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Next week’s US Election -M&G’s cross-asset class preview of what lies ahead

US debt

 

With the 2020 US election happening next week, anticipation is building worldwide over who will become (or remain) president of the United States. Will incumbent climate change sceptic Donald Trump stay in the White House to deliver his agenda on tax cuts and jobs? Or will Democratic hopeful Joe Biden – with his vastly different stance on foreign policy, green pledges and focus on higher spending – take office?

Whatever happens, the result is likely to have an impact on market sentiment, but only time can tell how significant that impact will be. Whether the outcome is to ‘Keep America Great’, or ‘Build Back Better’,  there will be winners and losers.

In this US election breakdown, several M&G Investments fund managers and specialists have outlined the possible outcomes and developments related to this seminal event, and what these scenarios could mean for investors, against a backdrop of the pandemic, climate change urgency and a struggling global economy.

US election outlook: Could we see a repeat of 2000?Randeep Somel, equities fund manager:

Incumbents are difficult to defeat. Over the last 44 years, only two sitting presidents (Jimmy Carter in 1980 and George H.W. Bush in 1992) have failed in their re-election attempts. Interestingly, in both cases, the parlous state of the economy at the time of the elections was seen to be the biggest determinant of their defeats. The current US economy is not exactly healthy, but there has been some improvement. According to polls in recent months, Americans have appeared to trust Trump’s handling of the economy more than Biden, and that is significant – though a more recent poll suggests that US voters are starting to turn against Trump’s economic policies.

While polls have consistently shown Biden ahead of Trump, it is worth remembering that Hillary Clinton won the national poll in the last US election, but lost the Electoral College quite heavily. The result will probably come down to six key states: Florida, Arizona, Pennsylvania, Michigan, Wisconsin and Minnesota. Trump will need to keep hold of Florida and Arizona to be re-elected. If he manages to hold them, then he will just need to win one of those other states to stay in the White House. This election is reasonably close and it could still go either way. Yes, Biden has the momentum, but it is not high enough at this stage to give us a clear idea of whether he might win. Similarly, the difference in those swing states is not high enough for us to assume right now that he will definitely be successful.

The biggest concern is that we wake up on November 4th to discover that there is no declared winner, with the process dragging on for a very long time and ending up in the Supreme Court. This happened in 2000, when the Bush-Gore race resulted in a Florida recount, leading to weeks of uncertainty following the election day. In the month of November, as the nation waited in limbo, the S&P 500 Index fell 8% and only recovered once the Supreme Court voted in favour of George W. Bush, with Al Gore conceding by mid-December that year. Given the rise in ‘mail-in’ votes this year, which take longer to count, a repeat of 2000 is possible.

The next president will ultimately decide on the direction of travel for the world’s biggest economy, and the result could also have a big impact on the country’s approach to climate change. Trump intends to withdraw from the United Nations’ Paris Agreement, but a Democratic victory will almost certainly see the US remain a signatory of the accord, with the aim of achieving net zero emissions by 2050. Biden has announced a climate plan that would involve spending $2 trillion over four years to significantly increase the use of clean energy in the transportation, electricity and building sectors. The proposal is designed to boost economic growth and strengthen infrastructure, at the same time as tackling climate change.

What impact could the US election have on the economy and markets?

Jim Leaviss, CIO of Public Fixed Income:

A Biden victory would lead to significantly higher fiscal spending, and the balance of that spending would be to areas with higher “fiscal multipliers” (the impact on a nation’s output arising from a change in government spending). Trump has called for tax cuts for businesses and wealthy individuals, but that approach would be a lot less powerful for the economy. Generally speaking, if you give a wealthy individual a tax break, that person will save most of the money. But when someone on a low income gets a few extra dollars in their pockets, they are much more likely to spend it – and that money goes into the economy. Fiscal multipliers will therefore be a lot more powerful under Biden than under Trump.

At the moment, the market thinks we are unlikely to see the first Fed hike until around 2024/25, but there is some research that indicates a Biden victory and a stimulatory fiscal policy would bring that forward by a couple of years – which would keep long-term rates underpinned.

Ultimately, we are unlikely to see substantially higher bond yields given that the inflationary outlook is still incredibly weak (and so is the growth outlook relative to potential growth rates). However, the world does need to worry about labour markets. We do not want people to leave the workforce and, even if economies rebound, there are many people who will struggle to find jobs again. We are in an environment where central banks and governments will not allow significantly higher rates from here, even if that is where the market wanted to go. As Biden becomes more likely to win, yield curves get steeper in anticipation of further fiscal stimulus, which could well be inflationary.

The worst outcome for the dollar, bond markets and risk assets would be if Trump were to lose the election but refuse to step down. Anything that causes us to question the sanctity of Western democratic law would be problematic, leading to issues around the state of the US dollar as the primary bond market, equity market and currency market.

Tristan Hanson, manager of the M&G Global Target Return Fund:

COVID-19 has wrought economic damage around the world, and America is no exception. US employment initially dropped by roughly 20 million jobs at the start of the pandemic, but it has started crawling back – and roughly half of those jobs have bounced back. Over the coming months, we will start to see whether this is a more enduring shock. The most remarkable aspect of this phase has been the degree of stimulus that has been channelled into the economy. Disposable income in the US has risen sharply despite the millions of jobs disappearing, given that fiscal spending has put money in people’s pockets. This has resulted in a unique situation whereby around 10 million jobs have been lost, yet aggregate incomes at a household level are higher.

