US election: Three risks markets are missing

If politics is performance art, nobody does it better than the US. The teeming rallies, the lavish spending and the soaring rhetoric capture the world’s attention. While American politics is often loud, disorganised and passionate, it is rarely boring. As we enter the summer, when Biden and Trump are likely to formally accept the nomination by their respective parties for president, bombast will doubtless reach new highs.

For markets, it is easy to get distracted by all this noise. As the Biden-Trump rematch begins, polling in swing states, performance at debates and Trump’s legal battles will be the subject of investor chatter for months to come.

But is the presidential election’s bombast disguising other risks? Perhaps so. Below we consider three underdiscussed risks, and their potential impact on geopolitics and markets.

The contested win risk

While candidates take any win they can get, a contested victory will give markets heartburn. US presidential elections count by state, and state processes for voting, collecting and counting ballots vary substantially. For example, Georgia requires voter ID to cast a ballot in person, whereas Nevada does not. Pennsylvania does not allow early counting of ballots (largely mail-in) before election day, while Arizona does.

These differences among major swing states can provide lucrative work for recount lawyers but make certifying election results lengthy and fraught, eroding trust in American institutions. Tense disputes around the ballot counts in key swing states have struck more than one presidential election.

In 2000, the Bush-Gore Florida recount took 34 days to fully certify amid agonised haggling over remnants of paper left in punched voter cards known as hanging and dimpled chad. In the end, it required a contentious intervention from the Supreme Court to resolve.

In 2020, amid delays in certification from swing states, there were intense disputes over the legitimacy of several state ballot counts. Such antics create space for markets to reprice downward and can heighten the damage caused by external actors. Amid a close election, with markets sensitive to heightened political risk from the US, and the Ukraine war ongoing, the fallout from a contested victory is likely higher than it has ever been.

The clean sweep risk

The presidency is not the only prize up for grabs this electoral cycle. All members of the House and 33 senators are also facing re-election, and the next session will shape coming legislation. Markets fret a ‘clean sweep’, where a single party takes control of the presidency, the Senate and the House of Representatives. Historically, this precedes substantial fiscal loosening.

Spending spigots are already turned up high, with fiscal deficits projected by the Congressional Budget Office (CBO) to remain at around 5% of GDP from 2024. Fiscal stimulus risks are only rising from here: CBO estimates assume the full expiry of Trump’s tax cuts, which seems highly unlikely. Moreover, both parties are drawing up expensive wish lists for the coming term, threatening to push debt and spending, which are already elevated, higher still.

Is such a clean sweep likely? Congressional results have become increasingly correlated with the presidential race over the past two decades. A win for Trump or Biden raises the likelihood their party’s cadres win in less illustrious offices. While a close election might raise the impact of so-called split ticketing, congressional results are increasingly feeding into the spending bias from the Federal government.

The early departure risk

Another risk is often alluded to but rarely discussed openly: that of the candidates’ age and corresponding risk of mortality. Biden and Trump are among the oldest figures to hold the presidency. Trump, at 78, matches previous oldest-President Ronald Reagan’s age at the end of his term. Biden, at 81, is older still. While no public figure’s health is better understood than the US president, concern about mortality risk, and accompanying disruptive change in personnel or policy, is reasonable given the age of the candidates. It also makes the role of vice president more important than ever.

For global markets, elections are a necessary risk. The bombast of public argument gives ample room for investors to put the worst construction on all news, even more so if the election is close. In keeping with our mantra of ‘prepare, don’t predict’, looking at the risks behind the vote itself is necessary to embrace contrarian strategies in times of crisis. We think uncertainty around the US election will be a market headwind as it comes increasingly into focus. As we enter the tumult of election season, we maintain a cautious stance on risk, concentrated in a credit underweight as spreads are already tight.