US Elections – Looking for Risks Hiding in Plain Sight
What happened last week?
Last week, the S&P 500 and Nasdaq shed -0.83% and -2.08% while the Dow rose by 0.75%, respectively, as Small Caps outperformed again.
President Biden’s decision to leave the race has lowered investor certainty of a “red sweep.” The chance that Congress and the White House will be unified under one party — to either cut taxes or spend unchecked — has been reduced. We loathe making portfolio shifts based on unreliable polling data. Given a history of rising market volatility in the summer before US Presidential elections, short-term hedging costs for portfolios remain attractive.
As we’ve said before (please see our CIO Bulletin of June 22), investors will have to live without knowing the US election outcome with any certainty. Congressional results are even less predictable. While there are multiple factors to consider, these events fit a historic pattern of rising volatility — and less robust market confidence — in the run-up to the election result.
3 Things to Know
The US President Does Not Drive the Economy (Alone)
Patient investors might be comforted by the fact that US Presidents take far more credit for economic outcomes and market returns than they deserve.
The last US President to preside over a negative return for US equities during his tenure was George W. Bush.
He had the misfortune of ending his administration in January 2009, two months before the historic bear market of 2008-2009 reached a bottom. The housing boom and sub-prime mortgage bust wasn’t arrested by his administration, but it wasn’t wholly his creation either.
Investors also often underestimate the ability of the economy to adapt to change. Europe’s adaptation to a historically-severe energy supply disruption from Russia is just one recent example.
We believe the anticipation of new US tariffs is already impacting trading patterns in a similar attempt to adapt. With that said, we can’t help but worry that some risks are hiding in plain sight if certain policies become a reality.
Fear Factor: Tariffs and Deportations
While both candidates highlight the importance of slowing the large migrant populations moving north, the rhetoric is starkly different.
Former President Trump cites a straightforward rationale to protect American jobs and bolster national security. This is contrasted with a more moderate approach from Harris who is interested in a path to citizenship, reinstatement of DACA (impacting children brought illegally to the US), and mitigation of the underlying causes of mass migrations from Central and South America.
These two policies have different implications for labor markets, business profits, and real economic growth.
The strong immigration restrictions of former President Trump would likely help maintain some of the wage gains at the lower end of the education/skill spectrum in the US. In contrast, the more immigration-friendly policies of Vice President Harris would likely put more negative pressure on wages at the lower end of the spectrum (Democrat administrations have generally attempted to mitigate this with proposals to increases the federal minimum wage. State-level data generally suggest a negative impact on business costs and employment.
Trump’s trade policies, particularly his tariff strategy against China, aim to protect domestic industries from foreign competition. While these tariffs were designed to rebalance trade relationships and support American manufacturing, they also risk inflating import costs and, consequently, consumer prices.
Nonetheless, the scale of the proposed tariff – 60% on Chinese goods imports and 10% for the rest of the world — would be unprecedented in modern times. The recent experience of producers passing price hikes on to consumers during the pandemic raises the probability of a larger impact than 2018.
This makes Trump’s tariff strategy riskier for markets in our view.
The Citi View: Downside Risks if Either Party has Full Control
It is unlikely that there will be a clear-cut stock market favorite candidate. Instead, some sectors and subsectors will be favored with a win by one candidate or the other.
With the poor track record of polling and political forecasters in recent years along with election surprises in France, India, and Mexico in the last few months, we would emphasize a durable and diversified portfolio designed to thrive in any potential political environment rather than attempting to forecast the US election.
See our weekly CIO Strategy Bulletin for more details