Pass the popcorn

American psycho

Potentially impacted by US events over the last week, it appears that Trump is ahead in the race to become the next US President. Opinion polls, like those tracked by the 586.com website, put Trump around two percentage points ahead of President Joe Biden. Despite that, there is uncertainty about how the election process will proceed. It is not clear that Biden will even be the Democratic candidate come November, amid news he contracted COVID-19, adding to the uncertainty and ongoing suggestions he will be convinced to step-down. However, for now the market narrative of a Trump victory and what that means for investors has become stronger.

Trump ahead, platform published 

The Republican policy programme makes interesting reading. The policy proposals are a mixture of trade protectionism, deregulation, fiscal largesse, anti-green energy, and social conservatism. There are several anti-China proposals, including ending its Most Favoured Nation status and preventing the import of Chinese manufactured vehicles. It purports to protect American businesses and jobs by controlling immigration and seeking what are described as fair, trade deals. There are calls for attacking “wasteful” Federal spending and reducing deregulation. The tax cuts introduced by President Trump are to be extended and the programme pledges no taxes on tips – that important waiting staff voter cohort is not being ignored!

Inflation 

One of the promises is to ‘defeat inflation and make America affordable again’. That seems to be mostly focussed on energy and the thesis that getting America to pump more oil and gas will prevent a re-run of the 2021-2022 energy shock. There is no mention of withdrawing from the Paris Agreement again but there is a clear tilt back to the traditional fossil fuel energy industry with a pledge to undo the Green New Deal. It remains to be seen whether the subsidies for green energy and low carbon activities embedded in the Inflation Reduction Act will be reversed, but the Trump proposals could be a major obstacle to further growth in the renewables sector. Indeed, environmental, social and governance (ESG) investing is going to be more challenging in the US in the years ahead. The aggressiveness displayed by several US States towards ESG might soon be amplified in Washington.

The presence and growth of renewable energy was not the cause of the 2021-2022 inflation shock, yet the populist view is that the US needs greater energy security through increasing production of oil and gas. Arguments about environmental issues, climate change and global marginal energy pricing are lost. It is interesting that the S&P 500’s energy sector has outperformed over the last couple of weeks. Meanwhile, most of the other proposals would tend to increase inflation – tariffs on imports, restrictions on immigration and a preference for lower taxes, and little evidence of any attempt to reduce the Federal deficit.

More broadly on inflation the plan aims to restrict immigration (and to deport illegal immigrants) and to follow more protectionist trade policies with higher tariffs on imports as part of that. These are supply side restrictions and inflationary. There have been suggestions that Trump also favours a weaker dollar to reduce the trade deficit. None of these are new, they were policies that Trump 1.0 followed, but they nevertheless should be a cause for concern if he is elected in November. Since 2020, the 10-year US Treasury Inflation Protected Securities break-even inflation rate has traded as low as 0.50% and as high as 3.0%. My bet is that testing the higher bound is more likely to be seen if these potential inflationary risks become more material under the next Administration.

Trump trades 

Very simply, looking at the programme one would conclude that a Trump presidency would be positive for oil and gas industries, crypto (ironic as one of the narratives to support extended use of crypto currency and digital assets is fear of inflation and lack of trust in government institutions), artificial intelligence (AI) - apparently J.D. Vance is a tech-bro - and industries that will benefit from protectionism (autos) and deregulation (pharmaceuticals). On the downside, fiscal largesse and a mix of inflationary market distorting policies could mean higher government bond yields and corporate borrowing costs. In the short-term the Federal Reserve (Fed) will keep a cap on interest rates and even bring them down, but yield curve steepening is a trade that works with both an easier Fed and Trump fiscal policy. There has been much progress towards decarbonisation and huge growth in solar and wind power assets, but the Republican programme is more of a headwind than a tailwind when it comes to green energy. As with most things where Trump is concerned, what ends up policy rather than just rhetoric remains to be seen. In his acceptance speech at the Republican National Congress, he pledged to “end the electric vehicle mandate”. Yet, one of his most vocal (and potentially most financially powerful) backers in recent weeks has been Elon Musk. Buy or sell Tesla?

Goldilocks consensus 

Like all political manifestos, what is promised and what will be done are not always the same thing. Meanwhile, the global economy will determine market performance in the months ahead. The International Monetary Fund (IMF) published its latest outlook this week, with the expectation that global growth will remain solid – at 3.2% this year and 3.3% in 2025. While it warns that service sector inflation remains a drag on disinflation, its forecasts are for global consumer price inflation at 2.7% this year and 2.1% in 2025. The baseline forecasts are positive as far as the outlook for markets go. Continued expansion, moderating inflation, and scope for monetary easing. The main risks in the IMF outlook come from policy uncertainty and trade tensions preventing inflation from falling further, meaning that interest rates stay “higher-for-even-longer”. It’s a common articulation of the risks in the outlook stemming from policy uncertainty against a backdrop of high deficits and potentially unstable fiscal paths. Decoding all of that probably means real bond yields stay relatively high (reflecting higher term premiums). But they are higher today than during the last decade, so it is not clear where the trade is here.

Rates and earnings are more important right now 

There are 16 weeks and a Democratic National Convention to go before the US election. Given the events of the last week, anything could happen. With that uncertainty in mind, at least we have more confidence that the Fed will cut rates soon. Market pricing is at 100% certainty for a cut in September and for another one after the election. This will support the bond market and the general drift towards yield curve normalisation. On the equity side, the second quarter (Q2) earnings season, so far, looks positive. Growth in reported earnings is running at 7% to 8%, with strong numbers coming from technology, consumer discretionary and financials. So far there have been no big negative surprises. Which suggests the broad stock market rally can continue.

Exceptionalism not over 

For equity investors, the key question is whether American exceptionalism is likely to fade. Of course, Trumpians would argue the reverse as they strive to achieve the MAGA ambitions. The IMF’s forecasts have the growth differential between the US and the rest of the world narrowing a little, but it is hard to see the trends that have led to US outperformance in recent years diffusing completely. The news of TSMC’s strong Q2 earnings tell us that AI remains a powerful force behind capital spending. Despite my pointing out that small cap equities had not performed very well this year, the Russell 2000 index had one of its best weekly price gains in a while and there were other signs of a broadening of stock market performance. The technology sector might have wobbled a little in the last couple of weeks but in the grand scale of things it is barely noticeable. The interest rate cuts that the market has priced in now suggest a recession is a way off, as does most of the economic data. For these, and other reasons, it is hard to call time on US outperformance. A proper bearish call requires something in the outlook that is much more damaging to economic growth and, despite the economic inconsistencies in the Republican programme, it is not a recipe for recession.

(Performance data/data sources: Refinitiv DataStream, Bloomberg, as of 18 July 2024, unless otherwise stated). Past performance should not be seen as a guide to future returns.