Citi Personal Wealth Management

Washington Watch:
The Path to the Presidency

Market Outlook: October 14, 2020

Highlights

The path to the U.S. presidency is a long and arduous one. With the U.S. election on November 3rd quickly approaching, uncertainty remains elevated.

National polling averages continue to favor the Democratic candidate former Vice President Joe Biden with a margin just shy of 9%. However, polls can swing substantially leading up to an election with forthcoming events likely to swing voters’ opinions. Polls are suggesting about a 60% chance of a Joe Biden victory and a 40% chance of a President Trump victory. Although national polling averages may not be the best indicator.

Since 1952, the incumbent party has lost every presidential election when a U.S. recession occurred during the year, impacting incumbent Vice President Richard Nixon in 1960, President Jimmy Carter in 1980, and Senator John McCain in 2008. However, in 1980 and 2008, the number of consumers saying that the government was doing a good job on economic policy was just 10% and 7%, respectively. That is not the case now with 31% of consumers still viewing government economic policy in a favorable light.

Betting markets are putting the odds of a Democrat-controlled White House and Senate at about 57% - implying that a Democratic sweep is starting to be priced in, but far from a guarantee. This scenario could translate into higher taxes for corporations and wealthier individuals, but a boost in spending in areas such as infrastructure, clean energy, healthcare, and education could provide a meaningful offset.

A second term for President Trump is well within the realm of possibility. Under this scenario, down-ballot voting would likely result in the Senate staying under Republican-control while the House stays under Democratic-control. Investors would likely expect more of the same with calls for deregulation and attempts to maintain lower tax rates for individuals and corporations. The Energy sector would likely fare better as well as Bank and Defense stocks.

A contested election may be the worst case scenario for financial markets. During the Bush / Gore election in 2000, the S&P fell more than 11.0% between election day and Al Gore’s eventual concession. However, since 1980, the S&P 500 was higher three months after the election 80% of the time. In the 12 months that follow, the S&P 500 was higher 90% of the time.

The Current Backdrop

The path to the U.S. presidency is a long and arduous one. With the U.S. election on November 3rd quickly approaching, election uncertainty remains elevated.

National polling averages continue to favor the Democratic candidate former Vice President Joe Biden with a margin just shy of 9%. However, polls can swing substantially leading up to an election with forthcoming events likely to swing voters’ opinions. As an example, here is a brief list of events that have occurred recently: Supreme Court Justice Ruth Ginsburg passed away, the first U.S. presidential debate, President Trump tested positive for COVID-19, Congress struggled to agree on a COVID-19 relief bill, and the S&P 500 corrected 10%. It’s nearly impossible to discern the long-term impact of each of these issues, which is why investors are often forced to look at polling data, even with its flaws.

According to Real Clear Politics, polls are suggesting about a 60% chance of a Joe Biden victory and a 40% chance of a President Trump victory. Betting markets are reflecting a similar outlook (see Figure 1). Although national polling averages may not be the best indicator of a candidate’s likelihood to win the presidency.

Figure 1: PredictIt – Who Will Win the U.S. Presidential Election?
Figure 1: Returns of Major U.S. Indices Since March 23rd (%)
This chart displays the likelihood of Donald Trump and Joe Biden of winning the presidential election in percentages over a period from December 2019 to October 2020.
Note: PredictIt is a political outcome exchange. It is a research project of Victoria University of Wellington and is operated for academic purposes under permission from the CFTC. The series can be used as a gauge of probability, but the two series may not sum up to 100%. There can be no assurance that these conditions will remain in the future.

The 2016 presidential election stands out as a key example with former Secretary of State Hillary Rodham Clinton leading in one national poll by 14.0% in mid-October, but losing the election with President Trump receiving 306 electoral votes and Hillary Clinton receiving 232 electoral votes (270 are needed to win the presidency). There are many reasons that 2020 polls may not be comparable to 2016 polls, such as a greater weighting being given to citizens without a four-year degree and fewer voters viewing Joe Biden as “very unfavorable” when compared to Hillary Clinton, but the takeaway should be that this election will likely be determined by battleground states. In 2016, President Trump won 18 states by fewer than 250,000 votes and won Michigan, Pennsylvania, and Wisconsin by 0.2, 0.7 and 0.8 percentage points, respectively — and by 10,704, 46,765 and 22,177 votes. Those three wins gave President Trump 46 electoral votes. If Hillary Clinton had done just one point better in each state of those three states, she may have won the electoral vote as well as the popular vote.

