Why does the market care so much about the US elections?

The original version of this article first appeared in The Business Times. 

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Following hard on the heels of the US Federal Reserve’s first rate cut, the race for the US presidency and control of the House and Senate is entering its final stretch. It is one of the closest and most unpredictable elections. The Fed will meet again and decide on the next rate cut the day after the US elections.

Between former president Donald Trump and Vice-President Kamala Harris, there have been many plot twists even before the actual voting day. But, what piques the interest of investors, unlike voters, is not only who will seize control of the White House, but also how the election outcome would alter the trajectory of markets, which have been on an upward trend throughout this year. How will the outcome set us up for 2025?

Republican or Democrat, does it matter?

Let us take a closer look at the stock market returns for the US and developed markets over the last eight US presidencies, including that of the incumbent.

We rewind to the days of Jimmy Carter. In 1976, the economy was going through stagflation (high inflation, low growth), and the country was in the middle of the Cold War, with an energy crisis on the horizon. Despite this, his Democratic presidency of just four years had a stock market return of 52%, bouncing back from all the troubles of the early 70s.

The impact of an election on markets is difficult to predict, given that economic and geopolitical issues can change the context in which the president must act.

When the past eight presidents were in office, it was not all smooth sailing – you would have had multiple periods of 20 to 50% drawdowns. But if you had stayed invested through this time, you would have enjoyed a fantastic average S&P 500 return, including under Joe Biden, of more than 114% up until Sep 30, 2024.

Only one president, George W Bush, had a negative return. Unfortunately, he inherited the 2000 dot-com crash and ended his presidency in the depths of the 2008 global financial crisis (GFC). His “market timing” was bad. If you had invested in a global balanced portfolio of 60% stocks and 40% bonds, you would have squeezed out a +14% return from his presidency.

That the classic 60/40 allocation weathered the dot-com bubble and ended 2008, with George W Bush in office, with positive returns, is not due to right timing. Instead, it benefited from asset class diversification that prevented an outright loss. When the US and global stocks were hit hard, bonds cushioned the equity drawdown.

Time for bonds, especially now

It is clear that nobody can predict the future, especially the outcome of a US election that has so many moving parts, where a small change in sentiment or external event could affect outcome in a big way.

This year’s election is also happening on the heels of the Fed’s first cut to the federal funds rate since March 2020. Two more policy meetings follow after the elections. Bonds have returned to the limelight; falling interest rates are a boon for fixed-income investors.

Amid so much uncertainty, we can focus on two key realities.

First, the rate environment is normalising, where it is expected that cash would yield less than longer-term bonds. The continued heightened geopolitical risks, including the widening Middle East conflict, also weigh on investors. The Fed clearly sees the resilience of the US economy, but is also concerned about the slowdown and, more importantly, rising unemployment with its dual mandate.

Regardless, it is likely that once the Fed has embarked on a rate-cut cycle, it will not stop at just the first 50-basis-point cut; more will come. This may not meet market expectations, but that is not the point. The point is that there is some certainty to the trajectory of rates from here, if not the exact shape of the trajectory.

Historical US Treasury 2-, 5-, 10-year yields

Second, bond carry is back. Fixed-income yields are at the highest level since the GFC, when the zero-interest rate policy was introduced. A higher starting yield means that investors can earn more income from bond investments. In addition, falling interest rates – even at a pace slower than expected – will still provide a cushion of returns.

The classic 60/40-allocation model took a hit in the last few years, especially in 2022 when we saw an unprecedented aggressive rate-hike cycle amid stubbornly high inflation. But we are in a different part of the rate cycle now.

We have seen in the past how throwing the entire balanced portfolio strategy out of the window came back to bite us, especially during the pandemic-induced market falls in 2020. The bottom line is that the diversification benefits of fixed-income assets, in a scenario where equities generate negative returns, will still hold true.

The simultaneous declines in stocks and bonds in 2022 were a rare event. Over a span of 94 years (1929 to 2023), there were only four instances when this happened. Bonds remain an effective diversifier, cushioning stock volatility through stable or falling interest rate environments.

Are we asking the right questions?

In the past six months, we have been inundated with questions: Is now the time to buy? How much longer will the rally persist? What will happen after the Fed cuts rates or after the US elections?

These questions persist, with only the subject matter changing – from the US to Japan, India and China. US stock markets are hovering around their historical highs, and investors hope for Asian stocks outperforming. It is only natural that investors fear they have missed the boat.

Asking the right question is key, but these questions are either about market timing or trying to actively choose which market will do best next. Long-term investing success revolves around asking questions about your personal investing goals, risk appetite and what risk you need to take in order to achieve those goals.

The three key pillars of long-term investing success are global diversification, long-term strategic asset allocation and low investing costs.

The future is literally anybody’s guess; it is a toss-up trying to predict whether Harris or Trump will win. We should not be making bets on short-term events that do not make a meaningful difference to long-term outcomes. No one individual or party will make a difference to future market returns.

It is exactly in such times of uncertainty that we should turn towards time-tested investing principles that have demonstrated resilience and are the only certainty amid constant change.