“Will you shut up, man”

It was a week of surprises. Yet somehow, it was not entirely unexpected.

On Wednesday, we were treated to a messy, rancorous, and unruly US presidential debate. Substance was utterly lacking, as the event devolved into a competition of who could dish out the most scathing one-line zingers as opposed to a spirited discussion of important policy issues. Even if there were any brief discussion of policies, one could not hear it under the din of President Trump’s relentless interruptions and attacks. “Will you shut up, man?” said an exasperated Joe Biden to Donald Trump, unintentionally putting into words what many tired observers were already probably thinking.

For those who watched the 2016 presidential debates between Hillary Clinton and Donald Trump, this was not at all surprising. In fact, it might have been foolish to expect President Trump to participate in a healthy argument about policy. Name-calling, yes. Debate, no.

Perhaps, the biggest surprise of the debate was the fact that President Trump stated that he may not accept the result of the election on the basis that mailed ballots are potentially fraudulent despite all the evidence to the contrary, increasing the tail risk of a contested election. This would be an issue in the event of a close race, won on razor thin margins in swing states. This would then trigger the process of recounts and spark a flood of messy legal challenges. This would be less of an issue in the event of a clear and decisive win for Joe Biden, which is yet uncertain.

Performance-wise, Joe Biden was judged to have fared better in the debates, having made real attempts at speaking substantively about policies and current issues, difficult as it was. He also took the opportunity to speak directly into the camera, highlighting the bullet points of his policy proposals, making the case for voters to choose him instead of Donald Trump. Yet, amid a reality show election, this may matter less to a hardened electorate.

More importantly, against his challenger’s relentless and seemingly unhinged interruptions and bitter personal attacks, Mr Biden came off looking better, which could sway undecided voters to his camp.

Covid-19 diagnosis

In an unexpected and seemingly cruel twist of fate, just a couple of days after President Trump mocked Joe Biden’s mask-wearing on the debate stage, he and First Lady Melania Trump were reported to have tested positive for Covid-19. This was after Bloomberg News broke the story that President Trump’s close aide, Hope Hicks, had tested positive for the coronavirus.

The story sparked concerns if the virus had spread among the President’s inner circle considering they had attended various fund raisers and political rallies without observing the same public health precautions that President Trump had earlier derided Joe Biden for.

Former presidential advisor Kellyanne Conway, former New Jersey governor Chris Christie, President Trump’s campaign manager Bill Stepien, Senator Mike Lee of Utah, Senator Thom Tillis of North Carolina and several others who were in President Trump’s orbit over the past week had tested positive for Covid-19. There were concerns that Joe Biden might have contracted the virus following the debate, but those concerns quickly receded after the Biden campaign announced that the former Vice President and his wife had tested negative for Covid-19. Vice President Mike Pence and his wife had also tested negative for the virus, which allayed concerns about a potential leadership vacuum in the event both leaders of the executive branch are unwell to lead.

As it stands, President Trump has been discharged from the hospital and will continue his treatment in the White House. He had issued a video statement over the weekend to clarify that he was making good progress and recovering well amid mixed messages by his physician and Chief of Staff.

Given the President’s old age and pre-existing medical conditions, concerns about his health and well-being are certainly not trivial or frivolous by any means. The good news perhaps, is that treatment for the virus has improved markedly since the pandemic began and as a result mortality rates have improved. Also, as president, Donald Trump clearly has access to the best medical care available.

Spooked

The first presidential debate and President Trump’s Covid-19 diagnosis were met with sharp and immediate risk-off reaction in the markets. The S&P 500 futures sank on both occasions while traditional safe haven assets like the Japanese Yen and gold appreciated sharply. October futures for the CBOE Volatility Index (VIX) spiked as well after these two events, before easing lower.

Interestingly, betting odds of a Biden victory and Democratic control of both chambers of Congress in November spiked late last week, after the first US presidential debate and news of President Trump’s Covid-19 diagnosis. This suggests prediction or betting markets are pricing in better odds of a Democratic sweep this election cycle.

In a sense, both observations might be linked.

President Trump’s debate performance and coronavirus diagnosis may have hurt his campaign, hence improving Biden’s election chances.

