The US election introduces a number of potential uncertainties for market participants. Options markets are pointing to elevated volatility throughout November, with the potential for more than an election day but rather an election week or month as millions of mail-in ballots are counted. We don’t have a crystal ball as to what the future will hold, but we do know that the lessons learned from navigating volatility earlier this year will likely prove useful yet again.
What will happen in November?
The Presidential race remains competitive, though former Vice President Joe Biden continues to hold a 7-10-point lead in the RealClear Politics polling averages. October surprises, including the passing of Justice Ruth Bader Ginsburg, new revelations on the President’s taxes, and President Donald Trump’s contraction of COVID-19 have amplified the urgency and intensity on both sides. While Election Day is now less than a month away, the race isn’t over.
Whichever way the presidency falls will likely influence the Senate as well, given the number of competitive seats up for election and the ability of presidential candidates to carry a down-ballot influence. Prediction markets as of October 5 placed a 66% probability that Democrats will win the White House, 66% that they will take the Senate, and 88% that they will retain control of the House of Representatives1.
The Senate race has commanded extra attention this cycle as Democrats have discussed the possibility of removing the filibuster – the mechanism that effectively requires at least 60 votes to pass legislation – if they were to win the majority. Removing the filibuster would likely happen by setting a new Senate precedent with support from a simple majority of senators, a process known as the “nuclear option.” It requires a senator to first raise a point of order in violation of the Senate rules, then for a senator to object to the rule being violated, and then for the majority to overrule the violation on appeal. In this case, the nuclear option could be used to override the need to have a 60-seat majority to pass legislation.
While removing the filibuster could be done with a simple majority, it is more likely to be done by a robust Democratic majority. If Democrats were to take the Senate, the likelihood of them proceeding would increase with the number of seats that they win. Should Democrats remove the filibuster, this could open the door to further legislation in the absence of the 60-vote threshold.
Source: Cook Political Report and GSAM. As of September 30, 2020. For illustrative purposes only.
Why isn’t the market pricing policy risks?
The market is a discounting mechanism, but it may have difficulty incorporating policy risks when the probabilities remain so uncertain. Not only are the election outcomes unclear, the subsequent policy priorities are as well. It is not guaranteed there would be tax reform, healthcare expansion, infrastructure, coronavirus relief, or anything else. Parties have robust platforms, but more limited opportunities to turn them into policy. The market, now accustomed to limited action amid heightened partisanship, has often taken a “show me the money” approach – not moving until there is definitive information to incorporate.
Additionally, politics and policy represent just a few of the many drivers of markets. As Exhibit 2 shows, over the course of history there has been limited evidence that any one party or partisan composition has been any more favorable for the market than others in the long run. Certainly they can matter, but through idiosyncratic issues each time.
Source: Bloomberg and GSAM. As of September 30, 2020. For illustrative purposes only. As of August 31, 2020. Analysis from December 31, 1946 to December 31, 2019. Strength of relationship is measured by the R-squared statistic, which ranges from 0 to 1, or weakest to strongest explanatory power. Returns show the median calendar-year price return for each Presidential party and corresponding Congressional party majority. Past performance does not guarantee future results, which may vary.
What’s an investor to do?
As investors, we are reminded again the importance of strategic discipline. The reality is that most investment horizons are substantially longer than political careers. In the long run, much of politics washes out as statistical noise. Still, these are uncertain times and consequently we would emphasize:
Ultimately, we believe a well-designed portfolio can endure a wide breadth of political, legislative, and economic scenarios. As such, we continue to campaign for strategic discipline, risk management, and a commitment to quality.