Election Risk Creeps into Markets: Investors Brace for Volatility
In a year marked by complacency and widespread option selling, the S&P 500 has enjoyed an almost uninterrupted rise, nearing 400 trading days without a 2% drop. It's no wonder that the upcoming elections haven't garnered much attention, despite their potential significant impacts on the US economy, Federal Reserve policies with Powell possibly out if Trump wins, and the market.
However, this may soon change. According to The Market Ear, option markets typically start factoring in US elections around three months before the event. While we're not there yet, increased volatility is expected soon. Goldman thematic trader Oscar Ostlund notes that election risk has started creeping into financial markets. In a poll of 800 institutional investors, three key views emerged. A unified government could increase executive spending power, which investors see as negative for bonds, regardless of the party. A Trump victory, either with a divided or unified government, is viewed as positive for equities due to the likelihood of a more dovish Fed policy. A Democratic win is seen as negative for the USD.
In essence, each election outcome presents challenges, but some scenarios might still be beneficial for stocks. Today's debate, as highlighted by Goldman strategist Dominic Wilson, could shift market focus toward the election, providing new insights into its potential impact on asset markets. Wilson outlines the fiscal and tax policy impacts expected in four main election scenarios Republican sweep Democratic sweep Trump with divided government Biden with divided government. The fiscal impacts vary, with the most significant changes in the sweep scenarios due to easier policy implementation. The Republican sweep might lead to tax cuts, while a Democratic sweep could see higher corporate taxes offset by an expanded Child Tax Credit.
For tax and regulatory policy, a Democratic sweep might raise the corporate tax rate from 21% to 25%. A Republican sweep might maintain current rates with potential cuts and deregulation. Under Trump with a divided government, regulatory policies might ease without tax changes. The impact on markets varies.
Republican sweep predicts a modest equity rally, yield increase, and USD appreciation. Democratic sweep predicts modest equity downside, USD depreciation, and higher yields. Trump with divided government predicts modest equity downside, slightly higher yields, and USD upside. Biden with divided government predicts flat equities, lower yields, and USD weakness.
Goldman suggests that markets might react more sharply if fiscal and tax policies become more ambitious. Trade policies will also play a crucial role as the election approaches. Finally, Goldman notes that USD strength might be a reliable hedge against equity downside in the event of a Republican victory. However, positioning for significant equity protection may still be the most efficient strategy, especially considering the potential for market focus to increase well ahead of the election date.