Currently, there are 15 battleground states with Florida, Pennsylvania, and Ohio likely to gather the most attention – though all are important. Biden maintains a lead in several key states including both Florida and Pennsylvania, but that leads narrows in other swing states like Ohio, North Carolina, and Arizona (see figure 2). Moving forward, swing state polling may prove more critical than national.

Figure 2: Real Clear Politics 2020 Election Polling (%)
Election 2020 Biden Trump Spread
RCP National Average 51.3 42.4 Biden +8.9
Top Battlegrounds 49.1 45 Biden +4.1
Latest Betting Odds 59.9 40.5
Battlegrounds / # of Electoral Votes Biden Trump Spread
Texas / 38 Votes 44.8 49.2 Trump +4.4
Florida / 29 Votes 48.2 46.8 Biden +1.4
Pennsylvania / 20 Votes 49.2 44.8 Biden +4.4
Ohio / 18 Votes 46.0 46.5 Trump +0.5
Michigan / 16 Votes 49.8 43.0 Biden +6.8
Georgia / 16 Votes 47.8 46.6 Biden +1.2
North Carolina / 15 Votes 48.5 45.8 Biden +2.7
Arizona / 11 Votes 49.3 46.2 Biden +3.1
Wisconsin / 10 Votes 49.7 43.7 Biden +6.0
Minnesota / 10 Votes 47.3 40.7 Biden +6.6
Iowa / 6 Votes 47.5 46.3 Biden +1.2
Nevada / 6 Votes 49.0 43.8 Biden +5.2
This table provides a breakdown of national polling figures for the U.S. presidential election between President Trump and former Vice President Joseph Biden.
Sources: Real Clear Politics and Citi Personal Wealth Management as of October 9, 2020. Note: Polling averages are subject to change throughout the election cycle.

Apart from polling data, the economy can also provide historical perspective on the likelihood of the incumbent party being re-elected. Since 1952, the incumbent party has lost every presidential election when a U.S. recession occurred during the year, impacting incumbent Vice President Richard Nixon in 1960, President Jimmy Carter in 1980, and Senator John McCain in 2008.

However, it should be noted that the 2020 recession may be viewed differently by voters given that it was causes by an external factor in the form of COVID-19. Combined with massive amounts of monetary stimulus and fiscal stimulus that helped to boost national incomes, consumer confidence gauges on economic policy remain higher than previous recessions in U.S. election years (see figure 3). In 1980 and 2008, the number of consumers saying that the government was doing a good job on economic policy was just 10% and 7%, respectively. That is not the case now with 31% of consumers still viewing government economic policy in a favorable light – even despite what is likely to be one of the deepest, but brief, recessions on record.

Figure 3: Election Results During Periods of U.S. Recession vs. Consumers View of Government Economic Policy
Election Year U.S. Recession Incumbent Party Incumbent Party (Won / Lost) % of Consumers Saying the Government is Doing a Good Job on Economic Policy (September Reading)
1960 Yes Republican Lost N/A
1964 No Democrat Won N/A
1968 No Democrat Lost N/A
1972 No Republican Won 23%
1976 No Republican Lost 15%
1980 Yes Democrat Lost 10%
1984 No Republican Won 35%
1988 No Republican Won 29%
1992 No Republican Lost 6%
1996 No Democrat Won 24%
2000 No Democrat Lost 44%
2004 No Republican Won 24%
2008 Yes Republican Lost 7%
2012 No Democrat Won 16%
2016 No Democrat Lost 22%
2020 Yes Republican ? 31%
This table highlights the election outcome for the incumbent party and consumer confidence from 1960 to 2020.
Sources: Bloomberg, PredictIt.org, and Citi Personal Wealth Management as of October 5, 2020. There can be no assurance that these conditions will remain in the future.

Both polling data and economic conditions appear to currently favor the challenger Democrat Joe Biden, but fortunes can change quickly and we still think it’s too early to feel assured of any one particular election outcome. As such, we think it’s best for investors to consider several different scenarios. We have divided the potential outcomes into four distinct categories: a Democratic sweep (Joe Biden victory and Democrat-controlled Congress), a President Trump re-election, a divided government, and a contested election.

Election Scenarios

Scenario 1: Democrat President; Democratic Congress (Somewhat Likely)

In this scenario, Joe Biden becomes President and both the U.S. House of Representatives and the U.S. Senate are under Democratic-control. There is a path that could lead to this result with polling suggesting that Biden is favored to win the presidency and the House very likely to remain Democrat with the party needing to win just 4 of the 31 “toss up” districts to obtain the 218 seats needed for a majority.

