The impact of the U.S. presidential elections on a major investor

Published on: 24 June 2024

Like many institutional investors, APG has significant exposure to U.S. equities and government bonds. How does a major investor handle the uncertainty leading up to the U.S. presidential elections on November 5? And does the increasing polarization in the country affect investor confidence? Thijs Knaap, Chief Economist at APG, shares his perspective. “As a long-term investor, we look at whether politicians can solve problems together. This is becoming increasingly difficult in the United States, and that can directly affect us as investors.”

In a nutshell
• The 'uncertainty index' VIX doubled during the last two U.S. presidential elections.
• Election years are generally good for the economy, but less so for the stock markets.
• The influence of the U.S. president is often overestimated, except in the area of international trade policy.
• A long-term investor like APG has more to fear from a further decline of democratic institutions in the U.S. than from who occupies the White House.

While events like a stock market crash, war, or natural disaster often come as a surprise, elections are predictable, says Knaap. "Only the outcome can be a surprise." This is certainly true for the upcoming presidential elections in the U.S., where - with four months to go - President Biden and his Republican opponent Trump are both polling at around 41 percent. "This keeps it a manageable risk: there are two realistic contenders, and the winner is usually known soon after the polls close. Investors dislike uncertainty, but in this case, they can manage it reasonably well."

Uncertainty Index
What you do see around elections is an increase in the number of options purchased by investors to protect against potential stock market losses, Knaap continues. "This is reflected in the CBOE Volatility Index, better known as the VIX. Based on a wide range of S&P 500 options, it shows the expected volatility of the S&P 500 index, and can be considered a sort of uncertainty index. During the 2016 presidential elections, when Trump was ultimately elected, it doubled compared to the previous months, reaching 22. In 2020, the VIX also doubled leading up to the elections, reaching 40. At that time, uncertainty was already high due to the pandemic. Currently, the VIX is at 13. Expect it to rise to 26 in the coming months. Investors like to hedge against uncertainty and tend to take fewer risks before major elections, typically resuming their usual strategies afterward."

Economic Impact of Election Years
In general, election years are good for economic growth. "That's not a coincidence. Most incumbent politicians ensure there is good news to share before the elections. Most policy programs are designed with this in mind. Although something unexpected can always happen, like the COVID-19 pandemic in 2020." Since the stock market tends to anticipate the economy, and good news is already priced in before the elections, the stock market often performs somewhat less during election years. "This is known as the 'political business cycle.' This year is an exception, as it has been a very good year for the stock markets so far."

Taxes and Regulation
When assessing presidential candidates, an investor will look at their positions on business, says Knaap. "If a candidate favors fewer regulations and lower taxes, you would expect stock prices to rise after their victory. When Trump was elected in 2016, the stock market rose by 5 percent that month. Everyone anticipated that the real estate magnate would lower taxes and reduce regulatory burdens. But surprisingly, Biden has also done a lot for businesses during his presidency. Think of the enormous stimulus programs for infrastructure and the energy transition. These resulted in significantly higher national debt, but the stock markets benefited. Therefore, it is difficult to determine who is better for business."

There is also the question of under whose presidency inflation will rise the most. "Looking solely at the person, it is likely under Trump, as he has little regard for an independent central bank and is simultaneously attracted to low-interest rates. But considering the track record of both, Biden seems more likely to cause inflation due to the enormous investments during his presidency."

Economists have debated for decades whether democracy is necessary for a healthy economy

International Trade
Even though Trump and Biden differ vastly in personality, we still do not know much about their specific policy plans, says Knaap. "More important is the question of whether Trump, after a victory, will change the rules of the game. He has little regard for (international) regulations and trade compared to Biden. This poses a risk. The global financial system relies on many tacit agreements, many of which involve U.S. institutions. For instance, the value of the dollar is based on free access to the U.S. market. Additionally, the creditworthiness of the U.S. government, the trade deficit, and the credibility of the Fed play significant roles."

In short, it is very difficult to predict what will happen on November 5 and beyond, says Knaap. Moreover, the influence of the U.S. president is generally overestimated, except in the area of international trade. "With one signature, the president can change policy in this area. Trump exercised his power in this regard, and surprisingly, Biden did not reverse his decisions. In fact, the Democrat advocates even higher import tariffs on items like Chinese EVs and computer chips. He also attempts to bring certain industries back to the U.S. One difference between the two candidates is that Trump often acted unpredictably and undiplomatically, damaging the international position of the U.S."

Institutional Stability
Knaap considers the state of democracy in the U.S. to have a greater impact on the economy than a presidency of Biden or Trump. "Politics there seems increasingly focused on scoring points and criticizing the opposition rather than solving societal problems. Democracy is not in good shape, and this trend unfortunately seems to continue. Economists have debated for decades whether democracy is necessary for a healthy economy. Since countries differ on more levels than just their political system, such as (population) size and the presence of natural resources, this is difficult to prove. We do know what is important in an economy: property rights and political and civil liberties, among others. My intuition suggests that democracy is essential for long-term national success. Potential discontent can be channeled through elections rather than through a revolution."

While Knaap does not see the upcoming presidential elections as a turning point, he is concerned about the stability of U.S. institutions. "The president is loved by one part of the population and hated by another. The same now applies to the Supreme Court. And then there is Congress, which has been unpopular for a long time. As long-term investors, we benefit from a world where contracts and agreements are respected and enforceable. We also look at whether institutions are stable and reliable, and whether politicians can solve problems together. This is increasingly becoming an issue in America."

Reliable Country
"A climate of political intolerance can directly affect us as investors. If both parties in Congress, for example, cannot agree on raising the debt ceiling, the Treasury Department will struggle to pay interest on government bonds, of which we hold quite a few. We still see the U.S. as a reliable country in which we want to invest, but we would like to see increased confidence in American democracy rather than its further decline. This long-term view also means that we do not change our investment strategy based on a Trump or Biden victory. Four years is, after all, only four years."