13 min read 6 Feb 20
Summary: As we look ahead to 2020, the US Presidential election is now seen as the most significant tail risk for markets. In this month’s video, Investment Director, Ritu Vohora looks at what the wide range of potential policy outcomes could mean for investors.
Following an exceptional end to 2019 for almost all asset classes, January started on an upbeat note, with markets riding a wave of trade optimism and solid economic data. Stocks pushed to all-time highs as investor optimism surged, and markets shrugged off rising US-Iran tensions. This proved to be short-lived, however, as markets shifted into risk-off mode in late-January. Worries about the spread of the Wuhan coronavirus unsettled markets and investors started to price in a drag on global growth.
Global equities finished the month down with the MSCI All Countries World Index posting a negative return. The US was the best performer, while other regions underperformed the global index. Chinese markets were closed for an extended Chinese New Year period, as authorities tried to stem the spread of the virus. Emerging markets finished the month down almost 5%, in US dollar terms.
Commodities suffered a broad decline in January. Brent crude took the biggest hit, weighed down by expectations that the spread of the coronavirus will slow the global economy – and hence demand for energy and industrial metals. Unsurprisingly, sector rotation was consistent with the fall in the oil price and bond yields with energy, banks and materials performing the worst.
Gold was the bright spot, as investors flocked to safe havens including 10-year government bonds in the US, Germany and Italy.
As we look ahead to 2020, global monetary conditions will stay accommodative and central banks’ continued support should help extend the cycle. Major threats such as the trade war between the US and China have abated for now, with an agreement on a Phase 1 deal. But uncertainty remains. US equities soared in 2019, driving up valuations and leaving less of a buffer to absorb the threat of a global coronavirus pandemic and what is likely to be a polarised and contentious US election year.
In fact, Bank of America Merrill Lynch’s latest Global Fund Manager Survey showed that the outcome of the 2020 US Presidential election is now seen as the most significant tail risk for markets in the year ahead. Trade wars slipped to second place for the first time since May 2019, having dominated over this period. While we may still see periodic threats and tweets on this front, with the election less than 10 months away, any rhetoric is unlikely to escalate. As campaigning enters a crucial phase, America’s public policy is likely to draw the most attention.
The US economy is set to continue growing, albeit at a slower pace, but so far few election-related impacts look to have been priced in. As we head towards polling day, a wide range of potential policy outcomes and competing policy agendas may weigh on sentiment, with ramifications for both the economy and markets.
The election appears to be a battle of extremes between polarised candidates. The Democrats are still deciding on a candidate and the primaries began on 3 February. It’s a tight race among popular but, ideologically disparate candidates. While Vice President Joe Biden aims to strengthen and build upon the centrist Democratic agenda, left leaning contenders Bernie Sanders and Elizabeth Warren are calling for big structural changes. They have put forward proposals that would fundamentally alter the business environment – with a likely negative impact on growth and stock markets. A second term for Trump would most likely involve a continuation of the rhetoric on trade, that has driven market volatility and business investment uncertainty.
While policies on trade and monetary policy will matter, fiscal and regulatory proposals, in particular, deserve close scrutiny, as they will exert the biggest influence on market outcomes. Implications for a substantial increase in government spending are not being factored into US government bond yields, and neither is a material increase in the US corporate tax rate into equity markets.
Sectors such as financials, energy, technology and healthcare could be volatile, due to the risk of heightened regulatory pressure. Issues up for grabs include how to structure a healthcare system for an aging population, growing income inequality, technological change and breakup of Big Tech, and environmental issues. The polarisation between candidates, magnitude of issues, and importance of the US for global markets, makes this election relevant for investors around the world. Policy will shape global trends and define sectoral winners and losers.
As we have seen with both the last US election and Brexit, it is hard to predict political outcomes and even harder to predict the markets’ reaction. With the US market now richly valued, market sensitivity to news flow is likely to be significant leading up to the election and we should see higher volatility as election day approaches.
But it doesn’t pay to be overly bearish ahead of the US elections. In fact, in the last 20 US election cycles, there have been only two instances of the markets going down in the 12 months leading up to the election results. As ever though, diversification remains key. Investors need to be selective to find those companies that can continue to deliver on corporate profits and focus attention on core policy priorities of candidates. Poll ratings will be an important driver in the months ahead.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.