How fund managers are investing ahead of US election

“It’s the economy, stupid”. Jim Carville, a strategist working for Bill Clinton, was clear about what would matter during his boss’ 1992 US presidential campaign to unseat incumbent George Bush. And it is advice that might equally apply to investors pondering the impact of this year’s election on the stock market: historical analysis suggests that it’s not elections themselves that matter so much to markets, but the economic conditions in which they take place.

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On the face of it, investors in the US stock market should not welcome presidential races. Analysis from asset manager T. Rowe Price shows that over the past 96 years, the S&P 500 index has delivered an average annual return of 11.6% in non-election years – but only 11.0% in years when a vote took place. In the year prior to an election, returns have also tended to be more volatile, the study shows.

Beneath those headline numbers, however, the story is more nuanced. “The health of the US economy appears to have played an important role in whether the incumbent party retained the presidency in an election year,” says Thomas Poullaouec, head of multi-asset solutions at T. Rowe Price. “In turn, whether the incumbent party won the White House seemed to influence trends in market volatility before and after past elections.”

Generally speaking, T. Rowe Price found that the US market proved more resilient when incumbents remained in office – and generally speaking, incumbents remained in office if the election took place when the economy was performing well. “Focus on what ultimately matters over the longer term: the economy and business fundamentals,” suggests Poullaouec.

Election impact on economy and businesses

That’s sound advice but leaves investors facing something of a dilemma – the outcome of November’s election, after all, is bound to have an impact on both the economy and business fundamentals.

Moreover, calling that outcome is currently very difficult. For much of this year, Donald Trump appeared to be heading for a return to the White House, consistently polling ahead of Joe Biden, particularly in key swing stages. However, the president’s decision to stand down from the Democrat ticket appears to have had a dramatic impact. Kamala Harris is now nudging ahead of Trump in most polls, boosted by the recent triumphant Democrat convention in Chicago.

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A Harris presidency might prompt investor concern, at least initially. For example, Harris has suggested raising US corporate tax rates from 21% to 28%, which would reduce profitability. She is also widely regarded as in favour of increased regulation in many sectors. Still, investors might also regard Harris as a president who comes with fewer uncertainties than Trump.

In the event of a Republican victory, meanwhile, Lisa Shalett, chief investment officer for wealth management at Morgan Stanley, points to three potential macro drivers to consider.

“A potential extension of 2017 tax cuts could contribute to higher interest rates that may weigh on corporate profits and stock valuations,” Shalett says of the likely impacts of a second Trump presidency.

“Tariffs could interrupt recent progress towards curbing inflation in the US, potentially exacerbating consumer prices from high prices. Proposals to curb immigration could slow US population gains that have supported economic growth and disinflation.”

That’s not a particularly happy prospect, but Morgan Stanley sees potential for several specific sector plays if the Republicans win. Energy businesses could benefit from support for fossil-fuel sectors, for example. Defensive sectors such as healthcare, industrials, aerospace and defence could also bear fruit. “Additional exposure to Japan, gold, hedge funds and investment-grade credit may also be beneficial,” Shalett adds.

How fund managers are preparing for US election

Still, for now at least, it would be brave to invest specifically on the basis of one side or the other’s victory. How, then, are fund managers with US exposure positioning their portfolios over the months ahead?

One common strategy is to focus on areas where the election outcome may be less significant. “Both Trump’s rhetoric and Harris’ continuation of the Biden administration’s policies suggest a persistence of foreign tariffs, infrastructure projects and deficit spending,” argues Richard de Lisle, manager of the VT De Lisle America fund. “Industrials such as manufacturers and raw materials producers stand to benefit, particularly smaller domestic companies as production is brought back to America.”

He also suggests caution regarding big technology. “Both candidates, albeit for different reasons, have expressed some disdain for the large tech companies, creating the potential for moves to rein them in,” de Lisle explains. “Combined with industrial spending in the American heartlands, we could see a rejuvenated rotation from high-valuation big tech to low-valuation small value.”

Similarly, Olivia Micklem, co-manager of the Artemis US Smaller Companies fund, suggests looking at infrastructure. “President Biden’s plans covered building and improving roads and bridges, setting up semiconductor plants and encouraging onshoring, but these are bipartisan issues,” she points out. “You don’t find many politicians saying they don't want the bridges fixed or not welcoming the arrival of a big semiconductor plant that will bring jobs and millions in tax revenue, so infrastructure winners appear in our US portfolios.”

Brad Weafer, manager of the IFSL Marlborough US Focus fund, points to stock-specific examples of how to play both sides. “We own credit reporting company Equifax Inc (NYSE:EFX),” he says. “A Republican administration is likely to be slightly easier on regulation in terms of credit than would be a Democratic ticket. However, Harris’ policies on home ownership could spur volume and benefit Equifax, which makes a profit on every mortgage application.”

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All these managers also spy potential opportunities from Democrat or Republican administrations. At Artemis, for example, Micklem suggests the housing sector could be a beneficiary of a Harris presidency, while deregulation under Trump might support many smaller companies. At Marlborough, meanwhile, Weafer points to the energy sector, although he warns against simply adopting conventional wisdom. “You would expect tougher regulations on oil and gas companies from the Democratic side,” he says. “But energy was the best-performing sector in the Biden presidency and the worst-performing sector in the Trump presidency.”

Diversification is key

Given such subtleties, Steve Tong, a portfolio manager at the global equity Mid Wynd International Investment Trust (LSE:MWY), warns against trying to speculate on the outcome of the election and suggests maintaining well-chosen, diversified holdings of US stocks instead.

“The quality of a company, not politics, is what creates investor wealth in the long run,” he argues. “It’s not clear which of the policies that have been put forward might be enacted, but the US remains a great place for long-term global investors to find great businesses and that’s what matters most.”

Interactive investor’s Sam Benstead, fixed income lead, takes a similar view, but also points out that the election is not the only thing to take into account.

“Politics can only influence the economy so much and the actions of the US Federal Reserve will still be a key factor in how the US stock market performs,” Benstead says. “If the central bank feels it can cut interest rates without creating inflation, this will be cheered by markets, but if interest rates stay higher than anticipated and inflation begins to rise again, this would have a negative impact on shares.”

All to play for in other words. Watch out for campaign promises from either side that appear too good to be true – tax cuts, big spending plans and other goodies might appear to benefit one constituency or another, but if the Federal Reserve feels it has to respond with tighter monetary policy, that could undermine any advantages.