Disputed Election, Confused Market
The impact of the COVID-19 crisis on voting intentions among the US electorate has made the 2020 presidential election difficult to call. It is becoming more likely that the result could be disputed, leading to a period of policy paralysis, confusion for the investor and higher volatility in equity markets. Nevertheless, this uncertainty will not stop investors from trying to take advantage of possible outcomes and we expect to continue seeing high trading volumes in sector ETFs.
Investors tend to position their portfolios cautiously before elections, and the nature of this year’s election suggests that we may see a similar approach. Historically, investors have increased their equity exposure after the event, and often in a pro-cyclical manner.
Sector Investing During Past Elections
It is difficult to identify a clear impact of US presidential elections at the market level; studies show little difference between market performance during Republican and Democratic administrations. However, at a sector level there can be major implications. According to S&P Dow Jones, the average range in monthly S&P 500 sector returns (calculated as the best-performing sector minus the worst performing sector) between 1990 and 2019 was highest (15.18%) in November during election years, far above the 10.8% average difference across all months.
Election impacts can be observed when investors price in the anticipated effect of the election winner’s policies on different market segments. A recent piece of research by State Street Global Advisors suggests that sectors are more sensitive to election outcomes than broad-based equity split by size and smart beta.
The opportunity (or risk) for sector investors is measured by the dispersion of performance between sectors – we only need to look back to the 2016 election as a prime example. While the S&P 500 rose just 4% in November 2016 following Trump’s win, there was 19.3% difference between the best-performing sector (Financials) and the worst-performing (Utilities). The chart below shows the whole range of performance across all sectors.
Cumulative Total Sector Returns in November 2016
We can also see that excitement over sector winners and losers had an impact on ETF flows. The chart below shows net flows into sector ETFs (split between the three regions of listing). There was a clear rise in activity in late 2016, and at SPDR we witnessed higher interest not only among our US clients, but also with European and Asian investors. Incidentally, this graphic also shows a fall in sector ETF flows in March and April this year but a sharp bounce back since then.
Sector ETF AUM across Regions
Sector Considerations in this Election
As illustrated above, correctly identifying who would win the 2016 presidential election, and the anticipated sector impact, offered the potential for considerable relative returns.
In 2020, headlines have focused on the challenges to corporate America under a Biden administration, principally related to tax plans and the re-imposition of certain regulatory rules, but there would be some winners from his public investment proposals. For example, US infrastructure is underfunded, and continued dislocation following economic shutdown provides the necessary political case for fiscal spending to boost demand across the economy.
In his platform developed before the onset of COVID-19, Biden had foreseen an annual boost of roughly $500 billion focusing on health care, transport, housing and education. He has added a substantial front-loaded proposal to enhance government spending on research and development (half of which would be directed toward clean energy) as well as US-focused procurement of products, materials and services. By contrast, areas that would lose expenditure include defence budgets.
A change in administration could create selective investment opportunities. Even under a status quo scenario, with Republicans retaining the presidency and the Senate, it is sensible to take a nuanced view of economic prospects and unequal recovery in certain sectors.
As always, sector investing is a good way to target sector opportunities, as well as avoid parts of the economy that could suffer under new policies.
Depending on how the election plays out, we see three sectors in particular that could see their fortunes shift.
Health Care – This sector has been a political football for years, kicked around by both the Republicans and Democrats on changing insurance plans, threats on pricing and prescription processes. These threats continue, but the difference in 2020 is the need for the president to manage the country through a pandemic, relying on health care provision and supplies. Full opening up of economic activity is only possible with an effective vaccine. While we wait for a vacine, there will be a heavy reliance on virus testing and the search for a COVID-19 cure, also resting on health care companies.
Financials - During the last campaign, Financials was also in the cross-fire and then, early in the Trump presidency, the sector benefited significantly from bank deregulation and moves by the Fed. Less has been discussed in the current campaign. Banks may continue to do better under the looser regulation of the Republicans, although going forward this could be tinged by interest rates remaining low for a very long time.
Utilities – This is possibly the most interesting sector for playing green policies. Biden’s focus on climate change and consequential regulatory implications for fossil fuels could benefit the sector as it embraces cleaner electricity generation. There may be lessons from large European electricity providers that have seen a rerating on the back of their leadership in energy transition. However, under the status quo, there may be some relief for Energy companies after a difficult oil market during the COVID-19 crisis.
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Investing involves risk including the risk of loss of principal.
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