Portfolio strategies for a contested US election
An election like no other: American democracy and prestige on the line as polling day looms. As Americans head to the ballot box in November, there is increasing market chatter that this election will be the most controversial in decades. These concerns are valid. The November election will see a record level of mail voting as result of the pandemic. But with 19 states allowing ballots which would arrive after election day to be counted, coupled with lengthier time needed to tabulate paper ballots, the risk of the election not being called on polling night is real.
Past trends and opinion surveys show that Democratic Party supporters are more likely to vote by mail compared to Republican Party supporters. This voting pattern will also mean that the Republicans may lead on polling day (as result of more in-person voting), only to see their lead eroded as more mail votes arrive. President Donald Trump has on numerous occasions claimed that mail voting is “fraudulent” and “corrupt”. Such a stance suggests that the incumbent is highly likely to challenge the result should he emerge on the losing end, dragging the country through a potential constitutional crisis.
There are various ways in which the election result could be disputed, for instance:
Mail-in ballot dispute: Ballots arriving via mail have to be verified for their signatures manually. Should the Trump campaign lead based on in-person vote count, they may claim victory prematurely and subsequently, take steps to invalidate as many mail-in ballots as possible on grounds of potential election fraud (such as inconsistencies in signatures or how the documents were sealed).
Electoral College dispute: In theory, the winner of the popular vote in each state will receive that state’s electoral vote. But the situation could change if the result is too close to call or, if there are rising claims of election fraud. In this situation, both Republicans and Democrats could end up sending competing certificates to support their respective candidates. These are unchartered waters which have to be resolved by Congress. Presently, the US Supreme Court states that “faithless electors” could face punishment. However, this ruling is not adopted in all states.
In the event of an election dispute, some states allow the candidate to request a recount while most states allow voters to contest on the election outcome should there be concerns on potential fraud.
Figure 1: Down to the wire – Biden’s lead over Trump has narrowed
Source: Bloomberg, DBS
A historical perspective of previous contested elections. Historically, there were several occasions whereby the US election outcome faced some forms of “contestation”, for instance:
1800 – Thomas Jefferson vs Aaron Burr: In this election, both candidates received the same number of Electoral College votes (73 each). Given the absence of a clear majority, a contingent election had to be convened by the House of Representatives and in the end, Thomas Jefferson emerged victorious.
1824 – Andrew Jackson vs John Quincy Adams and others: In this election, Andrew Jackson won the popular vote but managed only to earn a plurality of the Electoral votes (99 votes). Again, the election had to be decided by the House of Representatives and the presidency was eventually awarded to John Quincy Adams.
1860 – Abraham Lincoln vs others: The 1860 election was controversial. After Lincoln won the election by capturing 180 Electoral votes, the Southern states refused to accept the result given Lincoln’s anti-slavery stance. Lincoln’s ascension to the US presidency was the main catalyst for the American Civil War that took hold soon after the declaration of secession by several Southern states.
1876 – Rutherford B Hayes vs Samuel J Tilden: The election was contested due to the failure by several Southern states to declare a winner. An Electoral Commission set up by Congress negotiated with the various parties and the Democrats eventually accepted Hayes as the next president on condition that federal troops will be withdrawn from former Confederate states (under the Compromise of 1877).
1960 – John F Kennedy vs Richard Nixon: The 1960 election between Kennedy and Nixon was too close to call. While Kennedy defeated Nixon in the Electoral College (303 vs 219 votes), however, he won the popular vote by a mere 0.2% margin. Despite widespread allegations of voter fraud in Texas and Illinois, Nixon opted to concede defeat to avoid dragging the country through a constitutional crisis.
2000 – George W Bush vs Al Gore: In the 2000 election, the result for Florida was widely disputed as Bush won only by a thin margin and a recount was initiated. The latter was, however, halted by the US Supreme Court and the presidency was handed to Bush after Gore conceded defeat. This was considered one of the closest presidential race in history with Bush emerging victorious despite losing the popular vote.
1860 vs Now: Great differences. Evidently, in the course of America’s history, only one out of the six occasions had a contestation of an election result lead to a disastrous outcome, and that was in 1860. But the situation then was unique as the country was clearly divided over the issue of slavery. The Southern states supported it and believed in the “institution of slavery” while the Northern states that were loyal to the Union opposed it.
Geographically and politically polarised as it is, the level of divisiveness in the American society today is unlike those seen in 1860. Both the Trump and Biden campaigns could well contest the election outcome. But this would unlikely pose a genuine threat to the American political system. Ultimately, the system is robust enough to withstand contestations and challenges, in our view.
Bush vs Gore – Using the 2000 election as reference point. The most relevant reference point to this topic in recent history is the 2000 election. That year, the controversy surrounding the Florida recount ensured that the election was not settled until 13 December when Al Gore decided to concede defeat. From the time of the election till 13 December, the S&P 500 Index corrected 5.0%
That said, we would avoid drawing too many parallels between 2000 and now – for two reasons. Firstly, by the time of the election in 2000, the dot-com bubble had already collapsed and hence, the correction could actually be part of the broader market downtrend (Figure 2). Secondly, the level of monetary accommodation offered by the US Federal Reserve back then is unlike the levels seen today.
Investment Implications: How should investors position their portfolios. We have stressed that the American political system would remain intact even should the election be contested. So, from a portfolio perspective, the upcoming election would not have a significant bearing on the long-term trajectory of financial markets. Ultimately, the key drivers of risk assets (notably growth equities) lies on two things: (a) Global technological disruption and (b) Central banks’ monetary accommodation.
But having said that, we do not rule out momentary volatility that could trigger portfolio drawdowns, and our recommendations are:
Maintain Barbell portfolio approach; Gain exposure to gold and bonds for downside hedge: Despite the headwinds posed by potential contestation in the US presidential election, we advise investors to stay invested, simply because the tailwinds from technological innovation and central banks’ monetary easing far outstrips the headwinds.
The key strategy is to maintain a portfolio approach and buffer potential downside with effective hedges. Figure 3 shows that gold and bonds have been effective portfolio hedges during past crisis and shall remain so.
Election volatility presents investment opportunities: We do not expect any contestation of the election result to have long-lasting impact on financial markets and hence, any pullback in equities during the election will present an attractive opportunity for investors to gain exposure to growth sectors like Technology and Health Care.
Complement core portfolio with derivative hedges as satellite strategy: Lastly, investors can also explore using derivatives as a satellite strategy to hedge portfolio downside should volatility spike.
Figure 2: S&P 500 dipped during the 2000 election, but that was part of a broader market downtrend
Source: Bloomberg, DBS
Figure 3: Gold and bonds as portfolio hedges
Source: Bloomberg, DBS
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