Following Brexit, the US election will be the next big confidence shock to hit the global financial markets. That’s according to Bank of America economist Ethan Harris who, in a research note sent to clients at the end of last week, noted that a string of confident shocks since the financial crisis has weighed on investor sentiment causing a seemingly permanent subnormal recovery in Capex spending and the acquisition of durable goods.
The string of confidence shocks has, according to Harris also eroded central banks’ supply of policy ammunition, leaving them vulnerable to a recession shock. This is a clear warning to investors that they need to be prepared for the US elections later this year. Both candidates have unusually wide disagreements on a number of issues, and both have put forward some very aggressive proposals that could hurt growth in the near-term.
To help investors navigate the election, Credit Suisse has published a research document this week gathering together some thoughts on the US political landscape from its US equity strategist Lori Calvasina and Vice President Sara Mahaffy, CFA.
Credit Suisse on the US election
Credit Suisse expects the US election to be a potential source of stock market volatility during the second half. The election takes place on November 8 with a number of Presidential debates in the diary for the weeks beforehand.
As of yet, Credit Suisse believes it is too early to have a clear sense of what the election’s potential outcomes may mean for various sectors. That being said, one sector the bank believes could benefit from the event is Health Care. Credit Suisse argues that the election has been a key overhang on the Health Care space yet past experiences show that large-cap Health Care tends to lag ahead of presidential elections, but then goes on to outperform after the election date through to year-end.
Surveys by Credit Suisse reveal that most investors believe Clinton will win the White House, with 78% of the investors surveyed at the Credit Suisse Macro Conference back in April of this opinion. Conversations with investors over the past week lead Credit Suisse to conclude that this is still the case.
With such a high percentage of investors positioning for one outcome, a Trump victory could give rise to the kind of volatility seen post-Brexit but once again it is early days and polling results over the next few months are likely to drive investor positioning directly ahead of the event.
Simply put, at this early stage of uncertainty still prevails and the only guidance available as to how markets might perform after the election present is based on historical trends. Using data going back to 1928, Credit Suisse finds that the S&P 500 tends to do well in presidential election years, with median and average returns that have been meaningfully above trend. The only exceptions to this trend were 1992, 2000 and 2008. However, each of these years has three things in common, as Credit Suisse explains:
“(1) they occurred when the country was either exiting or in the midst of economic/financial market troubles, (2) the party affiliation of the President changed (R to D in 1992, D to R in 2000, R to D in 2008), and (3) the VIX started to move higher in the Fall, well ahead of the election. It is difficult to disentangle causation from correlation. But what we think this analysis is telling us is that the same underlying conditions that have precipitated a changing of party affiliation in the White House in the recent past have likely also roiled equity markets.” — Credit Suisse
Since 1928, in election years, the S&P 500 has seen median returns of 10% and average returns of 7%, returns that surpass the index’s 1928-2015 CAGR of 5.5%.
What’s more, data going back to 1928 shows that equity markets tend to continue their yearly performance after the election. Gains or losses before a Presidential election tend to be followed by a continuation of the same trend after election day. Put simply, if the S&P 500 is down for the year before an election it tends to remain down for the year following the election.
So, the developments over the next few months will be key in trying to decipher how markets will react following the US presidential election. If the S&P 500 continues its relentless march higher, barring an unexpected Trump victory, investors should have no reason for concern.
On the other hand, if markets start to trend lower, affected by political rhetoric or movements in the polls, past data shows the S&P 500 is likely to book a negative performance after election day.