The presidency is determined by who wins at least 270 of the 538 Electoral College votes, not a simple majority of the popular vote. In the 2016 election, President Trump was elected with 306 pledged Electoral College votes to Hillary Clinton’s 232, but actually lost the popular vote by nearly 3 million votes.

The map below shows the number of each state’s Electoral College votes, which is roughly proportional to the state’s share of the population. In all states but two, it is winner-takes-all for Electoral College votes. Therefore, small margins of victory in individual states can have an outsized effect on the Electoral College tally. In 2016, President Trump won Michigan, Pennsylvania and Wisconsin by a spread of less than 0.8%, or about 80,000 votes across the three states, delivering him 46 Electoral College votes and the presidency.

In 2020, these three states, along with the other 5 tightest races of 2016—New Hampshire, Florida, Minnesota, Nevada, Maine, Arizona and North Carolinae—will likely determine the outcome of the election. Due to the Republicans’ structural advantage in the Electoral College, former Vice President Joe Biden must outpoll President Trump by about 3% or more to be elected.

2016 Electoral College map

Source: 270toWin, J.P. Morgan Asset Management. Data are as of August 10, 2020.
Trump earned 306 pledged electors, Clinton 232. They lost respectively two and five votes to faithless electors in the official tally. These lost votes were from Hawaii (1), Texas (2), and Washington (4). Maine and Nebraska allow for Electoral College votes to be split.

Typically, incumbent candidates have a high likelihood of winning re-election. In fact, incumbents have won re-election 65% of the time since the Civil War. However, in all instances in which the incumbent lost, there was a recession or depression during their term. Coming into this year, economic growth was slowing but solid and unemployment was at a 50-year low. Now, the U.S. is in the deepest recession since World War II, with double-digit unemployment. In addition to the economic downturn, the country is still mired in the worst public health crisis in decades and confronting civil unrest over racial inequality.

In light of these multiple crises, former Vice President Joe Biden is gaining popularity and President Trump’s approval ratings have slid. Now, instead of running on a strong economy, President Trump will either have to convince voters he has managed this crisis appropriately or rely on his signature issues such as immigration, trade protectionism and infrastructure. While signature issues may resonate with his fiercely loyal base, economic realities could be more decisive in swing states. Among the ten states with the tightest margins in the 2016 presidential race, the majority have double-digit unemployment rates and all experienced their highest unemployment rates on record (dating back to 1976) in April or May.

However, the perception of the COVID crisis has also been highly partisan in some respects, so it is important to highlight that seven out of those ten states have Democratic governors. Governors have controlled the pace and parameters of lockdowns and reopenings. Therefore, swing state voters’ frustrations may either lie with President Trump or the Democratic governor leading their state.

Source: Bureau of Labor Statistics, Britannica, Five Thirty Eight, J.P. Morgan Asset Management. Of the 39 elections since 1864, 20 were re-election campaigns. Of those, the incumbent won in 13 races, and lost in 7 races. Tightest races are defined by spread of popular vote between candidates. Organized left to right by tightest race, Michigan, to tenth tightest race, North Carolina. Data are as of August 10, 2020.
Democratic governors: Michigan, Pennsylvania, Wisconsin, Minnesota, Nevada, Maine, North Carolina.

Polling and betting odds suggest the possibility of a Democratic sweep of the presidency, the Senate and the House of Representatives has risen. However, it is important to consider the pathways, rather than the polls, to this outcome.

As discussed in "How is the winner of the U.S. presidential election determined?”, the path to the presidency will be highly dependent on a handful of swing states.

As for Congress, in the Senate, the Republicans currently hold the majority with 53 seats. In order for the Democrats to win the majority, they must win net 3 seats if they also win the presidency (because the Vice President casts the tie-breaking vote in legislation), or net 4 seats if they do not. This year, 35 seats are up for election, 23 currently held by Republicans and 12 by Democrats. There appear to be at least seven competitive races (AZ, CO, GA, IA, ME, MT, NC) where Democrats could possibly flip Republican seats, but it is likely that Republicans will flip the Democratic seat in Alabama.

In the House, all 435 seats are up for election. Democrats currently hold 232 seats, Republicans hold 198, and there are four vacancies and one Libertarian. Assuming that the vacant seats return to the party that held them, that would give the Democrats 233 seats and the Republicans 201. This would leave the Republicans needing a net gain of 17 seats to regain control. While that’s possible, on average we see much bigger swings during mid-term election years, as these contests are considered referendums on the president’s first two years of the term. During the last three presidential elections, the House swung on average by net 12 seats. However, in the 2018 mid-term elections, the Republicans would have needed to win 19 seats for control of the House, which they could have achieved even if the Democrats had won by up to 3.8% of the vote. Therefore, even if the Democrats win a majority of the votes, they need to win by a wide enough margin to maintain control.

A lot has to go right for either party to sweep government control, but in this highly polarized environment, victory at the top of the ticket could lead to momentum down the ballot.