Currently, betting markets are putting the odds of a Democrat-controlled House at about 88%. The Senate is where the path narrows with 47 seats likely or leaning Democrat and 46 seats likely or leaning Republican. That leaves 7 seats as a “toss up” with 51 seats needed for a majority. Combined, betting markets are putting the odds of a Democrat-controlled White House and Senate at about 57% (see figure 4).

Figure 4: PredictIt – Will Democrats Win the White House and the Senate?
Figure 4: Will Democrats Win the White House and the Senate?
This chart displays a line graph of the chance in % that the Democrats will take the White House and Senate over the past few months.
Note: PredictIt is a political outcome exchange. It is a research project of Victoria University of Wellington and is operated for academic purposes under permission from the CFTC. The series can be used as a gauge of probability, but the two series may not sum up to 100%. There can be no assurance that these conditions will remain in the future.

This scenario could translate into higher taxes for corporations and wealthier individuals with the key issue for markets being the capital gains treatment. This could be viewed unfavorably by markets in the near-term as investors seek to lock in capital gains at a lower rate and adjust earnings expectations to reflect a higher corporate tax rate (perhaps a shift from a 21% corporate tax rate to 28%). Though we suspect that a rise to 25% might be more likely than to 28% due to oppositional forces in Congress. We would also point out that after selling off briefly in response to a higher capital gains tax, the S&P 500 marched higher following the capital gains tax increase in both January 1987 and January 2013. Lastly, a Biden victory could lead to increased regulations on the financial industry and polluting industries.

A boost in spending in areas such as infrastructure, clean energy, healthcare, and education could also provide a meaningful offset to these tax increases. According to Citi’s economists, infrastructure spending might total $2.4 trillion under Biden’s plan and be spent over a period of 10 years, with much of the spending being done in the first five years. This could lift U.S. real gross domestic product (GDP) by 0.8 percentage point per year during his term. This could spark further interest in areas of the market that may benefit from increased government spending with the MSCI Global Alternative Energy index likely already reflecting this trend ahead of the election’s results (see figure 5).

Figure 5. MSCI Alternative Energy Index vs. Biden’s Odd of Winning the Presidency
Figure 4: Will Democrats Win the White House and the Senate?
This chart shows the MSCI Alternative Energy Index vs. Biden’s odd of Winning the Presidency.
Sources: Bloomberg, PredictIt.org, and Citi Personal Wealth Management as of October 5, 2020. Past performance does not guarantee future results. There can be no assurance that these conditions will remain in the future.

Scenario 2: Republican President, Divided Congress (Current Situation)

A second term for President Trump is well within the realm of possibility. Under this scenario, down-ballot voting would likely result in the Senate staying under Republican-control while the House stays under Democratic-control. Investors would likely expect more of the same with calls for deregulation and attempts to maintain lower tax rates for individuals and corporations. If a lower capital gains tax is suggested, it could lead to a market sell-off if investors perceive that rate to be temporary and they try to take advantage of it. A continuation of trade wars may also be a possibility. Citi’s Chief U.S. Equity Strategist thinks that the Energy sector would likely fare better under President Trump and Banks and Defense stocks may as well, but trade uncertainty could weigh on multi-nationals. The Health Care sector may also come under pressure.

We think it is very unlikely that a President Trump re-election would be accompanied by a unified Congress under Republican-control, but if this did occur then investors should expect Tax Reform 2.0 and an infrastructure bill. According to Citi’s economists, this could add 0.2 percentage point per year to real U.S. GDP. This could benefit companies involved in the construction of hard assets like roads, bridges, and airports and also those focused on 5G deployment and rural broadband networks.

Scenario 3: A Divided Government (Somewhat Likely)

Either Biden or Trump could get elected, but be faced with a divided Congress where the House is still Democrat and the Senate is still Republican. This means that the President would depend upon executive actions and regulation to effect big policy changes. Both Obama and Trump used significant executive actions to govern during their terms. A Trump re-election would likely be more of the same for markets while a Biden victory could lead to increased regulations on the financial industry and polluting industries. There is some risk that a Biden victory with a Republican Senate could be viewed as dimming the odds of an infrastructure bill, which could lead to a modest pullback in equity markets as investors taper their expectations.

Scenario 4: A Contested Election (Unlikely, But Possible)

This is likely the worst case scenario for financial markets and represents a significant tail risk (meaning it is not our base case, but could happen). Citi’s economists point out that it is not a legal requirement for the loser of the presidential election to concede on election night, only tradition. With a significant surge in the number of mail-in ballots expected, an election result could be delayed by legally contesting election results. Both candidates can claim that proper election procedures were not followed or that fraud was committed. However, the claim must be substantiated and not a general complaint of unfairness.

