in financials, industrial, materials and energy, the firm added.
Focusing on Fundamentals Should Help Investors Weather Any Election Related Volatility
The strength of the U.S. economy has not only supported U.S. equity markets since the start of the year, but has also supported the cyclical trade. While the Republican policy baskets have benefitted from a jump in Trump’s presidential election odds and polling numbers, we also think the pro-cyclical nature of these baskets have benefitted from the “economic enthusiasm” we have seen so far this year.
Of course, investors should prepare for some election volatility which may stem from rhetoric around taxes, tariffs, big tech regulation and export controls, but we would continue to invest through it.
“We continue to believe that focusing on fundamentals and how economic data evolves will ultimately be more important than the election outcome. And regardless of outcome, markets have historically rallied in the 12 months following the election”, concluded the report.
To read the full report you must access the following link.
