Observations on the US Elections

Overview

On November 9, Donald J. Trump became the US President-Elect and the Republican Party has secured both houses of Congress. Though many polls reflected a tight race, the result was a surprise for markets and the initial reaction has been turbulent as investors adjust positioning. Among the sharpest moves were a drop in the S&P futures index, and weakening in the Mexican peso versus the US dollar and rallies in currencies that have traditionally performed well in periods of volatility, such as the yen and Swiss franc.

We expect volatility to remain elevated over the near- to medium term, and we are well placed to leverage opportunities as they arise.

Market Outlook

We think the market reaction to the election is likely to be similar to the UK referendum scenario: 1) a volatile, risk-off response, followed by 2) a gradual reversal as investors recognize that changes under a Trump administration will take time to play out and the US Federal Reserve (Fed) is likely to remain in wait-and-see mode, and then 3) isolated bouts of volatility as the administration’s policy priorities, and ability to execute them, become clearer.

Investment Implications

The election has not been a dominant theme in our portfolio positioning, and details of policies under a Trump administration are yet to be determined. That said, below are some of the issues we are watching as part of the broader investment strategies across our platforms. In particular, we see increased risks stemming from a more protectionist stance on trade. However, we are watching for a potential softening in tone in the coming months as senior Republican officials weigh in and the administration takes shape.

Broadly speaking, our fundamental economic outlook is unchanged. We expect healthy but unexceptional growth in the US of around 2% for the next couple of years, with continued strengthening in inflation.
We think the chances of the Fed raising rates in December have diminished. Policymakers are likely to delay any further tightening in a period of uncertainty, until the impact on financial conditions becomes clearer. However, we believe monetary policy bias is likely to skew more hawkish over the longer term, as the process for selecting Fed Chair Janet Yellen’s replacement starts next year.
We see near-term pressure on the dollar versus core markets and downward pressure on Treasury yields, consistent with more defensive positioning in a volatile market environment. While the dollar may weaken against the euro, Swiss franc and Japanese yen, we see potential for outperformance versus some emerging market currencies due to concerns over the trade outlook. Over the longer term, we favor equities over credit over government bonds.
Risk appetite may suffer at least an initial setback from the election result, due in part to uncertainty over domestic policy and concerns about the stability of existing international trade and security arrangements. Volatility across global markets should subside, but we see potential for continued pressures in markets most exposed to US policy uncertainty. We are looking for opportunities in any dislocations.
Trade policy uncertainty is likely to weigh on markets that are levered to US trade channels. We see potential for markets to further discount protectionist policies under a Trump administration. This concern could be a source of renewed pressure on emerging markets most exposed to the US and, to a lesser extent, countries dependent on global export growth. Mexico and Canada appear particularly vulnerable, as Trump has expressed opposition to the North American Free Trade Agreement (NAFTA) trade deal. We will follow the new administration’s foreign policy agenda closely as it evolves.
Heavy fiscal stimulus may support growth and inflation, and benefit targeted infrastructure sectors, but may face considerable opposition from within the Republican Party ranks. Trump’s infrastructure package is yet to be detailed, but he has pledged to commit far more than Clinton’s proposed $275 bn. His proposed combination of increased defense spending and tax cuts would likely amount to significant fiscal expansion.
Trump’s proposed tax cuts may support growth. Trump has pledged income tax cuts, along with a drop in the headline corporate tax rate from 35% to 15%. The Committee for a Responsible Federal Budget has estimated that these initiatives, which amount to around $5 trillion over the next decade, could push the debt-to-gross domestic product ratio well over 100%, which could add to upward pressure on US government yields.
Healthcare policies could be positive for insurers and pose a modest risk to pharmaceuticals. Details on a replacement for the Affordable Care Act are unclear. Insurers may benefit from the ability to compete across state lines, and particularly from proposed block grants for Medicaid. Trump’s proposed “free market for drug providers” could negatively impact the pharmaceuticals industry.
Energy sector deregulation and growth policies should benefit the pipeline and mining sectors.
The insurance industry may gain from deregulation, potential positive impact on financials from proposed rollback of Dodd Frank legislation.

We continue to monitor market developments and look for opportunities across any dislocations. Other events we are monitoring for the fourth quarter 2016 include:

China: Potential for growth disappointment. Next release of money supply and social financing data on November 14
Meeting of the Organization of the Petroleum Exporting Countries (OPEC) on November 30
Europe: Italian constitutional reform referendum on December 4
Europe: European Central Bank meeting on December 8
US: Expiration of budget spending authorization on December 9
US: Potential interest rate hike at Federal Reserve meeting on December 14