The closest example that investors have to look to for guidance is the George W. Bush Jr. / Al Gore election in 2000 when the vote count in Florida showed George W. Bush Jr. winning by such a close margin (537 votes or a margin of 0.009%) that state law required a recount. This led to a month-long series of legal battles that ended with a 5-4 Supreme Court ruling to end the recount. Between election day and former Vice President Al Gore’s concession on December 13th, 2000, the S&P fell a bit more than 11.0% (see figure 6). We could envision a similar response this time should it occur given that financial markets dislike uncertainty and an elevated level of social unrest in the country could cause further turmoil. Though it should be noted that the response could be more muted given the large amount of underlying support markets are receiving from the Federal Reserve and lingering potential for additional fiscal stimulus.

Figure 6. S&P 500 Stock Index Performance During the 2000 U.S. Election
Figure 6. S&P 500 Stock Index Performance During the 2000 U.S. Election
This line chart shows the S&P 500 stock index performance during the 2000 U.S. election and Al Gore's concession.
Sources: Bloomberg and Citi Personal Wealth Management as of December 31, 2000. Past performance does not guarantee future results.

Equity Market Performance During U.S. Elections

Investors tend to look for clear correlations between equity market performance and the political party that is governing the country, but historical data suggest that the relationships are not simple. When it comes to U.S. presidential elections, investors also tend to think that an election result that favors the party they oppose will lead to a sharp correction in stock prices. However, history shows that the weakest equity market performance usually occurs before the election, not after.

As figure 7 shows, the S&P 500 has averaged a 0.5% total return in the three months leading up to election day. Since 1980, S&P 500 returns during the three months prior to election day have been positive 60% of the time. In the three months that follow the election, the average total return improves to 3.3% with returns positive 80% of the time. In the 12 months that follow, the total return average improves to 14.1% with a positive return 90% of the time. Though we acknowledge that average returns across all election years likely masks the type of market performance that might prevail depending on whether or not the incumbent party loses or wins.

In order to adjust for that, market performance can be broken down to reflect years in which the incumbent party won versus years in which the incumbent party lost. As figure 8 shows, market performance in election years where the incumbent party won is noticeably stronger with the S&P 500 returning an average of 12.2% versus just 1.9% when the incumbent party lost.

Figure 7. S&P 500 Total Return Before and After U.S. Elections
Election Year 3-Months Before 3-Months After 6-Months After 12-Months After
1980 5.5% 1.4% 5.7% 3.3%
1984 5.8% 7.5% 7.3% 16.7%
1988 2.9% 9.5% 13.2% 27.2%
1992 -0.4% 7.2% 6.8% 13.4%
1996 8.8% 9.5% 17.4% 34.5%
2000 -2.9% -6.1% -11.2% -21.0%
2004 2.6% 6.0% 3.7% 9.4%
2008 -19.0% -16.6% -8.4% 6.9%
2012 3.0% 6.5% 14.5% 26.8%
2016 -1.3% 7.8% 13.3% 23.7%
Average: 0.5% 3.3% 6.2% 14.1%
Positive / Total 6 /10 8 /10 8 /10 9 /10
This table highlights the difference in the S&P Index 3 months before and 3, 6, 12 months after each Presidential election from 1980 to 2016.
Sources: Bloomberg and Citi Personal Wealth Management as of November 8, 2017. Past performance does not guarantee future results.
Figure 8. S&P 500 Total Return Before and After U.S. Election Day (%)
Figure 8. S&P 500 Total Return Before and After U.S. Election Day
This is a line chart with an x-axis of months January to January and y-axis of the rate of change to the S&P with All Presidential Election Years and where the Incumbent Party Wins and Incumbent Party Loses
Sources: Bloomberg and Citi Personal Wealth Management as of November 7, 2017. Past performance does not guarantee future results.

Based on recent market performance and past equity market patterns, one could reasonably assume that the stock market might be reflecting greater odds of a President Trump victory than national polling suggests, but it is also possible that recent equity market performance is reflecting growing optimism of a one-two combo of additional COVID-19 relief fiscal stimulus from Congress and a significant infrastructure bill should investors see a Democratic sweep of the White House and Congress. Our bigger takeaway from figure 8 is that once the election is over, equity markets tended to move higher.

