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The upcoming US election (probably the most polarised in recent US political history) is the event foremost in investors’ minds this month. They are trying to form a view based not only on macroeconomic data but also on the new president’s likely policy actions. Until last week, conventional wisdom at least informed who that president would be: most had little doubt Hillary Clinton was heading for victory while the Republicans were likely to retain a majority in the House of Representatives. Now, after the FBI announced it was reviewing new emails that could be related to its investigation into Clinton’s use of a private email server, the presidential race has taken an unexpected twist. Indeed, the current situation in the US brings to mind Great Britain during the last days before the Brexit vote, when most investors, pollsters, bookmakers and media alike regarded Brexit as an undesirable but unlikely scenario. The likelihood of a Remain victory was widely predicted to be around 75%. In the end, as a Black Swan was revealed, the pundits were caught off-guard.
There are investment opportunities in the post-US election landscape.
We believe there are lessons to be learnt from contrasting the Brexit referendum and the US election and – most importantly- that there are potential investment opportunities in the post-US election landscape.
In contrast to Britain in the run-up to the Brexit vote, we give Trump a far higher than 25% chance of winning the White House. Four factors in particular point to a Trump win: 1) voter turnout, 2) the populist vote, 3) the impact of mainstream media’s support of Clinton, and 4) a variety of prediction models.
The first is by far the most important factor. If the public is largely disenchanted by the campaign – and it has good reason to be – then voter turnout is going to be low. This plays to Trump’s hand: lowering turnout among African-Americans, Latinos, millennials and women – all of whom are more likely to vote for Clinton. Whether these groups remain devoted and enthusiastic about her candidacy, or are disgusted by the low level of political debate and the lack of focus from both campaigns on the key issues, remains to be seen. Clinton’s supporters overwhelmingly overlap with Obama’s, but there are important distinctions. Clinton is dependent on high enthusiasm and support among Latino and Asian voters, who appear very motivated to oppose Trump, but she enjoys less enthusiasm from African-Americans and millennials, who could well support her but may not turn out at the same rates as they did in 2008 or 2012. According to early voting data, more than 22.5 million Americans have already cast ballots and clear patterns are emerging: enthusiasm is up from 2012 among Latinos and liberal whites, and down among African-Americans.
The second factor, the populist touch, could yet prove Trump’s masterstroke. He knows that his supporters are going to turn out, because – quite simply – they are angry and they are not going to miss the opportunity to make that known. Trump’s traditional base is in rural and suburban areas rooted in conservative and patriotic values. However, there is a growing segment of non-urban, blue collar and very angry Americans that follows the sirens of populism ready to strike the establishment at its core. The similarities with Brexit are evident.
The bulk of the mainstream media’s support for Clinton is the third factor in Trump’s favour. It may sound counterintuitive but every time the media (which, large sections of the electorate regard as a mouthpiece for the very establishment they reject so passionately) voices support for Clinton, it feeds the populist vote for Trump. Consider, for example, the many polls that have shown a gain or even a lead for Trump – most have not been side-stepped until recently by the mainstream media.
Finally, there are a series of predictive models that investors should consider. We’ve presented some of these below because they provide a quantitative aspect to predicting the election’s outcome. Many point to a Trump win.
Although we are approaching November cautiously and with hedging in place, our investment team maintains a positive outlook for global equities and a negative one for government bonds. Before analysing the impact of a Trump win, let’s examine what both candidates have in common in terms of government policy actions. The single tangent point is expansionary fiscal policy and this is the main scenario on which we build our investment rationale. Monetary stimulus passing the torch to expansionary fiscal policy will have actual impact on inflation with different consequences on equities, rates, and the dollar.
The opportunities we see include:
Despite the anti-Wall Street rhetoric from both candidates (especially Clinton) implying that they will increase the sector’s regulatory burden and close loopholes, it’s clear that a steepening US yield curve supported by rising interest rates and benign inflation should provide an environment in which banks and financials in general will likely outperform.
Buy infrastructure, basic materials (non-precious metals) and engineering stocks:
The fiscal spending commitment and the need for infrastructure projects set the stage for stock appreciation in the various sub-sectors. The correlation between deb/gdp and equities (industrials in particular) is pretty high. An infrastructure play should appeal to voters and investors from both political parties.
Buy treasury inflation protected securities:
Expansionary fiscal policy will eventually lead to higher inflation. In such a scenario, exposure to linkers gives investors a better alternative than gold (correlation above 50%), since they can ride an asset class with positive carry.
Buy US dollar on weakness:
Both candidates will support and strengthen corporate America. It is the protectionist or free trade tone from the new president that will have the most impact on the US dollar. As with sterling in the Brexit scenario, the dollar under a Trump presidency may end up reflecting more than macroeconomic fundamentals. Our view is that a growing economy within a rising rates environment should provide support to the dollar.
Sell US Treasuries:
Again, fiscal policy and rising rates should be the reference point. Also, long term sustainability at current long term yields is definitely questionable for insurance companies, pension funds, and endowments.
Expect the unexpected
A win for Trump would challenge conventional wisdom and be a shock to many investors. Cross-asset volatility and a flight to quality in the short term would readjust asset valuations. The endurance of investors’ confidence in financial markets and perhaps their faith in capitalism will be tested. That said, we regard a Trump victory a significant possibility and are hedging against the volatility that will ensue while preparing for the investment opportunities it would create. We remain confident that corporate America will survive even in a more protectionist environment and this should provide optimism for risky assets.
As ever, in change lies opportunity.