In terms of the debate, his belligerent performance could potentially turn away would-be voters who would otherwise have been sympathetic to his core message. His refusal to denounce white supremacist groups could also jeopardise support among minority voters. But these are fleeting concerns that could easily be addressed by a change in rhetoric.

The coronavirus diagnosis, however, poses a real problem for his campaign and injects even more uncertainty. For one, President Trump will be unable to conduct his rallies and other in-person events during his quarantine and in-treatment period, which might dampen enthusiasm among his base during a crucial period before the election. His campaign has cancelled numerous rallies and events and are scrambling to shift activities online. While President Trump’s campaign surrogates can continue to drum up support in-person or through digital media as he recovers, it may not be as effective as having the man himself sell the message.

In addition, the diagnosis creates an optics problem for the campaign, in that it focusses attention squarely on President Trump’s problematic track record in managing the pandemic. President Trump has been known to publicly downplay the threat of the virus and was among the vocal few calling for states to quickly lift restrictions and reopen their economies. He conducted rallies in enclosed spaces and his campaign did not enforce mask-wearing or safe distancing measures during these packed events, jeopardising public safety. President Trump’s diagnosis has also occurred at a time when new coronavirus cases are trending higher in the US, drawing even more attention to his administration’s ineffective handling of the health crisis.

As it stands, the coronavirus is a losing issue for Donald Trump with polls showing an overall negative opinion of his handling of the pandemic.

Untroubled by such problems, Joe Biden’s seemingly prudent campaign looks more promising in comparison. What hurts President Trump’s campaign will necessarily benefit Joe Biden in this two-way contest. Hence, it is unsurprising that betting markets are pricing in better odds of a Democratic victory.

Betting markets aside, the Real Clear Politics general election polling average for both candidates have remained relatively stable over the past few weeks. Joe Biden continues to enjoy a 6 to 8-point lead against Donald Trump and this has not changed materially over the course of last week. In fact, issues with the Trump campaign would only cement Biden’s lead in the polls as the election nears and could point to a decisive win for Joe Biden, which would further reduce the tail-risk of a contested result and increase the probability of a democratic sweep.

On the surface, this might not be good news for the market given that a Democratic sweep of government portends significant policy changes ahead, including an increase in corporate taxes and a strong regulatory agenda, both of which could prove to be a formidable headwind for US equities. This could explain the risk-off position in markets.

Heightened risk of a contested election, prolonged election uncertainty and concerns about institutional stability amid the risk of key leaders in government contracting the virus may have also sparked a risk-off posture.

Looking forward

At this stage, much of this is just political speculation. It is just as likely that support for Donald Trump could increase following his Covid-19 diagnosis, much like the uptick in public support for UK Prime Minister Boris Johnson after he was hospitalised with complications from Covid-19 in April. Public sympathy for President Trump’s health predicament could narrow Biden’s lead and improve President Trump’s chances at the polls. A close race would heighten the risk of a contested election and prolong election uncertainty.

As it stands, much is still uncertain, and conditions remain very fluid.

Americans have begun voting early, in numbers dwarfing previous election cycles, and mail-in ballots are expected to account for about 40% of the total volume of ballots this year, far surpassing the share of previous elections. Things can change quickly and dramatically with less than thirty days before the election, but whether it meaningfully shifts the results given the high volume of early voting will only be clear after the election.

It is never wise to make directional bets on something as inherently uncertain and fluid as elections. Instead, investors are better off positioning their portfolios to guard against a period of higher than average market volatility ahead, be it through incorporating hedges or ensuring that portfolios are well-diversified across asset classes and regional exposure.

Indeed, it is a time for caution, but certainly not panic. Ultimately, we remain constructive on the long-term outlook for risk assets on the back of improving fundamentals, including a global economy that is gradually recovering, albeit at a slowing pace, and a policy environment that remains supportive and conducive for growth. In the US, we will likely see an expansionary fiscal agenda by the next administration, whether or not Trump or Biden wins. Politics is hardly a long-term driver for markets. It creates noise in the near-term and injects volatility into markets, but then, this too shall soon pass.

Given these dynamics, we would seek to add risk opportunistically if prices become sufficiently attractive.