Votes or seats in the Electoral College, Senate, and House of Representatives

Source: 270toWin, J.P. Morgan Asset Management. Electoral College: Trump earned 306 pledged electors, Clinton 232. They lost respectively two and five votes to faithless electors in the official tally. Senate: 51 seats are needed for a simple majority, but if the president and majority are of the same party, only 50 seats are needed because the Vice President casts the tie-breaking vote. The 47 Democratic seats includes 2 Independents that vote with the Democrats. House of Representatives: There are currently 4 vacancies and one Libertarian. Chart assumes that the vacant seats return to the party that held them. Data are as of August 10, 2020.

As discussed in “Will there be a one-party?” the odds of a one-party sweep appear to have increased since the beginning of the year. The major implication of a one-party sweep is that that administration can more fully enact its policy agenda, while a divided government entails more compromise, or as we’ve seen in recent years, more stalemates.

From markets perspective, since 1949, equities have tended to perform better under Republican control, with average annualized returns of 11.8% on the S&P 500, vs. 9.2% under a Democratic control and 6.1% under divided government. The three major periods after WWII of Republican control and coinciding stock market climbs were the early Eisenhower years, the lead up to the Financial Crisis and President Trump’s first term at the tail-end of a record-long economic expansion.

From an economic perspective, economic growth tends to be stronger under Democratic control. Since 1945 real GDP growth averaged 4.4% annualized under Democratic control, 2.8% under Republican control and 2.5% under divided government. For Democrats, this includes the post-WWII economic expansion, as well as the healthy period of growth throughout the 1960s, as Baby Boomers began joining the workforce.

While divided governments tend not to have the optimal economic or market outcomes, it is important to keep in mind that the U.S. is governed by divided government 62% of the time, compared to 11% for Republicans and 27% for Democrats. That encapsulates most economic conditions, good and bad. If the 2020 election results in a divided government, the distribution of power will actually be as it has been for most of the last 70 years.

S&P 500 Price Index

Rolling six-month

Real GDP

Quarter-over-quarter % change, seasonally adjusted annualized rate

Source: FactSet, Office of the President, J.P. Morgan Asset Management, (Top) Standard & Poor’s; (Bottom) Bureau of Economic Analysis. Top chart shows S&P 500 price returns. 
Guide to the Markets – U.S. Data are as of July 31, 2020.

On average, returns have been lower and volatility has been higher during election years compared to non-election years. But what do averages really tell us? Sure, political volatility does impact markets, but let’s consider recent election years, such as 2008 and 2000. 2008 was marked by the onset of the Financial Crisis, and 2000 by the tech bubble bursting. Returns and volatility during those years were driven by prevailing market and economic conditions at the time, not the election. This year, lower returns and higher volatility will almost certainly be attributable to COVID-19.

Therefore, investors should instead continue to monitor economic fundamentals, tilt towards quality in both equity and fixed income, and maintain a well-diversified allocation. This doesn’t mean there won’t be interim volatility around the election, but that volatility is unlikely to warrant dramatic portfolio changes. Moreover, timing the market is a very difficult strategy, and no less so during an election. Recall that in the early hours of November 9, 2016, futures plummeted as election results were coming in, but markets closed positive after that day’s regular trading session. Investment time horizons extend far beyond election cycles and presidential terms, so sticking to an investment plan is more crucial than ever.

Equally important to what investors should do is what they shouldn’t do: Don’t let you how feel about politics overrule how you think about investing. To illustrate this point, the chart below shows a poll conducted by the Pew Research Center, in which respondents rate present economic conditions as excellent, good, fair or poor. During the 8 years of the Bush Administration and since the start of the Trump Administration, those who are or lean Republican felt positively about the economy while Democrats felt less favorably. The opposite was true during the Obama Administration. But what’s most striking is how much attitudes pivot on Election Day itself, ten weeks before the new president is even inaugurated and has no direct influence over the economy yet.

One might extrapolate that investors may be under-allocated to risk assets or even pull out of the market if they feel strongly negatively about a president. However, investors would have missed out on above-average returns on the S&P 500 during the Obama Administration and the first three years of the Trump Administration if their political views governed their investment decisions.

Source: Standard & Poor’s, FactSet, J.P. Morgan Asset Management. Data are as of August 10, 2020.

Percentage of Republicans and Democrats who rate national economic conditions as excellent or good.

Percent

Source: Pew Research Center, J.P. Morgan Asset Management. Pew Research Center, April 2020, “Positive Economic Views Plummet; Support for Government Aid Crosses Party Lines” Question: Thinking about the nation’s economy, How would you rate economic conditions in this country today… as excellent, good, only fair, or poor? Survey data collected from April 7-12, 2020. Guide to the Markets – U.S. Data are as of August 10, 2020.

One of the key policy items of the next administration will be the U.S. approach to China. Being tough on China appears to be one area that President Trump and former Vice President Joe Biden agree on in principle, although perhaps not in implementation. It is also an area where American voters seem to agree. According to a poll conducted by the Pew Research Center, the majority of both Republican and Democrat respondents have an unfavorable opinion of China, which has intensified over the last two years.

Thus far the current administration has proposed or implemented a number policies targeting China, including banning U.S. companies from doing business with certain large Chinese companies, restricting access to U.S. equity exchanges, revoking Hong Kong’s preferential status, and, of course, tariffs.

