While the US elections are five months away, current polls suggest incumbent President Joe Biden is trailing rival Donald Trump, leaving markets to hedge their bets on the many ways this could play out.
So far, they have focused on upsides like lower taxes and less regulation if Trump returns or paid little attention to the elections.
“But that may change as it draws near,” said AMP’s head of investment strategy and chief economist, Shane Oliver, with the first debate scheduled for 27 June.
According to Oliver, a Trump victory runs the risk of weakening US democracy and US global alliances and threatens a big ramp-up in protectionism and a further reversal in free trade.
Furthermore, without the possibility of running for a third term, a second Trump presidency could lack the electoral constraints of his first term, which led to the Phase One trade deal with China and is likely to have fewer “adults in the room”, Oliver added.
Trump, viewing the US trade deficit as exploitation, would likely escalate deglobalisation, Oliver warned, and provoke larger-scale global trade wars, unrestrained by political considerations.
Expounding on the impact of a trade war on Australia, the economist said a Trump victory could leave Australia vulnerable.
“As a relatively open economy with high trade exposure to China, Australia would be vulnerable to an intensification of global trade wars as a result of a Trump victory, particularly if it weighs on demand for Chinese exports,” he said.
According to an OECD study, Australia runs the risk of a 1.2 per cent reduction in GDP as a result of a 10 per cent reduction in global trade between major countries, second only to Korea in OECD countries.
“Resources shares would be most at risk and the Australian dollar would likely fall,” Oliver remarked.
“Of course, similar fears existed during the last Trump trade war, and it didn’t turn out so bad. Much would depend on how other countries respond and how hard Trump goes.”
Election to hinge on economy
Much of the election could hinge on whether the US economy can remain resilient until November, he observed. However, a surge in oil prices could pose a significant risk, potentially sliding the economy into recession.
“The historical record indicates incumbent presidents tend to be re-elected if there is no recession in the two years before the election. Since 1932, all incumbents seeking re-election have failed if this was not the case. While leading indicators point to a high risk of recession, so far, the economy has been strong. But how it behaves up to November is critical,” Oliver said.
Turning to markets, Oliver pointed out that historically, markets have fared well in election years, with an average return of 12 per cent in an election year or a president’s fourth year since 1927.
However, Oliver tipped that in the run-up to this year’s election, there could be increased share market volatility if Trump remains ahead and investors focus on risks like a hit to the US labour force and a new trade war.
“After Trump’s victory in 2016, shares soared 38 per cent to January 2018 as the focus in his first year was on business-friendly tax cuts and deregulation, but they fell in 2018 as the focus shifted to trade wars.
“So, if there is a Trump victory, the share market’s reaction in the first 6–12 months will be heavily influenced by his sequencing of tariff hikes versus tax cuts,” Oliver explained.
At present, Trump is threatening to impose a 10 per cent tariff on all imports and a 60 per cent tariff on Chinese imports, which would take the average US tariff rate from around 2.5 per cent to around 17 per cent, surpassing the 3 per cent peak seen in his first term.
“This may be ‘maximum pressure’ bluster, but while ‘we shouldn’t take him literally, we should take him seriously’,” Oliver said.
A Trump presidency would likely mean higher bond yields too, said Oliver, with somewhat higher inflation and budget deficits and a higher US dollar partly reflecting higher global economic uncertainty and the impact of US tariffs.
Other policy changes under a Trump regime that could rattle markets include a possible effort to roll back the Fed’s independence with the replacement of Jerome Powell, and a ballooning budget deficit under Trump’s proposed tax policies.
On the upside, Oliver cited Trump’s intention to slash regulation particularly benefiting the energy and financial sectors, which could help boost the supply side of the US economy via a boost in productivity.
But, again, a number of risks remain.
“On balance, Trump’s policies – with higher tariffs and hence higher import prices, sharply lower labour force growth and moves to weaken the Fed’s inflation fighting credentials – will likely add to inflation,” Oliver said.
“There is also a risk that a higher budget deficit, with no sign of improvement at a time when US public debt is now very high (at 125 per cent of GDP), will result in a market backlash and higher bond yields.”
Moreover, Trump’s “erratic” policy-making style could also hamper business investments due to added policy uncertainty, Oliver said.
“A lot will depend on the sequencing of his policy moves. If he runs with tax cuts first it could boost the economy in, say, 2025, but if he runs first with sharp tariff hikes, immigration cuts and an attack on the Fed, it could be taken more negatively early on. In 2017, he ran with the positives first to help shore up the economy, but this time around, he may run with negatives first as there will be no constraint from the desire to win another election.”
Also reflecting on market focus on the upcoming US election, the portfolio manager for the T. Rowe Price Global Equity Fund, Scott Berg, who candidly said neither candidate “would likely qualify for any corporate board in Australia or America”.
But on the positive side, as Berg noted at the Morningstar Investment Conference 2024 in Sydney last week, both Trump and Biden have already been president as he questioned how bad either win could be for markets, given that US stocks have performed well over the past eight years under their leadership.
“In a way, sometimes I think people over-index to elections, and the strength of the US system is that either one who wins inherits a divided Congress.”
