How will the Iowa caucus impact the Brazilian market?

Every time financial analysts attempt to forecast trends in Brazil, they have one eye looking abroad. As an emerging economy without investment-grade status, Brazil’s future is largely influenced by foreign factors. In 2020, U.S.-Iran tensions and the coronavirus outbreak have already shaken markets and weighed down Brazil’s currency. And now, on the first Monday in February, investors with positions in Brazil should brace themselves for more volatility, as the Iowa caucus kicks off the process to select the U.S. Democratic Party’s candidate to face Donald Trump in the upcoming presidential election.

On the U.S. stock market, the effects of the Democratic Party’s primaries are already being felt. Senator Bernie Sanders—who has promised a single-payer national health insurance system—has gained momentum. FiveThirtyEight’s poll aggregator has Mr. Sanders leading the way. Since Monday, shares of private health insurance operators have plummeted, including Cigna (-2.4 percent), UnitedHealth (-2.31%), and Anthem (-9.12%).

It is only a matter of time until these effects are felt in Brazil, where over 40 percent of the São Paulo stock exchange’s trading volume is operated by foreign investors. 

The U.S. election chessboard

After likely dodging an impeachment process, U.S. President Donald Trump will fight for re-election while banging the drum of the country’s full employment and 2.3-percent GDP growth in 2019. Still, some risks are looming, with the U.S. public deficit set to top USD 1 trillion in the fiscal year of 2020, which would be the biggest such deficit since the Great Depression—the biggest not caused by the Great Depression.

At this stage, the fight for the Democratic nomination is between two candidates: former Vice President Joe Biden in the center, and Senator Bernie Sanders to the left. In the chasing pack, we have former New York City Mayor Michael Bloomberg—who joined the race at the 11th hour—former South Bend Mayor Pete Buttigieg, and left-leaning Senator Elizabeth Warren.

A good performance on February 3 will be key for some of these candidates, with the Joe Biden campaign reportedly relying on a caucus victory to keep fundraising rolling. According to Levante Investimentos’ political analyst Felipe Berenguer, “we shouldn’t have a clear-cut favorite until Super Tuesday,” when 15 states hold their primaries on the same day.

The importance of the Iowa caucus

NPR describes the Iowa caucus as a series of “neighborhood meetings where people get together and—out in the open, with no secret ballot—try to win over their friends, family, and neighbors to support their preferred candidate.” It is a complicated process with a voter base that is overwhelmingly white and not that representative of the U.S. overall polls.

Still, it is “terribly important [for the outcome of the primaries, as it is] the candidates’ first test in the nation,” as former presidential candidate George McGovern described it.

So far, the Iowa race is incredibly unpredictable. As statistical analyst Nate Silver wrote, “primaries are much harder to poll than general elections, and caucuses are even harder to poll than primaries.”

---

---

Effects on the market

Despite traditional volatility, historical data from 1956 to 2016 compiled by Trefis shows that S&P500 has generated positive returns in 87.5 percent of election years. A possible explanation is the market’s appreciation for certainty: a 2016 report by Guggenheim Investments shows that both large and small caps performances’ pick up after the elections, judging by the performances of S&P500 and Russel’s 2000 indexes in election years since 1988. 

Partisan differences also tend to interfere in market performance. By analyzing data from 1880 to 2004, the study “Partisan Impacts on the Economy: Evidence from Prediction Markets and Close Elections” discovered that “electing a Republican president raises equity valuations by 2-3 percent, and that since Ronald Reagan, Republican presidents tend to raise bond yields.” Also according to Trefis data, “the average index return in the year leading to a change in the party in the presidency is low at 5.2 percent.” 

While the data suggests markets could be more comfortable with a Donald Trump re-election, a Lazard Asset Management report points out that there are risks on both sides. 

“If a candidate who is more pro-trade than the sitting president is elected, it could mean an improvement in global business sentiment, the unleashing of dormant corporate capital, and a pickup in manufacturing activity,” analysts wrote. “However, many left-leaning Democrats, including Senator Elizabeth Warren, are just as skeptical as President Trump about the benefits of trade. If Mr. Trump were unseated by one of these individuals, we believe the corporate spending limbo would likely continue into 2021 and perhaps beyond.”

They add that the pro-growth policies proposed by each candidate “will likely have ramifications for emerging markets equities”, such as Brazil’s. They do stress, however, the major role represented by local measures, such as administrative and tax reform, to boost the local market. 

Possible scenarios after Iowa

An eventual clash between Donald Trump and Bernie Sanders is seen as the riskiest outcome for markets. “It may stress investors as Mr. Sanders is more radical in economic terms than Mr. Biden. And President Trump may adopt a more radical stance to fend-off a more radical opponent. This may put pressure on the S&P500,” explains Mr. Berenguer, adding that it could have a knock-on effect for Brazilian markets.

While the proudly socialist Mr. Sanders was once panned by Wall Street as having “crazy” ideas to tax big fortunes and scrap student loan debts, Mr. Biden is considered by the markets as a more even-keel candidate. He has focused on infrastructure investments and has less comprehensive plans for education, such as two tuition fee-free years of community college, instead of fully public higher education.

Stock market trader Gabriel Rech believes the market will adjust the equities’ risk premium according to each scenario, so any candidate’s victory will be priced by the time of the election. “Variables are neutral for a Trump-Biden election, positive for Trump-Bloomberg—and negative for an election featuring either Ms. Warren or Mr. Sanders. I believe the markets will be positioned for each one of these disputes”.[/restricted]