INFORMATION FOR INVESTMENT PROFESSIONALS

What the US election means
for markets … and what it
doesn’t!
Markets | October 2020

Colin Moore
Global Chief
Investment Officer

The election cycle will increase short-term volatility, but we don’t believe it will
have much influence on market averages over the long term
While every US presidential election is contentious, this year’s race seems especially divisive.
Partisanship is extreme, and the difference between Donald Trump and Joe Biden in approach,personality and behaviour is stark. The charged rhetoric may increase the uncertainty andanxiety for investors as we approach election day. Most recently we saw evidence of this anxiety
as the market reacted to news of President Trump’s positive Covid-19 test.
But what does the election really mean for the economy, markets and investors? In my view,elections cause a lot of volatility and anxiety beforehand, and then not much of substance for thebroad economy and financial markets afterward. A lot of that temporary volatility comes frompoliticians making speeches about policies and programs that they are rarely able to fully enact.
Long-term market and economic direction are about what actually happens, and in that respect,a single election is almost irrelevant to our long-term outlook.
This is because changes in presidential administrations rarely lead to material fundamental
changes in how the US economy works, even when we swing from conservative to liberal, or
vice versa. Investors were more concerned about radical change when candidates such as
Elizabeth Warren or Bernie Sanders appeared to be leading the Democratic primaries –
although we should note that we don’t know what role they may yet have in setting policy. In
some important categories there is little material difference between the two main parties.

There is no truth to the claim that Republicans are conservative on fiscal policy and Democrats
are big spenders; they both spend like it's going out of fashion. There is a difference, of course,
in sources of taxation and where the money might be spent, but the total amount of money going
into the economy in aggregate is not, in my view, going to be materially different under one partyor the other.
In terms of overall market performance, we have seen the markets do well under Republicanand Democratic presidents. In fact, since the Truman administration just after World War II, only
Richard Nixon and George W. Bush had negative market returns during their tenure. Market
reaction to those administrations had less to do with economic policy and more to do with theWatergate scandal in the early 1970s and the terrible events of 11 September 2001.
This year, however, there is also the prospect of a delayed result or a contested election toconsider. If either candidate’s winning margin is decisive, we don't think there is much possibility
for real contention at election time. It is important to distinguish between challenges to votecounts generally or the inclusion of some mail-in votes specifically and an outright refusal tohand over power or accept defeat. There is a strong possibility for the former caused by legal
challenges that might extend the time taken to certify the election, creating a period ofuncertainty. Pricing for index options maturing after election day indicate that equity market
investors are expecting greater volatility due to this uncertainty. While this isn’t ideal, it is not
unprecedented, and we have constitutional backstops that address inconclusive results.
All this is to say that there are remedies for the situations that some predict will happen aroundthis election, and when election results have been delayed or questioned previously we havebeen able to move on without significant political – or economic – disruption.
But while we believe the election is unlikely to impact the overall direction of markets, there will
likely be some short-term uncertainty, and there certainly could be effects on industry groups
and individual companies. In addition, there are things that we think investors should be paying
attention to, and some actions to take.
Evaluating the potential impacts
If Biden is the presumptive winner, it is important to look closely at his tax plan which is central tohis platform (Figure 1). His plan to roll-back the Trump tax breaks, tax income differently above acertain level and tax capital gains at the ordinary income tax rate is likely to cause a lot of taxrelated trading before the election. The more convinced you are that Biden will win, the more you
should be preparing to realise investment gains in 2020 rather than 2021, when you could pay ahigher price in taxes. Depending on the rules, it may be better to preserve losses for 2021
instead of automatically netting against gains in 2020.

