Does the change at the top of the Democratic ticket bring new policy impacts and potential market effects? Though no one could have expected the events of the last month, for the moment, Morgan Stanley Research thinks the answer is no.
To recap: On June 27, President Joe Biden’s weak debate performance led the Democrats to call for change at the top of the ticket. Two weeks later there was an attempt on former President Trump’s life, followed by the Republican convention where Trump chose Ohio Sen. JD Vance as his running mate. Then, on July 21, the world watched a sitting U.S. president announce that he would not run for a second term. Biden endorsed Vice President Kamala Harris, who soon secured the party convention delegates she needed to become the presumptive nominee and rallied the Democratic Party behind her.
Despite this political surprise, our advice is to ignore the noise and stick with the playbook. Here’s what we think investors should keep in mind.
It’s a Close Race Again
In the days since President Biden stepped off the ticket, polls show the race has pulled tighter than the previous month, when Trump opened up a post-debate lead. Harris enjoyed an immediate jump in national polling relative to Biden and is either slightly behind or ahead of Trump. Polls in key swing states similarly show Harris in a competitive position.
Harris’s early strength, relative to Biden, also makes possible a range of possible outcomes in the Senate and House of Representative elections. Accordingly, prediction markets have largely reset to where they were before the June 27 debate. Prediction markets currently indicate the probability that former President Trump will win has reverted to 60% from a high of nearly 75%, while the probability of a Republican sweep of the White House, Senate and House of Representatives is down to about 35% from a high of over 50%.
Policy Continuity
The Democratic ticket has changed, but the potential policy impact of a Democratic win hasn’t: The vice president appears to overlap with Biden on the key issues that matter to markets.
During her 2020 primary campaign, Harris’s positions on healthcare and tax policy were closer to Biden’s than those of most of the other contenders. Whether or not Congress passes her policies into law depends on who controls the House of Representatives and the Senate, and by what margin.
On matters under the White House’s control, such as tariff policy, there is little reason to think Harris’s positions would differ from Biden’s in a way that’s meaningful to markets.
The event of a Harris victory in November therefore could bring continuity on the policy front. Clean energy could fare better because Democrats would protect renewable energy spending under the Inflation Reduction Act. Meanwhile energy and telecom could be pressured under the Democrats’ plan to extend expiring tax breaks for lower-income individuals.
Look to the Business Cycle, Not the Election Cycle
With uncertainty about the outcome and the lack of a historical pattern for market behavior in the run-up to voting, investors should stick to the cross-asset strategy Morgan Stanley Research outlined at the end of May. In equities, we recommend going long on European and Japanese equities, and in fixed income, holding an overweight position in corporate credit and agency mortgage-backed securities.
While markets have been focused on the rising odds of a Trump win, the state of the business cycle—that is, whether the economy is growing and how fast—will ultimately be more important for equities than who is in the White House.
For example, Morgan Stanley’s U.S. equity strategy team notes that the recent outperformance of small-cap stocks, premised on the idea that a Republican victory would bring aggressive tax cuts, doesn’t jibe with current economic cycle pressures of slowing growth with falling inflation, and may not last.
The consensus view in the event of a Trump victory is that higher tariffs, less immigration and, in a Republican sweep, aggressive tax cuts could bring higher deficits and inflation, with a downside risk for growth—and for small-cap equities.
None of this means the election won’t affect the markets—far from it. History tells us the policies set in motion will matter a lot across markets. Sectors that could benefit in a Republican sweep include industrials, telecom and defense. A Democratic victory, meanwhile, points to macroeconomic and policy continuity: slower nominal growth and falling inflation and rates.
In particular, we’re eyeing impacts for Treasuries, the U.S. dollar and key corporate sectors that may be more sensitive to policy changes. For now, investors should keep in mind that fluctuations in election news don’t appear to reveal any new outcomes that could impact markets.
