Press Releases | Ravenscroft Group | Kevin Boscher
04 Sep 20
Boscher's Big Picture - What could the US election mean for investors?
In his latest piece, Kevin Boscher, chief investment officer, takes a closer look at the US elections
I have been optimistic on equities over recent months and remain so for reasons previously outlined. However, the potential disruption surrounding the US election in November is certainly a threat to markets and needs to be carefully considered. Whilst former Democratic Vice President Joe Biden is leading the polls and is the betting markets clear favourite, it is too early to call the result and election polls are notoriously unreliable. A lot can change over the next few weeks including voter sentiment, the state of the economy and the path of Covid-19. Given that a Biden victory, together with the Democrats’ regaining control of the Senate, could lead to profound and sweeping changes in economic policy, it is sensible to examine the potential outcomes and try to understand the likely impact on markets.
Defending his title
President Trump has extraordinary support from his base and the vast majority of Republicans love him, no matter what he says or does! However, the Trump base is only 35-40% of American voters and he needs to do well amongst moderates, who have been dissatisfied with his performance during the pandemic. Key demographic factions have turned away from him including young people, environmentalists, college-educated women and minority ethnic groups.
Importantly, however, there are a number of things that Trump could do to try to turn things around. Firstly, voters perceive that he lacks empathy in a year dominated by a pandemic and racial protests, so he would likely gain support if he shows more concern for the suffering and a more conciliatory approach. Secondly, he will aggressively attack Biden and his policies, criticising both his mental acuity, his agenda and family links with both China and Ukraine. Finally, Trump needs to get on top of the virus and make the most of the economic recovery and strong stock market.
Where is Joe?
Joe Biden has so far kept a low profile, leading to speculation that either he is unwell or hiding from the battle. There are even growing rumours that he may not contest the election or will stand down early, paving the way for his running mate Kamala Harris to become America’s first female President. It’s clearly difficult to judge Biden’s mental health, but friends have admitted that he does struggle with a stuttering problem and has had two brain aneurysms. However, supporters point out that there is merit in standing back and observing your opponent self-implode. As the election is now rapidly approaching, Biden will have to become more visible and one of his challenges will be to choose whether to move to the left and embrace the views of Elizabeth Warren and Bernie Sanders, or come across as a moderate centrist. The former strategy could be risky and polarise his support, although Biden does appear to be left leaning in matters such as the environment and higher taxes.
What are the likely outcomes?
There are three likely scenarios moving forward. If Trump wins the election, Republicans retain control of the Senate and Democrats rule the House, then the status quo would prevail. Under this outcome, Trump would continue with his current policies targeted towards market friendly tax cuts, regulatory easing and business on-shoring, although this would be partially offset by growing China bashing and trade concerns.
A second possible result is that Biden wins and helps the Democrats control both houses of Congress. This combination would likely be the least favourable outcome for markets since it would imply sweeping tax increases, tougher regulation for financial, pharmaceutical and technology companies and a huge spending spree on infrastructure and clean energy projects. Again, however, some of these potential negatives would be offset by a less aggressive stance on China and trade. Also, whoever wins will need to focus on ensuring economic recovery whatever the path of the virus and reducing unemployment, thus any anti-business rhetoric or actions may need to be moderated for a year or so.
The third option, which doesn’t get much attention but arguable should, is that Biden is elected but the Republicans retain the Senate. A split government of this sort would potentially be good for markets since investors would benefit from increased fiscal spending, a more predictable trade and China policy and an effective continuations of Trump’s tax policy, although regulatory costs would increase.
Poles apart policies
Looking more closely at the respective policies, there are five key areas on which Trump and Biden differ and which could shape the economic and market outlook for the next few years.
The biggest difference is on taxation and spending. Biden support measures which, if implemented in full, would raise personal and corporate taxes by a material amount in order to fund increased government spending on infrastructure and clean energy. The investment programmes would total approximately 10% of US GDP over a four-year period. By contrast, Trump has expressed support for another round of tax cuts. Whilst these plans differ materially, both would require full control of Congress to push through and the priority for either administration will be economic recovery and accommodative fiscal policy over the next few years.
Biden’s plans to reform public health and protect the current Affordable Care Act would have a modest impact initially but the ultimate goal for the Democrats is to ensure all Americans are insured and a public healthcare option would be expensive, game changing and achieve that goal. Trump, on the other hand, would largely leave the existing system in place although both candidates favour tougher action on drug prices which could help to keep a lid on medical care inflation over the coming years. Trump would continue his deregulatory agenda, but there are few signs, so far, that this has meaningfully benefitted the supply side of the economy. While Biden is seeking a higher minimum wage and tougher environmental regulations, which are a clear negative for some service sectors and energy firms, they are unlikely to have a significant economic impact. In any case, the main factor likely to hold back the economy over the next few years is weak demand.
