As political tensions and uncertainties rise during election cycles, investors face the challenge of navigating volatile and unpredictable financial markets. In light of the upcoming 2024 U.S. presidential election, UBS Global Research flags the critical importance of portfolio diversification as a strategy to mitigate risks and safeguard investments.
The approaching U.S. election presents a variety of potential outcomes, each with significant implications for financial markets. A key development in the race is the shift in the Democratic ticket, with Vice President Kamala Harris stepping in as the presidential candidate in place of President Joe Biden. This change has altered the dynamics of the race, leading UBS to reassess the likely scenarios and their potential market impacts.
UBS analysts now assign a 15% probability to a "Blue sweep," where Democrats would gain control of both the presidency and Congress. This scenario is viewed with caution, as it could lead to higher corporate taxes and increased regulatory scrutiny, both of which are seen as negative for equity markets.
On the other hand, the probability of a "Red sweep," where Republicans control both the executive and legislative branches, has been set at 35%, which might bring different economic policies and market reactions.
“We continue to advocate for portfolio diversification to dampen bouts of volatility, to broaden sources of return, and to help investors avoid behavioral bias into key risk events,” the analysts said.
“We expect the S&P 500 will rally toward 5,900 by December 2024, with strong earnings growth near 11% this year and 8% in 2025,” they added.
First, diversification mitigates the impact of market volatility. Election periods are notorious for causing fluctuations in financial markets, driven by the unpredictability of political outcomes. By spreading investments across various asset classes and sectors, investors can reduce their exposure to any single market segment's adverse movements.
Second, a diversified portfolio provides multiple sources of return, which is especially crucial when certain sectors may be more vulnerable to election outcomes. For instance, under a Harris administration, sectors focused on renewables and energy efficiency might thrive, while traditional energy sectors could face challenges.
Conversely, under a Trump-led government, these dynamics might reverse, highlighting the importance of not relying too heavily on any one sector.
Finally, diversification helps investors avoid the pitfalls of behavioral bias. During election seasons, there is a tendency for investors to react impulsively to short-term news, making hasty decisions that can derail long-term investment goals.
A diversified portfolio encourages a balanced approach, ensuring that investment strategies remain aligned with broader financial objectives despite the noise of election-related developments.
While maintaining a core position in equities, investors should consider allocating funds to sectors that are less sensitive to election outcomes. Sectors such as industrials, materials, and utilities, particularly those focused on renewable energy, could offer greater stability.
In contrast, sectors like financial services and fossil fuels might encounter headwinds depending on the election result.
Incorporating alternative investments such as hedge funds and private equity can provide diversification benefits due to their low correlation with traditional asset classes.
Hedge funds, with their flexible strategies, are particularly well-suited to navigating volatile markets, while private equity offers exposure to growth opportunities in smaller companies, which tend to exhibit less price volatility.
UBS continues to view gold favorably as a safe haven, especially in the context of geopolitical tensions and potential shifts in fiscal policy. Commodities in general are also recommended as a hedge against inflationary pressures that could arise from election-driven fiscal policies.
To mitigate the risks associated with U.S. election-related market turbulence, UBS advises considering international exposure. Reducing overexposure to U.S.-centric sectors, currencies, and regions can help balance the portfolio against the uncertainties specific to the U.S. political environment.