Although Joe Biden does not have an explicit proposal for how he would address ties with China, in his proposals to rebuild domestic supply chains, he notes he would “impose targeted restrictions on imports from nations such as China and Russia that pose national security threats.” He references China multiple times in this proposal, aiming to reduce U.S. dependency on China in supply chains and trade.

These efforts by either candidate could result in higher costs for U.S. companies and hurt corporate profitability for two reasons: import tariffs could boost input costs, and reshoring of supply chains would be expensive to relocate and maintain given higher labor costs in the U.S. On the other hand, it could also create opportunities to automate supply chains domestically and to build new domestic technologies, such as 5G. Despite a politically tough stance on China, it is still a critical market from an asset allocation standpoint. It represents 41% of the MSCI Emerging Markets index, and will continue to be a source of growth ahead.

Percentage of Republicans and Democrats who say they have an unfavorable opinion of China

Source: Pew Research Center, J.P. Morgan Asset Management. Survey of U.S. adults conducted March 3-29, 2020. Data are as of August 10, 2020.

On November 3, voters will either head to the polls or post their mail-in ballots in advance. COVID-19 may complicate both of these methods.

The first successful socially-distant election was held in South Korea on April 15th—replete with masks, hand sanitizer, gloves, diligent disinfecting, temperature checks and ample spacing. However, subsequent in-person primaries in the United States have been fraught with long lines and inconsistent safety measures. Without adequate preparation and resources, these issues could repeat on Election Day, discouraging some degree of voter turnout. Increased voter turnout is thought to favor Democrats, so this could hurt their results.

Others may opt to mail their ballots in, which some states (Colorado, Hawaii, Oregon, Utah and Washington) already do exclusively. However, mail in voting is a hotly partisan issue which Democrats support to increase voter turnout, and Republicans denounce as they claim it exposes elections to fraud and favors Democrats. Yet, there is little evidence to indicate that mail-in voting specifically benefits any party, particularly this year when older voters, who often vote Republican, may mail in their ballots since they are most vulnerable to COVID-19. Nor is there compelling evidence of significant fraud. The Republican Secretary of State of Washington State found 142 cases of potential fraud in the 2018 general election out of 3.1 million ballots cast, which translates to a 0.004% fraud rate ¹. Regardless, restrictions on mail-in voting could result in voter suppression, which historically has disenfranchised minority voters, who tend to vote Democratic. An increase in mail-in voting could mean election results could be delayed as ballots are counted, and because of the suspicions of fraud, could also result in a 2000-style recount of the ballots. This could all threaten the smooth transition of power if the president is not re-elected.

For investors, the implication is that volatility will likely be heightened in the run-up to the election, but could also be in the aftermath. Usually elections reduce uncertainty which is positive for markets, but in this case, uncertainty may extend beyond November 3, , as we will likely not get the full results on Election Day. While this doesn’t warrant dramatic repositioning of portfolios, a balanced approach should serve investors well through the volatility.

¹ https://www.sos.wa.gov/office/news-releases.aspx#/news/1401

While markets are likely to experience volatility in the lead up to and the aftermath of the election, ultimately, it’s policy, not politics, that matter most for the economy and markets in the long run. One policy proposal that has garnered the attention of most is an increase in the corporate tax rate.

From 1993-2017 the top corporate tax rate was 35%, until the 2017 Tax Cut and Jobs Act (TCJA) reduced it to 21%. Democratic nominee Joe Biden has proposed to partially reverse this cut, increasing the top corporate tax rate from 21% to 28%. This would bring it in line with the OECD GDP-weighted average of 26.53%. However, most companies do not pay this top rate, and the effective tax rate is typically below it. In 2019 it was 17.5%, and based on the relationship between top rates, effective rates and nominal GDP over time, we estimate it could be north of 21% with a partial tax hike. This could reduce S&P 500 operating earnings per share by roughly 7 USD, disrupting, but not reversing the fragile profits recovery. This compares to the 12 USD boost in operating earnings per share attributable to tax cuts in 2018, the first year the TCJA was in effect.

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With the presidential election just under two months away, investors are considering how individual income tax changes proposed by both candidates might affect the municipal bond market and their tax-advantage benefits.

Under a continuation of the current administration’s agenda, current individual income and estate tax changes under the Tax Cuts and Jobs Acts (TCJA) could remain in place through 2025 with the potential for the 3.8% mandatory net investment income tax to be repealed. Given this, under current law, its unlikely individual municipal bond demand would be meaningfully impacted. On the supply side, it’s reasonable to expect taxable municipal bond issuance to continue to remain robust in the years ahead given the elimination of issuers’ ability to issue advance refunding tax-exempt municipal bonds under the TCJA.

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Current municipal tax equivalent yields under various individual tax schemes

Municipal bond tax equivalent yields by rating

FactSet, J.P. Morgan Asset Management. Municipal yields are based on Bloomberg Barclays Municipal Bond subindices. Tax equivalent yields are based on current yields and calculated as current yield/(1-top tax rate). Data are as of September 10, 2020.