Figure 1: Joe Biden’s tax plan at a glance

Source: Columbia Threadneedle Investments, 1 October 2020

While there is always a lot of tax-loss harvesting and capital gains realisation in the second halfof the year, we expect it will be much more significant this year. And that might then affect thesectors that have had the biggest gains, like technology. We view these merely as volatility
factors, however, not harbingers of any dramatic shifts. They don't necessarily mean there will
be any significant long-term change in direction or fundamental health of that particular sector orother sectors that might also be affected.
The potential new tax structure will have an impact on business as well. Under Biden’s plan weestimate an average drop in earnings per share of around 5%, though this will not be evenly
spread across sectors. In more “normal” circumstances you might say that’s not too bad, but on
top of a Covid-19-ridden economy in which earnings are down significantly from where they werein 2019, we should be vigilant regarding the cumulative impact on corporate earnings. This levelof expectation may lead to a rotation in the market, but we don’t see it leading to any kind ofbroader collapse.
It’s also important to note that the tax plan Biden has laid out as part of his campaign is notnecessarily the same as what might actually come to be. In the current environment, sweeping
tax change may not happen in the short term, particularly as the country continues to deal with
the impact of the pandemic.
There will also be likely winners and losers on the sector side due to shifts in policy. Energy,
financial services and healthcare will likely be affected. Healthcare is interesting – the potential
expansion of Medicare and Medicaid may benefit the hospital subsector, but pricing restrictions
may impact pharmaceuticals. Other sectors such as energy and financials will probably feel theeffects of any increase in regulation, as regulation represents a cost to business. It might help
the safety of products and workplaces, or help preserve the environment, but whatever it is, it’smore expense for a company’s balance sheet and may affect smaller companies more thanlarge companies that have the resources to deal with the additional requirements. More expense
for companies implies potentially lower returns for shareholders. So individual security andsector selection will be very important in investing, rather than relying on the overall direction ofthe market.Trade is another important business and economic factor, and here the election could havesome impact. While Congress has the ultimate authority to approve trade agreements, thepresident has the power, in many cases, to handle negotiations and set tariffs and duties. The
president’s personal role is primarily diplomatic – and it’s here that the styles of Trump and Biden
come into play. While I believe the Trump administration has many legitimate goals andconcerns about US trade policy, the president’s negotiating style has created additional tension,
particularly with China. A different approach might help to build more productive global
relationships, even if the substance of the trade initiatives and goals is not really all that different.
The Covid-19 factor: political uncertainty compounded by economic uncertainty
I have commented that election cycles typically don’t have much influence on the behaviour ofthe markets in aggregate. In many ways, this election is no different. But in one way it couldn’t
be more different: it is being contested during a global pandemic that has brought regulareconomic activity to a virtual halt. The election-related short-term volatility and the structural
pandemic market effects are, in effect, amplifying each other, and we are experiencing one of
the longest periods of sustained high volatility that we’ve ever seen (Figure 2).
Figure 2: Market volatility remains elevatedSource: Columbia Threadneedle Investments, 30 September 2020. Implied volatility is a measure of the market’s forecast of the annual
move in the underlying securities price. Realised volatility is a historical measure of the actual volatility using a three-month rolling dataset.

This is where the commitment to additional fiscal support could make a real difference. Think of
the current health crisis as a giant chasm. There is nothing wrong on the other side of the gulf;
economic, market and business activity have resumed there. But you’ve got to get there without
falling in. Short-term fiscal stimulus is the bridge, and the longer it persists the greater thelikelihood that you successfully bridge the gap in economic health. It is here that the compositionof the House and Senate make a significant difference.

We saw a meaningful bipartisan effort in the first rounds of stimulus succeeded by greater
election-driven partisanship that has derailed ongoing support. Once we are past the election it
will be critical for leaders to get back to negotiating on programs that can support the individuals,
businesses and municipalities most impacted by Covid-19 restrictions. In the first round, speed
was critical, but the support was spread too widely. The second round needs much greatertargeting, but there is still an urgent need for support if we want the recovery to be strong.
The economy and markets will move on
Over the coming weeks the anxiety around the election will no doubt intensify, and the voices
feeding the uncertainty and volatility will only get louder. Emotions are running high on bothsides of the political divide and the fight over the next Supreme Court appointee will act as anadditional incendiary element. It will be important for investors to overcome a reflexive tendency
to respond emotionally: though volatility and uncertainty will be high both before and after theelection, the economy and the markets will move past this. When the pebble falls in the pond
there is an initial large splash and then the disturbance dissipates quite quickly.

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