Since 1960, the S&P 500 has returned an average of 1.3% between the election day and year-end during all presidential election years. This compares to an average of 1.8% when the incumbent won and 0.7% when the incumbent lost (see figure 9). While it is a constant refrain that the stock market will crash depending on the election result, historical data back to 1960 suggest otherwise with only two election years standing out for their negative performance – 2000 and 2008. As mentioned early, in 2000, the S&P 500 sold off as a result of the contested U.S. election and in 2008, the country was in the midst of the global Financial Crisis. While the 2000 election could be pointed to as an example for this election, it was not because one particular party bested the other, it was due to heightened uncertainty in financial markets. If we have clarity on the election several days afterwards, we think the odds of repeating the equity market performances witnessed in 2000 and 2008 are relatively low.

Figure 9. S&P 500 Return Between U.S. Election Day and Year End
Election Year Incumbant Won / Lost S&P 500 Return Between Election and Year End (%)
1960 Lost 5.4
1964 Won -0.5
1968 Lost 0.7
1972 Won 3.6
1976 Lost 4.2
1980 Lost 5.2
1984 Won -1.9
1988 Won 0.9
1992 Lost 3.8
1996 Won 3.7
2000 Lost -7.8
2004 Won 7.2
2008 Lost -10.2
2012 Won -0.2
2016 Lost 4.6
Average: 1.3
Average if Incumbant Won: 1.8
Average if Incumbant Lost: 0.7
This table shows the S&P 500 returns between U.S. election day and year end for each election year between 1960 and 2016
Sources: Bloomberg and Citi Personal Wealth Management as of December 31, 2000. Past performance does not guarantee future results.

For a more in-depth look at equity market performance during past U.S. elections, please see figure 10 from Citi’s Chief U.S. Equity Strategist Tobias Levkovich which provides more details on election outcomes with swings in party control included. One general conclusion from the figure is that equity markets can perform well under both parties as American entrepreneurship, ingenuity, and technological advancements are often key drivers of financial markets, not politicians. Another conclusion is that market performance under a split Congress tends to be weaker, reflecting a lack of meaningful legislation being passed under such a scenario.

Figure 10. Post-Election 12-Month Performance: Performance from October 31st (Prior to Election) to Following October 31st (Since 1990)
S&P 500 DJIA
Average if Republican Senate 8.10% 7.88%
Average if Democratic Senate 9.72% 8.86%
Average if Republican House 8.78% 9.41%
Average if Democratic House 9.16% 7.83%
Average if Republican President 6.45% 6.45%
Average if Democratic President 11.94% 10.70%
Average if All Republican 6.59% 6.39%
Average if All Democratic 9.94% 7.76%
Average if Senate Change: D to R 9.42% 11.60%
Average if Senate Change: R to D 4.74% 8.94%
Average if House Change: D to R 11:00% 14.45%
Average if House Change: R to D 3.97% 2.12%
Average if House and Senate Split 1.94% 0.70%
Average if any type of Grid-Lock (anything but an all Democrat or Republican Control) 9.61% 10.05%
This table describes Post-Election 12-Month Performance of the S&P and Dow Jones from October 31st (Prior to Election) to following October 31st (Since 1990)
Sources: Citi Investment and Research Analysis – U.S. Equity Strategy as of October 31, 2017. Past performance does not guarantee future results.

The Importance of Staying Invested

The direction of the country is extremely important and policy changes can have a meaningful impact on financial markets and citizen’s daily lives. However, when it comes to investing, it is a marathon, not a sprint. Long-term investing remains staying focused on long-term goals and not letting political noise or emotion distract from those goals. As an example, if an investor had invested $10,000 on January 20th, 1961 when President John F. Kennedy won the election and only invested in the S&P 500 when Democrats were president, their portfolio would now be worth nearly $180,887. On the other hand, if they only invested under Republican presidents from thereafter, their portfolio would be worth just $32,392. However, if they remained invested in the market under each type of administration, their portfolio would be $585,932 (see figure 11). We outline this scenario not to suggest which political party is better for the market, but to highlight that staying invested is often a better approach than letting politics guide investing decisions. After all, it is often the economy that impacts elections more than elections impacting the economy.

Figure 11. Growth of $10,000 While Investing By Presidential Party (S&P 500 Index, January 20, 1961 – Current)
Figure 11. Growth of $10,000 While Investing By Presidential Party (S&P 500 Index, January 20, 1961 – Current)
The is a bar chart showing the growth of $10,000 while investing By Presidential Party (S&P 500 Index, January 20, 1961 – Current)
Sources: Citi Personal Wealth Management as of October 13, 2020. Note 1: S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market. An investment cannot be made directly in a market index. Note 2: Past performance does not guarantee future results. For illustrative purposes only.