US Elections: Noise and Temporary Dislocations

"The selloff last night was an hysterical reaction," said David Bianco, chief U.S. equity strategist at Deutsche Bank. "There are a lot of potentially damaging policies that could be introduced, but we think sober minds will prevail." (CNN, November 9, 2016)

This issue of our newsletter will try to unpack potential market moves generated by the US elections.

It is also an excuse to throw our hat into the race for election outcome predictions…

A “Trump trade” was first initiated in early June, when the race seemed over due to President Joe Biden’s cognitive decline. His debate performance only further convinced investors that a second Trump trade was all but inevitable.

That trade included shorting the long-end of the US Treasury curve, as investors factored in higher inflation generated by new tariffs.

Former President Trump was always seen as bearish for US rates, yet it is worth reminding that the 2016-2020 Trump Presidency was also characterized by the Fed’s first rate hikes post-GFC, which may have had some impact on the long-end of the curve.

Post debate, clean energy companies also suffered. Below, you can see the performance of First Solar (FSLR) on June 27-28, the day after the now iconic June 26th Presidential debate that factually ended Biden’s campaign.

As Biden passed the baton to Vice-President Kamala Harris at the end of July, pricing somewhat adjusted to increased odds that Democrats would hold on to the Presidency, as well as to the potential for a divided government that would make any large spending bill less likely.

But as the race ground on, despite a deluge of favorable media coverage, and a flurry of the usual gaffes and unforced error that former President Donald Trump has gotten us used to, Harris did not gain any significant advantage in either national or swing state polls.

In fact, perhaps surprisingly for many foreign media pundits, the race remains painfully too close to call and - we believe - is more likely to swing in Trump’s direction.

But why is that? A couple of points are worth making.

1. The focus on “undecided” voters has always been a myth in US elections, and this is especially true since the country became more polarized post-2016. Most voters have already made up their minds, and only pretend to be undecided because they do not want to reveal their political leaning to the poll interviewer or media focus group. The real campaign goal for both Republicans and Democrats is to turn out their respective bases by creating enthusiasm.

2. Despite the picture that most mainstream media - including some Republican leaning ones - have been portraying since her entry into the race, Kamala Harris has not been able to generate the kind of enthusiasm needed to mobilize the Democratic base.

3. Democrats have recently won Presidential elections either through a combination of union workers/suburban women (Biden), or thanks to the overwhelming support of minorities (mainly latinos and black voters, Obama). But Harris lacks Obama’s charisma and Biden’s brilliance at retail politics. Her campaign appears to be mimicking the struggles of former Secretary of State Hillary Clinton’s, although voters seem to recognize Harris does not have the same kind of baggage.

4. Trump, on the other hand, really connects with voters. While Kamala Harris has a life story that many Americans feel they should cherish, Trump has the life story most Americans do cherish. He long ago unveiled the hypocrisy that is the undertone of the American political discourse - the “I come from a modest family, worked my way up” rhetoric. His strong popularity shows US voters continue to be captivated by his story.

The most unnerving story for Democrats is the thin lead Harris has in the crucial Great Lakes swing states of Michigan and Wisconsin - not to mention the deadlocked race in Pennsylvania.

In 2020, then candidate Biden came into the last week of the race with 5+ point-leads in all crucial swing states, and only ended up carrying them by a much smaller margin.

To be clear - the gap between Biden’s polls as election day approached and his actual result was not massive (~3 percentage points). But as things stand, it would be sufficient to hand the election to Donald Trump if the 2024 result was to replicate the 2020 election-to-polls gap.

All that said, the reverse happened in the 2022 midterms, when polls projected a Republican “red wave” that did not materialize. Instead, Democrats kept the Senate and almost retained control of the House, in an unprecedentedly positive outcome for the political party in power in a midterm election.

If 2022 was to be repeated - which we believe is unlikely - Harris would win the election by a large margin.

Policy plans: Blurry and Vague, but Well-Known

A lot has been said about the two candidates’ economic plans. The general feedback from non-partisan analysts is that they both add to the deficit and that they are both unattainable. But this is par for course in politics.

If anything, both Trump and Harris have kept their economic goals extremely vague, be it for fear of alienating parts of their voting bases, or in an attempt to appeal to marginal voters - for Republicans, white suburban families that shifted from Trump to Biden in 2020 and to the Democratic Party more broadly in 2022, and for Democrats, minority voters that were skeptical of Biden and were not planning to show up at the polls.

Outside of campaign noise, partisan ads and pundits talking points, the differences between a Trump Presidency and a Harris Presidency in terms of policy are unlikely to be significant.

