US election 2020: of mountains and molehills?

Contested election

A contested election is more likely for three reasons

1. Early voting has in recent years showed signs of leaning Democratic (the so-called “blue shift”) and mail-in ballots take longer to count due to the need to verify signatures and open envelopes. The pandemic has accelerated the rise in early voting, and led to a disparity in voting by party affiliation. This could lead to election results being dominated by Republicans on the night, then gradually turn Democratic in the days and weeks ahead, creating a window for the election to be disputed.
   
   
   • 52% of Americans plan to vote early (33% by mail; 19% in person). This matters because it implies a sharp rise from the last election, when 57 million voted early, around 40% of voters
   • Early, absentee, and mail-in ballots will skew Democratic this year. 54% of Republican leaners say they will vote on the day, while 71% of Democrats plan to vote early
   • Mail-in ballots take longer to count due to the need to verify signatures and open envelopes
   • Crucially, polls have shown a partisan divide in perceptions over the danger of coronavirus
   • Significant recent delays in the postal service amid concerns of political interference add to concerns
2. The president is unwilling to commit to abiding by the results of the election. He continues to allege that early voting is fraud-prone, laying the ground for a challenge
3. On the Democratic side, there have also been noises about not conceding. Hillary Clinton has said Biden should “not concede under any circumstances.” There is an increasing delegitimation of the Electoral College on the Democrats side, as the Democrats have lost only one popular vote in 28 years.

What should we expect?

In the 1920s Keynes and Knight noted the difference between risk and uncertainty. Risk is when there is a scientific basis to form probability distributions; it is resolvable. Uncertainty is what cannot be resolved. Contested elections are uncertainty.

The election is going to be chaotic. Both sides have defined this election as existential. Each thinks the other side is planning to cheat. Mailed ballots are not going to be counted for days. There is a well known imbalance between the Electoral College votes and the popular vote. Federal laws and the Constitution are vague on crucial matters. Trump is fighting for immunity from future prosecution. The election is happening in the middle of a pandemic that has left 200,000 Americans dead and amidst the starkest racial tensions for decades, not to mention wild conspiracy theories.

If there is a contested election scenario, we should expect:

• An election potentially lasting from November 3 to Jan 20. Go to sleep on “election night.”
• Mass protests. A contested election would likely be decided politically, not legally
• The Democrats may push for electoral reform in the event of a contested election
• What will Russia and China do amidst nearly three months of chaos?

Ultimately, this is still a tail risk case. The US has a long history of democratic continuity, and inertia counts for a lot.

What does this mean for investors?

During the Bush-Gore contest in 2000, US equities dropped 7% from their pre-election level, but never recovered given that the US entered a recession in late 2000/ early 2001. US IG and HY spreads widened 20bp and 100bp, respectively, in November, though it is difficult to distinguish the recession influence from the political one. The trade-weighted dollar was firm given high US yields at that time, but gold decoupled from FX markets and firmed during this period of heightened political risk.

The cyclical setup today has parallels given the expected recession and the tech euphoria. But a contested election in 2020 would be more chaotic.

Some of this is in the price. Nevertheless, it is unlikely that the market has fully priced in the vast uncertainty stemming from a contested election scenario.  A move towards traditional FX safe havens and away from US risk assets would be the main ways to express this view.

The risk case to the risk case if Trump is defeated

What if Trump decides not to  leave?

It is within the realm of possibility. It’s not the first precedent Trump has broken, and he himself has floated it, as have his supporters. His former lawyer Michael Cohen suggested it could happen. Nixon thought about it.

Still, it is pretty unlikely. The 20th Amendment of the Constitution says that “the terms of the President and Vice President shall end at noon on the 20th day of January.” On the dot of noon Jan 20, 2021, Trump loses control of the nuclear codes (technically, an officer with a book of launch codes).

The entire US military will salute President Biden in the inauguration—there is no real evidence of military dissatisfaction with the Democrats so far—quite the opposite. The secret service will abandon Trump and Biden’s acting attorney general will have arrest warrants drawn up for Trump and anyone who remains at his side. If militiamen block this, tanks will be rolled down Pennsylvania Avenue.

Bottom line: this is a highly risky strategy for Trump to take, and it is likely that he will fail if he tries.