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On the attack: Donald Trump and Kamala Harris. Picture: Reuters/Jonathan Drake, Kevin Lamarque
On the attack: Donald Trump and Kamala Harris. Picture: Reuters/Jonathan Drake, Kevin Lamarque

As the 2024 US presidential election approaches, investors are bracing for political uncertainty and its effects on global markets. Political events have long been key drivers of market volatility, with elections in major economies such as the US having the potential to unsettle investors worldwide.

The US, as the world’s largest economy, has an outsized influence on global financial markets. Shifts in political leadership can lead to significant changes in areas such as trade policy, regulation and fiscal stimulus. These policy shifts often cause investors to re-evaluate risk, sending shock waves through equity, currency and bond markets.

In the 2016 election, Donald Trump’s surprise victory led to widespread volatility as investors feared for global trade, particularly with China. Emerging markets, which are especially sensitive to US policy changes, saw capital outflows as investors moved into safe-haven assets such as gold and US treasuries. Despite the initial sell-off, markets rallied after Trump’s first speech, demonstrating the difficulty in predicting market reactions even when political outcomes are clear.

Fast-forward to 2024, and many of the same uncertainties persist. The race is tight, with key swing states holding the balance of power. However, despite rising volatility, market indicators suggest investors may not be fully pricing in the risks of a contested or uncertain election result. This complacency could leave portfolios vulnerable to sudden shocks.

If past elections have taught us anything, it is that accurately predicting market reactions is far more challenging than predicting election outcomes. Investors often get caught up in the headlines and fail to consider how much uncertainty is already priced into the market. Rather than trying to forecast election results or market reactions, a systematic, data-driven approach can provide much-needed clarity.

For instance, in 2020, the Cboe volatility index — a highly regarded measure of market volatility — spiked in the lead-up to the US election. This reflected investors’ fears about prolonged uncertainty. As results were contested, markets remained volatile, and safe-haven assets such as gold and the yen outperformed. Yet today, we find that implied volatility is lower than historical averages, suggesting markets may be underpricing the risk of political uncertainty in the coming months.

By analysing key metrics such as implied volatility, volatility skews and term structures, we can assess how much risk is priced into different asset classes. This systematic approach allows us to see past the headlines and focus on underlying market dynamics, ensuring that we position portfolios appropriately without succumbing to the noise of election-related media coverage.

Diversification is often referred to as the only ‘free lunch’ in investing, and this remains true in times of political turbulence

Learning from the past

History offers valuable lessons about the impact of elections on financial markets. The 2000 US election between George W Bush and Al Gore is a prime example. The contested result and subsequent recount left markets in limbo for weeks, resulting in heightened volatility. During this time, defensive assets such as US treasuries and gold outperformed as investors sought safety.

In 2020, a similarly contested election prolonged uncertainty and, once again, investors turned to safe-haven assets. Despite the extended volatility, diversified portfolios that included these defensive positions were better able to weather the storm.

One of the most effective ways to mitigate political risk is through diversification. Elections often have a broader economic impact, influencing areas such as consumer confidence, corporate investment and business sentiment. Prolonged uncertainty can delay corporate spending and dampen consumer activity which can, in turn, affect earnings and market performance.

A diversified portfolio that includes defensive assets such as US treasuries, gold and stable currencies such as the yen can help cushion against downside risks. These assets have consistently provided protection during periods of political uncertainty, and their inclusion in a broader portfolio allows investors to manage volatility while still maintaining exposure to growth opportunities.

Diversification is often referred to as the only “free lunch” in investing, and this remains true in times of political turbulence. By spreading risk across asset classes and geographies, investors can ensure that they are well positioned to withstand market shocks, regardless of political outcomes.

In an era of heightened political uncertainty, the value of a systematic, data-driven investment process cannot be overstated. Political developments can stir up emotional responses that lead to poor investment decisions. By focusing on empirical data, investors can avoid the biases and knee-jerk reactions that often accompany volatile periods such as election cycles. By eliminating emotion and staying disciplined, investors can navigate even the most turbulent political periods with confidence.

Teichgreeber is chief investment officer of Prescient Investment Management

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