Effects of the U.S. election on the capital market

The presidential election of the United States, which kicked off on November 3, is possibly one of the most important presidential elections in American history.

Under the impact of the COVID-19 pandemic and an increasingly divided society, the election is full of risks and uncertainties. Although the Democratic candidate Joe Biden has always been in the lead in polls, Donald Trump attempted to catch up, and many are worried that the 2016 results will be repeated.

For the capital market, the final result of this presidential election may cause changes in monetary policies and fiscal stimulus policies, which will affect future expectations, but what worries the market the most is that there will be unresolved situations of which the election will not produce a result in the short term.

This may cause risks of capital outflow, especially for the stock market, which is already in a precarious situation, while some are in fear that stock market crash in March will repeat itself all over again.

At present, judging from the U.S. stock market’s performance, the anxiety of waiting for the results is already apparent. The U.S. stock market recorded its worst weekly performance since March last week. The S&P 500 Index fell nearly 6% in a week, marking its biggest weekly decline since March.

The VIX, which measures the volatility of U.S. stocks, exceeded 40 and continued to climb to a new high in the past 6 months. It is still hovering at a high of 37.70.

At the same time, the technology giants that are driving the stock market are under increasing pressure. Although their performance levels have reached new highs, they are far from satisfying the appetites of their investors.

This also creates hidden dangers for short-term market turmoil. Some market institutions believe that FANG stocks, i.e. Facebook (FB), Amazon.com (AMZN)，Netflix (NFLX) and Google parent Alphabet (GOOGL), which are the representatives of technology stocks, have always been the main driving force of the stock market rebound.

The total market value of these four companies is nearly US$ 5 trillion, accounting for one-fifth of the S&P 500 index. As investors need to digest the bad news from the earning reports, combined with the uncertainty of the general election, the worsening of the pandemic and the continuous delay of fiscal stimulus, the short-term market may fall into a cycle of shocks and decline.

Figure 1: Volatility of the Three Major U.S. Stock Indexes this Year

The volatility of the stock market will also affect bonds, foreign exchange, commodities, and financial derivatives markets, thereby creating a chain reaction. Now, the international crude oil market is also experiencing a continued decline.

Although the impact of the pandemic on oil supply and demand is the main factor, the uncertainty of the U.S. election is also one of the reasons for investors leaving the market.

In addition, it has been reported that the Bank of China and the Bank of Communications issued an announcement stating that market risks in the precious metals and foreign exchange markets are expected to increase. If market volatility increases, trading of precious metals and foreign exchange products may be restricted.

If the “blue wave” shown by the polls emerges and Biden wins the election while the Democratic Party also controls the Senate and House of Representatives, the United States is expected to introduce a large-scale stimulus plan to continue the current economic policy responding to the impact of the pandemic.

However, in the short term, the United States may adopt strict prevention and control measures. Although these factors will affect the U.S. economy in the short-term, they do not affect the long-term economic growth expectations, which is good for the capital market.

As Reuters has reported, this can boost the stock market, making the trend of the depreciation of the dollar and the steepening of the U.S. Treasury yield curve more obvious.

However, the Democratic Party’s victory will cause many concerns for stock market investors. These include the possibility of raising corporate taxes from 21% to 28%, which may depress corporate profits and herald a more stringent regulatory environment.

The Wall Street Journal believes that if the Democratic Party wins, it may lead to an increase in corporate tax rates, which will impact the stocks of large technology companies in the U.S., and may weaken a major driver of the U.S. stock market’s rebound this year.

If the Democrats fail to control Congress, the new stimulus policy will be difficult to implement quickly, which will continue to put pressure on stock market liquidity in the short term.

It should be noted that however, Biden may negotiate with China and other trading partners in a more calm and rational manner to reduce the various effects of trade frictions, which will not only help stabilize the U.S. market but also boost the economic growth prospects of other countries which is good news for emerging markets.

In the unlikely scenario that Trump wins, it would have no negative impact on investors and capital markets at all. After all, since Trump was elected as the President in 2016, U.S. stocks have risen by about 53% and have repeatedly created new highs. This will cause investors to reinvest in those areas that benefit from Trump. According to JPMorgan Chase, the scenario where Trump’s “orderly” victory was the most favorable outcome was for the stock market. If Trump won the election and the Democrats dominate the House of Representatives, this result of maintaining the status quo will make investors think about the possibility of introducing a milder fiscal stimulus.

The most worrying outcome is that there would be no definite result after the election, or that the close number of votes would spark a controversy.

The instability of the political system, coupled with the impact of the pandemic will bring disastrous consequences to the capital market. As many voters in the United States have already voted in advance by mailing ballots, the statistics of these ballots are not expected to end on November 3.

Moreover, Trump complained that the electoral system was “rigged”, which raised concerns that it would be difficult to achieve a peaceful handover. This will cause the market to be in a state of political uncertainty. Invesco’s Kristina Hooper said that if the election result is unclear, investors may flock to safe-haven assets such as gold and U.S. Treasuries, possibly including the yen and the dollar.

However, if the outflow of capital forms a “stomping”, the “stock market crash” in March is likely to recur. Another issue of concern is that under the monetary stimulus policy, the three major indexes of the U.S. stock market have now broken new highs. The outflow of funds is bound to cause the burst of the bubble, which will lead to chain reactions and disastrous consequences, a scenario that is more than likely to happen.

Final analysis conclusion:

The result of the U.S. presidential election is bound to affect the direction of the capital market, but the most pressing concern is the uncertainty of no definite result in the short term. The longer this uncertainty lasts, the greater the impact will be on the capital market.

Founder of Anbound Think Tank in 1993, Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.

Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing. Established in 1993, Anbound