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Watchers of American politics know that the election cycle there never really ends.

Even in the weeks after an election result, attention quickly turns to who the party out of power will choose to challenge in four years’ time. Mid-term elections come after two years of the four-year Presidential election cycle and the lengthy process of selecting a challenger candidate begins about the same time. Comprehensive polling means the next race for the White House is ever-present in news headlines.

But the year before a November election sees the race take on new intensity and campaigning ahead of the 2020 vote is now very much underway. Now is when election messages are finalised and we can see the shape of the choices facing US voters. It is the time, too, when investors the world over begin to weigh the competing outcomes and assess their likely impact on the markets.

What can history tell us, if anything, about how markets will behave this time round? And what specifically should investors be monitoring as President Donald Trump matches up against Joe Biden?

Lessons from history?

For an industry which prides itself on rational decision-making, the world of investment indulges in rather a lot of superstition about how markets behave. One such superstition is that market peaks and troughs correlate to the Presidential cycle.

The crude logic goes like this: markets rise in two years running up to a Presidential election as the incumbent adheres to the adage that “it’s the economy, stupid” and takes action to encourage strong growth as voters go to the polls. The first years of a Presidential term, conversely, are when decisions tend to be taken - tax rises, for example - that might be negative for markets.

Superstition or not, academic studies of this Presidential cycle theory show a surprisingly strong level of correlation between elections and market peaks. A 2004 paper by Marshall Nickles for Pepperdine University examined market peaks and troughs going back to the Second World War, when theories of the economic cycle began to take hold that meant the actions of Government more directly affected the economy.

His work shows that in the 16 Presidential terms going back to 1942, stock markets hit a bottom in the second year of the term on 12 occasions. They hit a bottom in the first year on three occasions and in the third year just one. There were no years when the bottom came in the fourth year of a Presidential term.

In other words, gains in this period have been highly-concentrated in the second half of a President’s term, with losses concentrated in the first.

The theory has, however, come unstuck since then. The second half of the second term under George W. Bush included the credit crunch and global financial crisis, leading to big losses. Then, in each of Barack Obama's terms in office, the first two years were more profitable than the third, and for Trump the first year was more profitable than the second with very strong gains in the third year and now losses in the fourth year thanks to Covid-19.

It seems then that, like many other stock market superstitions, the Presidential cycle theory holds up until atypical events - like the financial crisis or a global pandemic - intervene.

2020: the economic battleground

The pandemic and the recession that follows it make predictions in 2020 even more difficult. It appears unlikely that Trump will be able to point to a thriving economy when the polls open, but that doesn’t mean we won’t be seeing some signs of recovery by November and the President will be eager to claim credit for any bounce-back.

Markets have had a love-hate relationship with the Trump Presidency. They initially rallied on the back of his deep tax cuts for corporates and stand to benefit if the President can force more accommodative policy from the Federal Reserve. But Trump’s bellicose approach to global trade has also knocked markets. Business wants and needs relations between the US and China to be stable but the President’s brinkmanship has meant periodic crises of confidence. A rough-and-tumble campaign in which China is cast as the bogeyman is unlikely to make trade discussions any easier should Trump be re-elected.

For Joe Biden’s part, much will depend on how markets view his approach to business. Unlike other potential Democratic candidates Biden is not regarded as radical, yet he is under pressure to assuage the left of his party which is desperate for more distributive policies on tax. A question remains over whether he would reverse those juicy tax cuts that Trump made in 2017.

Whoever wins in 2020 will have a huge task in rebuilding the US economy and tackling likely high levels of unemployment. This means the make-up of the other branches of Government beyond the Presidency are also very important to market sentiment. An election in which Biden beats Trump but Republicans retain control over the Senate could lead to huge rows over debt levels and how much largesse the new President could use to ease the squeeze on American households.

Investing around an election

The numerous possible permutations of the US election make betting on one result (and the market’s interpretation of it) a high-risk game. The only thing that can be said with any certainty is that, whatever the course of the campaign and the result, volatility seems likely to continue.

One way to hedge against volatile markets is by investing for dividends, where regular shareholder pay-outs provide consistent upwards pressure on total returns and give you some insulation against wild share price movement. The JPM US Equity Income Fund is managed by Clare Hart and features on our Select 50 list of favourite funds. There are three pillars to the fund’s investment approach: quality, value, and a dividend yield of 2% or more.

Hart aims to minimise the fund’s volatility by buying quality companies which represent good value and pay strong dividends.

For those more bullish about the US’ ability to bounce-back - whoever is the President - the Schroder US Mid Cap Fund, managed by Jenny Jones, gives access to investment ideas in the mid-cap segment of the market where shares are more frequently mispriced and where undervalued stocks have a chance of putting on a serious spurt in growth if the economy picks up.

More on the Select 50

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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