Most commentary on today’s election begins with a series of caveats: “the outcome is uncertain”, “we don’t know which policies the winner will be willing/able to put into action”, and “there are a whole host of other forces that will drive markets.” It would probably be sensible to stop there.
There is a high degree of acknowledgement that the outcome is hard to call, probably because experience has revealed the risks of being overconfident about election outcomes. When it comes to short term market response however, there seems to be a clear consensus. Most commentary suggest that a Clinton victory would lead to a “relief rally” in risk assets, while a Trump win would mean “risk off behaviour.”
These forecasts may be correct, perhaps even self-fulfilling, but the question for investors is always the same: “if everybody thinks this way, how can I make money out of it?” Making predictions can be fun, but our preferred approach to managing money is to react to what does happen, or, as Tristan recently discussed, to look for instances where pricing suggests overconfidence with regard to one outcome or the other.
What should we really worry about?
The real impact of the election will be felt over many years, in complex ways that will be interconnected with a whole host of global dynamics. It won’t be the result itself that matters so much, as whether it represents a stepping stone on a path to broader change. We feel there are two key areas where the election result might be illuminating.
- Economic policy
Both Trump and Clinton have suggested they may be willing to pursue looser fiscal policy to try to stimulate growth. In the context of broader changes to the consensus for policy makers as we have discussed here and here, this could be significant. The chart below shows how attention has turned to fiscal policy (the previous two spikes in 2012 and 2013 were around the “fiscal cliff” concerns in the US).
What does greater fiscal expansion mean for investors? If it manages to stimulate growth, it can mean rising interest rates and greater inflationary pressures. But fiscal policy can take many forms, which have different impacts according to the prevailing state of the economy. Last year, the IMF published an extensive paper on this. It suggested that tax cuts may be the most effective way of stimulating growth while expansions in expenditure seem to have had a bigger effect in developing economies.
In this sense, a Trump presidency with greater emphasis on tax cuts and infrastructure spending could suit the Fed most. Moreover the areas where Trump may be most likely to secure Congressional support would be on tax-cutting and deregulation. In the case of either candidate winning, successful fiscal policy could allow the Fed to “normalise” interest rates, giving them more firepower to fight future downturns.
For Trump, this could well be an unintended consequence, given his recent public attacks on the Federal Reserve as an institution.
- Pro-trade and pro-capital
We’ve written a couple of times on how politics matters to investors, particularly when we can detect sea-changes in the prevailing regime. Falling inflation and interest rates and greater corporate profitability seem to have benefited from a more de-regulated global system. Clinton has frequently struck an anti-Wall Street tone which means we should be wary of dismissing her as “more of the same” but it is Trump’s anti-trade rhetoric which could pose the greatest risk to investors.
Protectionism, while often presented as a fight against the ‘excess of capitalism’, is frequently associated with the creation of new sets of vested interests, inefficiencies, and inflationary pressures. This could be damaging for all assets but it would be too early to make an assessment even in the event of a Trump victory.
As with the Brexit process in the UK, it is critical to focus on action rather than rhetoric if we are to avoid slipping into the dangerous world of forecasting.