06 Oct Guest Commentary, Gord Glagau: Elections and Markets…..Oh Canada, where art thou? (Sept 22 2020)
Elections and the Markets
One of the biggest enemies of growth for equity markets is uncertainty. We saw the dramatic collapse of equity prices in March of this year, coinciding with the early stages of the COVID-19 pandemic. At the time, it was a fairly unknown virus with a substantially higher mortality rate than the normal flu. As horror stories started coming in from China, then Italy, Spain, the UK and the US, governments around the world reacted with a broad-based lockdown. Further uncertainty was added by speculation as to how it was transmitted and the additional nasty and seemingly lingering effects on the human body. Hope, like light at the end of a dark tunnel, returned to investors with talk of a quick-to-market vaccine that could provide immunity and a return to a normal way of life. Removing this overhang of uncertainty fueled the markets to all-time highs despite the limited recovery in the underlying economy.
Economic historians, with the benefit of hindsight, will have much to say about 2020. Was the response to the pandemic adequate? Should there have been even more fiscal and monetary supports? Was protection provided to the most vulnerable in society: the poor, elderly and marginalized/minority communities? While we might not get a clear answer on these questions, general elections do tend to provide insight into how the electorate feels, even if the national mood is volatile and hard to predict.
As with any election, pollsters are busy trying to read this national mood. And, despite numerous opinion polls in the lead-up to an election, there can still be surprises. Case in point: in the 2016 US election, Democratic candidate Hillary Clinton was leading in nearly every national pre-election poll. And we all know how that ended up. It was billed as one of the greatest political upsets of modern US history. While Clinton won the popular vote by almost 3 million votes, Donald Trump defeated her by a wide margin in the Electoral College, becoming the US president. The initial reaction to this upset saw the Japanese Nikkei 225 down 5%, the Mexican peso down over 11%, the over-night US equity futures down 5%, and, in a flight to safety, gold surged 3%.
So, what is certain is that there will be a US election in the next few weeks. US Bank Wealth Management just published an interesting analysis of the relationship between elections and the markets going back 90 years. Their conclusion was that uncertainty causes equity markets to underperform in both the year before and the year after an election with an even larger underperformance if there is a new president. Interestingly, the bond market mirrors the stock market in the year leading up to the election, but outperforms in the year following.
Sectors within the US stock market see varying levels of performance as well. Often times, pharmaceutical companies become targets of campaign rhetoric, along with defense contractors, energy companies and those reliant on international trade. But the sell-off in these sectors usually presents an excellent buying opportunity for the longer-term investor.
For the Canadian investor, there is an additional level of uncertainty surrounding a minority government. With the commencement of Parliament in the next few days, the current government’s priorities may not receive the backing of all opposition parties which will trigger an election. Investors will be closely watching the government’s proposals for handling the pandemic, what happens to the budget deficit, and industrial and trade policy in a pivot to a “greener” economy (mostly affecting the energy industry).
But what is certain is that over the past five years, a Canadian investor would have been far better off in the US. The underperformance of financials and energy stocks has led the TSX Composite only 21% higher over five years against the S&P 500’s increase of 72% over the same period! This underperformance of the Canadian equity markets has come from both Canadians and foreigners selling Canadian stocks. In the absence of a convincing reason to change this behavior, Canadian equity investors should continue to follow the herd and invest outside of Canada.