A Biden victory could dramatically change the trade policy with a less confrontational tone towards China, although he would likely maintain pressure on issues like technology transfer and broader security concerns. Having said that, tensions are likely to keep rising over the long-term as China increasingly rivals the US as the dominant economic, military and technological super power. Finally, both candidates are likely to keep the pressure up on the Fed and push for looser monetary pressure, albeit via different means. Trump will continue to try to promote “doves” to the board and may look to replace Powell as chair in 2022. Biden would probably re-nominate Powell but a Democratic- controlled Senate would pressure the Fed to support their spending and social welfare priorities. A Biden victory in November together with Democrats regaining control of Congress could lead to a significant increase in taxation and government spending, in addition to a shakeup of healthcare, trade and regulatory policy. Whilst this would be expected to have some impact on the US economy over the longer-term, particularly from a sectoral makeup viewpoint, it is unlikely to dramatically change its course over the next couple of years. I expect monetary and fiscal policy to remain exceptionally accommodative whoever occupies the White House and the priorities will be to ensure the economy recovers from the pandemic as soon as possible. Indeed, both candidates are intent on using Keynesian style fiscal and monetary measures to boost long-term growth prospects. It’s true that Biden’s policies, if implemented in full, would likely be more inflationary down the road due to the fact that a sustained public sector investment spree financed by the Fed will eventually result in significantly increased demand. However, the current crisis is a deflationary shock which will last for some time and inflation is unlikely to become an issue whilst the economy has so much spare capacity. In any case, the government and the Fed would welcome higher inflation at some point to boost nominal growth and help reduce the growing debt burden.
The impact on the markets
Stock markets seem unfazed so far by the prospect of a Biden Presidency, despite the fact that his policies appear to be less market friendly. There are probably a number of reasons for this including Trumps’ improving ratings, supportive monetary and fiscal policies, plentiful liquidity, very low interest rates and bond yields and the fact that this is unlikely to change whoever wins the election. Also, the stock market is a weighing machine that considers all expected shifts in economic trends and policy. Although Biden’s proposed tax increases are potentially bad news for stock prices, his infrastructure and clean energy programs should boost domestic demand, thus benefitting some sectors of the market. In addition, the dollar has weakened this year, which is equivalent to monetary easing and will boost exports and corporate profits from overseas markets. The election result will likely have an impact on the longer-term performance of certain sectors and market leadership may change. For example, infrastructure, renewable energy, biotech and managed care stocks should benefit whilst big tech and pharma companies might struggle on the back of tighter regulation. Importantly, however, I expect the stock market direction over the next year or so to be driven largely by a continuation of the same policies that have dominated since March this year, namely extremely favourable monetary and fiscal policies, a post-Covid economic recovery, plentiful liquidity and improving sentiment.
From a bond perspective, the election result is unlikely to have a material impact over the next few years. The background macro environment remains challenging as the global economy struggles to recover from the pandemic-induced shock at the same time as structural growth headwinds (such as demographic trends, low productivity and excess global savings) and disinflationary pressures dominate. This will force the Fed to keep interest rates at current levels (or even lower/negative) for many years to come and we will likely see additional QE and other measures, such as yield curve control or more explicit forward guidance, before this cycle ends. Indeed, the Fed has recently published a similar view. It will be essential that the Fed continues to fund any increased government (and corporate) spending at very low costs and this will necessitate low yields across the curve. Financial repression, whereby investors are forced up the risk curve in the search for yield, is very much intact. It’s true that this policy would become more problematic should inflation start to rise materially above the Fed’s long-term target but this is a long way away and would be a welcome problem for the Fed to address. It is more likely, however, that the dollar will continue to weaken over the next few years given the probable economic trajectory and subsequent policy response. This trend might accelerate in the event of a Democratic clean sweep, which would imply bigger fiscal deficits, but this is by no means clear at this point.
It is sensible for investors to start positioning for a possible change in US leadership in November. But it is important to remember that the election is far from over, Trump could yet make a comeback and many potential outcomes remain open. Also, it is wise to remember that when dealing with politics, the economic and post-election reality is always more complex and unpredictable than the relatively easy canvassing narratives. For example, in 2016, most brokers predicted that the US stock market would perform poorly if Trump implemented his election promises. Whilst policy could look very different in five years, time, depending on who wins and the makeup of Congress, the impact on the economy and financial markets will probably be fairly muted over the short term. Perhaps a bigger risk is that the result could be so close that it takes weeks or even months to determine the outcome, with allegations of electoral fraud and the uncertainty unsettling markets. This would be particularly worrying should civil rest ensue, which is not beyond the realms of possibility. Investors need to watch events carefully over the next few months but should also keep an open mind when assessing the likely election result and subsequent implications of any policy change. Importantly, whilst a threat, this event is unlikely to seriously impair the economic and market recovery that started in March this year.