For most Americans, November 3rd can’t come soon enough.
U.S. presidential election campaigns are always hideously long and this one has felt particularly painful, with such a deep divide between the supporters of the rival candidates. However, recently there has been increased speculation about the grim possibility of the election outcome being contested. Quite apart from the further division this would inflict upon our bruised democracy, many investors are wondering what this could mean for the economy and markets.
It is a fair question to ask for two reasons.
First, most of us remember the contested election of 2000, which helped topple the economy into recession and provided fresh fuel for an on-going bear market in stocks.
Second, the pandemic is impacting how we vote. The vast majority of Americans strongly believe in the expressed will of the people and recognize that every vote is of equal value whether it is cast by mail box, by drop box or by ballot box. However, it is clear that it will take longer to count the votes this time around because of the very large number of people requesting mail-in ballots due to the pandemic. It may well be that, as dawn breaks on November 4th, no victory has been credibly claimed, grudgingly conceded or unofficially declared.
Nevertheless, for investors, it is important to recognize that the odds still strongly favor the election producing a clear winner within a few days and the inauguration of that winner, on schedule, in January.
That being said, investors have good reason to worry that continued partisan bickering over basic public health practices could extend or worsen the pandemic. In addition, a contested election, even if the eventual outcome was clear enough, could distract Washington from providing further appropriate support to displaced workers, disrupted businesses and distressed state and local governments. The economic recovery already looks set to slow very sharply in the fourth quarter and political divisions could, at an extreme, lead to a double-dip recession, with negative repercussions for stocks in the months ahead.
We should emphasize that this is not our base case scenario and we don’t believe investors should delay appropriate investments until after the election. After all, almost all elections end up reducing political uncertainty rather than increasing it, and stocks tend to fare better when uncertainty falls. However, this is a good time to check portfolios to ensure that they are sufficiently diversified to weather extended election turmoil should it unfold, but also positioned to benefit from a global recovery from the pandemic in 2021 and beyond.
Addressing these issues in slightly more detail, it is important to emphasize that there is a big difference between and inconclusive election and an un-conceded one.
While the election of 2000 is often pointed to as an example of what could happen in a close race, it needs to be emphasized that 2000 was an extraordinary statistical fluke. First, it was the only election in over a century to come down to just one state. Second, within that state, according to the eventual official tally, George W. Bush beat Al Gore by just 537 votes out of almost 6 million cast - a margin of 48.85% to 48.84%.
We can say, with absolute confidence, that the result this November will not be that close and if, as is much more likely, one of the candidates is ahead by two or more states and by tens of thousands of votes in those states, then they will almost assuredly be inaugurated President. While the legislative and judicial machinery necessary to ratify the result is complicated and more partisan than it should be, it is hard to believe it is capable of denying the obvious verdict of the people in any state.
Moreover, the overall result should become relatively easy to surmise, if not on election night, then within a few days thereafter. Every state is different in its rules with regard to the counting of mail-in and early ballots and some will get to a nearly complete count pretty quickly. Comparing the results from these states and their congressional districts to the 2016 results should provide political analysts with significant information in predicting vote swings in other areas. In-person exit polls will unfortunately be useless because of an expected sharp partisan divide in use of early voting or voting by mail. However, phone or on-line surveys on how people actually voted could also help solidify forecasts of the eventual official result.
In short, while a large number of Americans will be unhappy with the result, the odds are we will know who won within a few days and that that person will become President.
On the second issue, the election drama of 2000 does appear to have contributed to the recession of 2001.
For background, it is worth remembering that the stock market peaked in March of 2000 and had already fallen 6.3% from that peak on Election Day. Despite this, the economy had continued to grow at a moderate pace throughout the year and the unemployment rate, at 3.9% in November, was basically unchanged from its April low of 3.8%. With the election uncertainty, however, consumer confidence fell sharply, with the University of Michigan index of consumer sentiment slumping from a very healthy 107.6 in November to 94.7 by February. This probably did contribute to a sharp decline in investment spending in the first quarter and a slowdown in the growth of consumer spending. Real GDP fell in the first and third quarters of 2001 and began to recover in the fourth quarter despite the trauma of 9/11. The National Bureau of Economic Research eventually announced that the recession began in March of 2001 and ended in November of the same year.
Analysts should, of course, be careful in applying the lessons of this episode to any uncertainty that could follow this November’s election. Our politics, economics and markets are all in very different places from where they were back then. That being said, this would be a particularly inopportune time for a prolonged bout of political uncertainty.
Data this week should allow analysts further hone their estimates of 3rd quarter GDP. The most important numbers include advance estimates of August inventories and international trade in goods, due out on Tuesday, and August consumer spending and September light-vehicle sales due out on Thursday. Overall, we anticipate a sharp bounce in real GDP, potentially rising by 32% annualized in the third quarter, following a 31.7% drop in the second.
However, percentages can be very misleading when looking at declines and rebounds. It would actually take a 46.4% annualized jump in 3rd quarter GDP to fully recover from a 31.7% decline in the prior quarter. Consequently, we expect real GDP to still be down 3.6% in absolute terms from its 2019 peak in the 3rd quarter. This is only a little better than the 4.0% peak-to-trough decline in real GDP seen in the Great Financial Crisis.
Moreover, even without the extra drag of election uncertainty, we now expect growth to slide to just 3% annualized in the fourth quarter, reflecting the lack of further federal stimulus and a potentially worsening pandemic, as colder weather drives people indoors where they are more likely to spread infection. A prolonged contest over the election could, at an extreme, further slow consumer and investment spending and potentially trigger a double-dip recession.
A similar story can be told looking at employment numbers. So far the economy has recovered 10.6 million or 48% of the 22.1 million jobs lost in the pandemic and this Friday’s jobs report could add close to a million jobs to the recovery total. But thereafter the jobs recovery is likely to slow, with the layoff of some 247,000 remaining temporary census workers, the scheduled furlough of thousands of airline workers on October 1st, below average seasonal hiring at retailers, the layoff of restaurant workers as outdoor dining becomes more difficult to sustain, and potential state and local government layoffs. While we expect hiring to accelerate with the arrival of a vaccine, a united effort to defeat the pandemic, rather than a divisive conflict over the election, will be necessary to put the economy firmly on the path of recovery.
If the economy does double-dip under the combined weight of a resurgent pandemic and political conflict, both U.S. equities and the U.S. dollar could be expected to suffer. For long-term investors this suggests the need for broad diversification and a more global approach to equity investing.
In three months’ time, Americans will join the rest of the world in saying goodbye to 2020. Never will so many have said “good riddance” with such fervor. As the dawn breaks on 2021 the election will, very likely have been long decided and we will, to that extent, face less uncertainty than today. That being said, the problems confronting our society, our economy and our markets will be formidable. The challenge for investors is to make sure they are positioned appropriately today for that more certain, but still troubled, landscape of 2021.