We woke up this morning to the news that the President of the USA himself has tested positive for COVID-19. With US markets forecast to open lower today, and much activity going on across the pond the article below asks: What might the US presidential race mean for markets?
Making sense of markets relies foremost on growth and monetary policy – and investors will be watching closely as US voters go to the polls this November. Below we discuss what the possible outcomes of the US election might mean for investors and explain why diversification remains as important as ever.
- The US election is one of many important uncertainties facing global markets over the coming months.
- The most pressing risk for investors is the prospect of no party gaining overall control. We believe this is potentially the most concerning outcome for markets, creating potential for legislative gridlock.
- The US election result poses a wide range of potential outcomes for markets. It is therefore important to have an all-weather portfolio which is diversified enough to navigate the uncertainty in the run-up to November and beyond.
ECONOMIC ACTIVITY IS PICKING UP
In terms of economic growth, the worst-case coronavirus scenarios we all contemplated in March have not come to pass – outside the most vulnerable emerging markets, many of which remain in dire straits.
In fact, most economies in the West and Asia are managing to get to within 5% of ‘normal’ in terms of economic activity. Of course, this still equates to a significant depression by any normal standards. However, note the recovery in leaders such as car sales and housing, and the surge in household savings permitted by income support policies. We could stand on the precipice of a genuine, fiscally-driven, boom (‘austerity’ is so 2010). ‘All we need’ is a vaccine, rolled out widely, before too much more economic damage is done. The first half of next year looks like a plausible timeline for this.
‘FLEXIBLE AVERAGE INFLATION TARGETING’
On monetary policy, markets seem to expect incredibly low interest rates, indeed deeply negative real (inflation-adjusted) interest rates, for at least a decade. They may well be justified in doing so.
First, the US central bank (‘the Fed’) recently announced a new framework dubbed ‘Flexible Average Inflation Targeting’. Simply put, compared to the past, for any given level of inflation they will keep interest rates lower than they previously would have. They will certainly not raise rates pre-emptively to cool an economy that looks to be booming. Second, the glut of government-backed borrowing that has been required to keep current and future growth supported during Covid-19 makes it harder to raise interest rates later. The increased burden would slow the economy down too much for policymakers to accept. Finally, no central bank wants to emerge from this crisis the way the European Central Bank did following the Global Financial Crisis – reacting to a temporary pick-up in inflation with even a slight rise in interest rates, before being forced to backtrack and having egg on their collective faces for years.
This cocktail of higher nominal growth and significantly lower US interest rates – the cost of borrowing for highly-rated companies has fallen by nearly 2% – could, in theory, have dramatic asset market implications, providing that it comes to pass.
THE US ELECTIONS
This is why November’s election will be a focus for markets – and investors. While some are focused on the likelihood of incumbent President Donald Trump winning again, some polling data is fuelling increased speculation of a Democratic ‘clean sweep’, where the Democrats could win both the Presidency (under Joe Biden) and control over the Senate. Whilst it’s unwise to rely on polls, and there is still a way to go before the election in November, this type of clean sweep would potentially leave the Democratic Party free to engage in a large fiscal stimulus, likely with a ‘green tinge’ based on some of the messages around the campaign. Such policies could lead to higher growth, inflation, and government debt, and possibly lead the Federal Reserve to raise interest rates. Some commentators speculate that the Democrats could pursue higher taxes and regulations on US companies and multinationals, in a reverse of the Trump administration’s S&P 500-supportive measures. Of course, the details of any potential policy measures – in the event of a Democratic or Republican win – will not become clear until after the election, but investors will be watching closely as the candidates spell out their priorities over the coming weeks.
While it’s interesting to weigh up the potential policies of respective administrations after November, perhaps the most pressing risk for investors is the prospect of ‘no clean outcome’, with no party gaining overall control. We believe this is potentially the most concerning outcome for markets, creating potential for legislative gridlock. Worse, while corporate taxes would not rise, it could nonetheless likely lead to a large ‘fiscal cliff’ in a year or so. The expiry of temporary income support measures, with limited offset, would lead to the exact opposite of a fiscal boom. Given that non-temporary unemployment continues to rise sharply in the US (despite strong economic growth data, it has not all been good news since March), the US economy could struggle to stomach this outcome.
After a decade of secular appreciation, the US Dollar remains very expensive but is showing signs of weakness. If it enters a secular bear market, as happens every other decade or so, it could supercharge a rotation out of highly-valued US assets. Emerging Asia remains a structural underweight in many investors’ portfolios relative to its economic importance. Crucially, it captures many of the growth and technological trends that have buoyed American asset markets, but without the premium valuations, and without the exposure to the uncertainty of the US election.
Ultimately, the US election is one of many important uncertainties facing global markets over the coming months. Investors have no edge in predicting the outcome, and many have learned tough lessons from recent elections and referenda that speculating based on polling data and news headlines is unwise. Instead, it’s important to weigh up the potential range of outcomes, and position a portfolio accordingly – aiming to balance risks for the longer term, diversifying across asset classes, global regions and sectors to navigate an uncertain environment in the run-up to the election and further into 2021.
Source: Fidelity International 29/09/2020
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