How Will the US Election Affect Markets?

If You Thought The Primaries Were Crazy…

Now that the US presidential primary season is winding down and the two main contenders have become clear (Donald Trump and Hillary Clinton), it’s time to take a step back and consider how the US presidential election will affect markets.

To begin, if there’s one thing we’ve learned in this election cycle, it’s to expect the unexpected. Indeed, there may still be more surprises heading into or at the party conventions in July. And even after the conventions anoint their nominees, both candidates have various clouds hanging over their heads: Clinton is under an FBI investigation for her use of private email while Sec. of State, and Trump? Well, let’s just say he’s Trump. To my thinking, investors need to brace for further uncertainty from the political sphere as the main campaign unfolds.

As the campaign intensifies, we can also expect more confrontational rhetoric from both campaigns, casting a pall over news coverage on both the economy and the overall state of politics in the US. There has already been a noticeable drop in US consumer sentiment over the last few months, with many analysts attributing at least part of the decline to the negativity of the primary season. 

The circus-like atmosphere emanating from the Trump campaign also highlights the degree of dysfunction in the US political system, beyond even what has existed over the last seven years. Taken together, further deterioration in both US consumer sentiment and global perceptions of the US as a source of stability do not make for an especially upbeat market environment.

How to Understand the Campaign Polls

I expect to see many stories suggesting that poll data is increasingly meaningless, but I also expect people and markets to still respond to incoming polling results. In the grand scheme of the apparent Trump vs. Clinton presidential campaign, my calculus will be based on the premise of ‘Known’ (Clinton) vs. ‘Unknown’ (Trump). After decades in government, Clinton is a relatively ‘known’ quantity, while Trump has demonstrated a degree of unpredictability and a lack of policy specifics, making him the ‘unknown’ element.

To the degree the ‘known’ candidate is leading in the polls, markets are most likely to be unaffected, and will respond mostly based on day-to- day economic news and data. The more the ‘unknown’ candidate is closer or potentially ahead in the polls, the more unsettled I would expect markets to be. I think this is most likely to see an asymmetric effect, where negative economic news/data results in larger downside volatility, while positive news/data is more likely to be discounted, with smaller and shorter upside swings in stock markets.

Look Beyond the White House

Economists generally have a hard time ascribing economic performance to the policies of any individual president, raising the question of whether who wins the White House even has any real economic or market impact. More important, to my thinking, will be how the presidential race affects Congressional elections (House and Senate) and even state election contests. Those are the levels of government that have the capacity to enact tax and spending policies and ultimately influence the economic outlook.

In that regard, the result of the presidential contest can have a great impact on the outcome of elections farther down the scale. The general rule is that the larger the margin of victory/defeat on the presidential level, the more likely it is to flow down to Congressional and state contests. For example, a landslide win by one party is likely to see similar gains by that same party in Congressional and state races. A close presidential race holds fewer implications for Congressional and state contests. 

Markets will be most heavily focused on the Congressional races, where the Republicans currently control both houses (House of Representatives and the Senate), which underlies the current legislative gridlock between the President (Democrat) and Congress (Republican).

Democrats could conceivably win control of the Senate by picking up 4-5 seats, which would likely require a large winning margin in the presidential race. However, even if control of the Senate switches hands, it’s far less likely that the House would also flip, leaving a divided Congress and continued legislative paralysis.

Only a runaway presidential election race, where one party seems likely to win it all—the White House and both houses of Congress—seems likely to have a pronounced effect on markets and the economic outlook. For what it’s worth, the most recent (May 10) Public Policy Polling national election result shows Clinton leading Trump by 6 points-- 47-41—in a one-on- one contest.

The margin is even narrower (Clinton ahead by 4 points) when other candidates (Libertarian and Green parties) are included. It’s much too early to infer anything meaningful from the polling numbers, but if there’s one thing we can expect going into November, it’s to be surprised. For markets, though, I would view the election more as a sideshow.

Market Outlook

For investors, I’d stay focused on the incoming economic data and impending Fed (June 15) and Brexit decisions (June 23). As far as the election goes, the market impact is likely to mainly be inertia. Don’t expect anything positive in the way of stimulus coming from Washington anytime soon, and there could even be another debt-ceiling impasse as a stunt going into the November election. Given election-year uncertainties and overall lackluster US outlook, corporate investment doesn’t seem likely to pick up meaningfully in the months ahead either.

That leaves the US consumer as the primary driver of the current expansion. (April US retail sales on Friday will be key.) To the extent that consumer sentiment is undermined by a vitriolic campaign, the bias on the consumer spending front is also skewed to the downside.

Since mid-April, global markets have re-traced about 25% of the recovery from the February lows (see chart above). My overall view is for a further downside correction, though we could see a prolonged sideways movement for the next several weeks. A drop into the cloud (blue area) on a move below 392 (and rising) in the MSCI World Index would suggest an imminent further correction lower. Sustained strength above recent highs at 410 will be needed to signal renewed upside potential.