Neither candidate has any intention to give up the “America first” agenda - after all, it was President Biden who passed infrastructure legislation, the CHIPS act and the “Inflation Reduction Act,” all of which were aimed at stimulating internal consumption and protecting US manufacturing, especially in strategic sectors such as semiconductors.

Tariffs on Chinese goods - both consumer and industrials - were also largely kept in place by the Biden administration, though Trump plans to be much more aggressive when it comes to hitting Europe with levies (Biden, on the other hand, lifted European tariffs in the context of a broader strategy of engaging democracies against autocrats). Even then, most European manufacturers have already adapted by building factories in the US.

US tech, on the other hand, is likely to come under additional scrutiny from the EU if Trump were to be true to his rhetoric, which has often slammed the EU as a “consortium” that is treating America “very very badly.” EU’s reaction to tariffs is likely to be directed at regulating and targeting US tech with antitrust actions.

One of the key “Trump trades” was shorting clean energy US companies, with he former President threatening to withdraw subsidies that have been put in place via the Inflation Reduction Act. It will be interesting to see what the Congress will look like in order to gauge the severity of these threats, especially considering how clean energy production has taken hold in “red” regions of the country, and how it employs an increasing number of blue collar workers. That said, clean energy stocks are likely to react negatively to a Trump election regardless of the long-term effects.

Another sector that is worth keeping an eye on is defense.

Many readers will be surprised to learn that US military aid to Ukraine was, in fact, a form of domestic stimulus spending, as money to replenish depleted stocks of weapons and munitions were paid by the US government to the military industrial complex. At the same time, fears over China’s Taiwan takeover plans will likely accelerate US rearmament - it remains to be seen if the US government will aim for the scale that is considered necessary to counter China’s threat.

Large US military contractor stand to benefit from the inevitable increase in defense spending, and the increasingly likely possibility that the US could be involved in a war - be it to defend Taiwan or to fend off Putin’s goal to test the NATO alliance’s red lines. While Trump claims to be willing to find a diplomatic solution on the Ukraine crisis, he has often been in practice much more hawkish than his words had been suggesting. In fact, it was Trump who started supplying Ukraine with lethal aid - Obama having famously rejected Kyiv’s pleas in that regard.

In the immediate aftermath of a Trump victory, oil companies would also be naturally benefiting from the former President’s pro-drilling rhetoric although even there, it is questionable whether this effect is likely to sustain for long after the elections. The Biden Presidency has not exactly been “anti-oil” or anti-fracking, as the graph below shows…

Healthcare and pharmaceutical companies would have to deal with a renewed push from the government to negotiate the price of drugs for seniors if the Democrats win. If Trump prevails, the market’s knee-jerk reaction is likely to be positive, though it remains to be seen if Trump will reverse very popular recent achievements, such as the cap on the price of insuline.

More in general, equities are likely to rally if Trump wins, due to the prospect of a reduction in corporate taxation - which the former President has pledged to pursue.

Finally, the crypto and blockchain industries stand to gain from Trump’s explicit endorsement. The reaction to Trump’s win is likely to be a “buy” across the board, but it remains to be seen if Trump’s verbal support will turn into comprehensive and concrete policy moves - especially as firms like crypto.com are currently being targeted by the SEC. Since the latter approved both BTC and ETH spot ETFs, there is little that can be done concretely to materially improve access to digital currencies, but the general sense that a crypto-friendly President is in the White House will likely contribute to positive sentiment.

As a reminder, these projections are related to the immediate aftermath of the election. Long-term effects are not discussed in this piece, as they are going to be determined by additional factors - most of them unrelated to politics.

Conclusion

While a Trump victory is not certain, certain elements seem to point to Kamala Harris’s weakness and to the former President’s strength. His resilience despite the relentless attacks and numerous awkward comments, her failure to connect with voters and apparent incapacity to build a winning coalition, and the percentage of Americans thinking the country is going in the right direction (~25%, which is historically one of the lowest levels) all point to a second term for former President Trump.

Like all elections, the immediate aftermath of the vote will bring some temporary dislocations that capable traders may be able to exploit.

These may include weakness in clean energy stocks, strength in traditional energy and US manufacturing firms, as well as crypto, higher long-end Treasury rates. The short-term path of the dollar may be harder to figure out, as Trump’s policies can have opposite effects on the currency.

Longer-term consequences of a Trump presidency are more complex, and need more in-depth analysis. As soon as the political noise subsides, reality will likely kick in and that means earnings, rates, inflation will again become front of center of investor concerns.

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