As stimulus starts to fade back, it is hoped that some of those jobs will return as the economy recovers. But how will the US election pan out for markets? One key issue is the US yield curve. The Fed has cut rates aggressively, and yields have followed that to some degree. There is a view that a Biden victory would be negative for the bond market, with potentially greater fiscal stimulus, more borrowing and – ultimately – a stronger economy. Crucially, investors must beware the immediate aftermath of the election. However financial markets react, they can be fickle, and it may take time for markets to digest the outcome and how to value assets under a different regime – depending on the election result.

What the election result could mean for international relations and emerging markets

Gregory Smith, emerging markets strategist:

The US is a massive economic power, but the impact on emerging markets from the outcome of this elections will vary mostly on US foreign policy. A Biden victory would see a more predictable foreign policy, which would be better for a lot of countries. However, it’s important to bear in mind that there will be winners and losers. We would see a more multi-lateral approach, perhaps with SDR allocations – giving more firepower to the IMF, which would be good for poorer countries.

A Biden administration will initially prioritise the pandemic response and US domestic economy. But there will also be a continued focus on America’s relations with China, with China’s growing influence remaining a bipartisan concern.

Depending on the outcome of the election, we could see the dollar move and this would impact on emerging markets. Clearly, if the dollar weakens that would benefit emerging market currencies. If the dollar strengthens due to the US economy doing well, this could benefit emerging markets if it leads to the US economy promoting global growth. But if the dollar strengthens off the back of higher interest rates, this wouldn’t be beneficial for emerging markets.

If Biden wins, one of the biggest losers is likely to be the Middle East – with oil exporters having to switch up their business models to fit in with a new global order that is more focused on tackling climate change. A Biden win may be more aggressive towards Turkey and Russia, which could push a more underweight view there. And in Mexico, there could be some upside for better trade policy relations with the US. Lastly, one of the biggest factors would be how the US deals with Iran over the next couple of years. If a Biden victory leads to negotiations and restored removal of sanctions, then that could impact oil supply which would put pressure on the OPEC+ agreement – creating uncertainty.

Stepping back, the biggest impact on emerging markets – more so than the US election outcome – will be the path of the COVID-19 pandemic, in terms of how countries recover over the next year or so, and how deep their debt scars are.

The US green agenda and healthcare

Maria Municchi, manager of the M&G Sustainable Multi Asset Fund:

One aspect of a Democrat victory that could be particularly interesting is Biden’s wide-ranging Green New Deal. There is an aspect of social and environmental justice to the deal – combining the likes of infrastructure spending and growth with social outcomes. This is really important when looking at fiscal spending across areas of the country that have been underserved or left behind by previous administrations.

When it comes to social policy, one of the hottest topics is healthcare. In this election, although healthcare is important, share prices have not moved around as much as during previous elections – given the absence of candidates such as Elizabeth Warren and Bernie Sanders calling for a nationalised healthcare plan. Joe Biden does not want to roll out the national health insurance Medicare programme for all, and both candidates agree on bringing drug prices down, but there are still some significant differences between the two candidates’ pledges.

Biden aims to build on the existing Affordable Care Act (ACA), expanding it, extending it and making sure a public option is available across all states. The introduction of the ACA brought the number of uninsured people in the US down significantly, but there are still many people that do not have health insurance. Moreover, the pandemic has brought the importance of quality healthcare to the fore. Biden is looking to reduce the age of Medicare eligibility from 65 to 60 years old. This would boost the number of people that fall within that policy to about 20 million. This is very different from what we could expect from Trump, who is still looking to repeal the ACA through the Supreme Court. Fundamentally, we are looking at two very different approaches and policies which could have a very different impact on society in the US.

The future of US infrastructure

Alex Araujo, manager of the M&G Global Listed Infrastructure Fund:

The need to modernise and expand US infrastructure is one of the few things that the Republicans and Democrats both agree on. Higher spending on infrastructure has played a big role in fiscal stimulus packages across the world, yet it has been notably lacking in the US.

Infrastructure is a major source of jobs in America, with 17.2 million people employed by the industry. Whether we are talking about motorways and airports or electricity and water systems, there is no doubt about the fact that a significant amount of improvement is required across the nation. Infrastructure-related spending decisions are by and large governed by the different states. It falls under the jurisdiction of these states to administer infrastructure plans, though they do need federal assistance.

Trump has attempted to stimulate infrastructure by easing the permitting process around environmental requirements. However, this has backfired because the positioning of governments at state level has been in favour of more stringent environmental standards. Depending on the election result, any infrastructure initiatives that do take place are likely to be inspired by federal policy. The private sector is likely to play a bigger role, with the use of private sector capital and concession grants from various states to build more and better infrastructure – particularly in states with fast-growing populations, such as Texas.

With regard to opportunities and gaps within US infrastructure in supporting the climate energy transition, regional utilities and private enterprise are already investing in green opportunities – even under Trump’s presidency. However, a Biden victory is likely to drive renewable energy deployment further, given the candidate’s plan to build “an equitable clean energy future”.

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