Another nail-biter ahead and duelling economic visions

Former US Secretary of State Madeleine Albright once described the United States as the “indispensable nation.”

While the United States is no longer as dominant as it once was, as other countries, most notably China, have risen, what happens in America, and what it does on the world stage, remains highly consequential.

For the third successive race for the White House, America’s choice matters even more than usual because Donald Trump is the Republican Party’s candidate.

He’s far from being a policy wonk but his strongly held views on:

• trade, where he proposes a 10-20% tariff on all US imports, and 60% tariff on imports from China
• immigration, where he’s sceptical of legal immigration, and promises to deport millions of undocumented immigrants
• tax, where he proposes to lower the corporate tax rate to 15%, from its current 21%, and extend 2017 income tax cuts, set to expire at the end of 2025, and
• regulations, where promises to “deconstruct the administrative state” by, amongst other things, slashing environmental regulations, and boosting fossil fuel production, could have ramifications far beyond America’s shores.

In contrast with the scope of Mr Trump’s proposals, Vice President Kamala Harris’ plans for:

• tax cuts aimed at benefiting “100 million working and middle-class Americans”
• making home ownership more affordable by increasing housing supply and as well as providing greater financial assistance for first home buyers, and
• fostering the formation of 25 million new businesses, are more tightly focussed.

Despite great differences in temperament, beliefs, and policy, they do share one thing in common — a lack of serious plans to tackle the country’s thumping budget deficit, now standing at more than 6% of Gross Domestic Product (GDP), and national debt, now at a towering 123% of GDP.

Incidentally, the Congressional Budget Office estimates that extending individual, estate, and business tax provisions of the 2017 Tax Cuts and Jobs Act (TCJA), along with the expansion of individual retirement accounts (IRAs) “to credits that subsidise the purchase of health insurance on Affordable Care Act exchanges — would increase deficits by nearly $5 trillion from fiscal years 2025 through 2034, adding to the rising pile of debt.”

Possible market reactions to contested election outcome

Our analysis of US presidential elections all the way back to the 1960 race, won by John F Kennedy, reveals that sharemarkets are usually relatively flat up to voting day, and then rally after the outcome.

Many national as well as ‘battleground state’ polls show a very tight contest shaping up to be like the nail-biters of 2016 and 2020. Bear in mind that the US presidential election is not won by the candidate securing the most votes. Rather, it’s won by the candidate who secures at least 270 Electoral College votes.

Hillary Clinton won about 3 million more votes than Donald Trump in 2016, but he got the keys to the White House because of narrow victories in battleground states like Pennsylvania, and Michigan that put him past the magic 270 Electoral College threshold.

Four years later, Joe Biden bested Mr Trump by around 7 million votes and gained the presidency by a securing a similar number of Electoral College votes to Mr Trump’s 2016 winning score.

It’s possible there will be a repeat of 2016 in which Mr Trump finishes second in the popular vote but secures an Electoral College majority.

Another possibility is a repeat of 2020, on steroids, in which Mr Trump refuses to accept the result and wages a protracted legal and political battle, right up to inauguration day January 20, 2025, to try to overturn the result.

Financial markets will be hoping for a clear-cut result and acceptance of the outcome by the losing candidate, otherwise we can expect market nervousness, until the issue is resolved.

Modest economic consequences of Mr Trump’s tariff proposals

Our investment team has run a magnifying glass over the potential consequences of Mr Trump’s tariff and tax plans.

From an economic perspective, tariffs are a bad idea. They increase the price of imports, and those higher costs are ultimately borne by consumers.

That said, our analysis of three possible tariff scenarios — a full threat scenario, a scaled back but still high tariff scenario, and a scaled back low tariff scenario — suggests modest one-off impacts on US GDP and US corporate earnings (Charts 1 and 2).

Chart 1: Tariffs likely to have modest one-off impact on US GDP….

% change to real GDP

Chart 2: …and corporate earnings

% change to corporate earnings

Likewise, tariffs would, under the same three scenarios, push consumer prices temporarily higher, as measured by the Personal Consumption Expenditures Price Index (PCE Index) (Chart 3).

Chart 3: Tariffs would likely have one-time higher inflation impact

% change to US Personal Consumption Expenditures Price Index (PCE Index)

Trump tax cut proposals a bigger deal

While we think the impacts of Mr Trump’s tariff plans may be relatively modest, we believe his proposed corporate tax cut may have far greater consequences for US economic growth, as measured by changes in GDP, as well as corporate earnings. If all his proposed tax changes go through, we expect a significant uplift to US GDP (Chart 4).

Chart 4: Acceptance of all Trump tax changes would materially boost US GDP…

% change to real GDP

By the same token, cuts to corporate rates could increase US corporate earnings by 6%, if the corporate tax were to fall to 20%, and rise by 8.5%, if the corporate tax rate fell to 15% (Chart 5).

Chart 5: …and US company earnings

% change to US corporate earnings

The long-term matters, but managing market events that can sideswipe portfolios matters too

There’s plenty for market participants to absorb not just on economic issues, but also the possibility of protracted political tensions if the election result is contested.

That said, campaign policy is rarely implemented cleanly, if at all, as it’s so heavily dependent on the final composition of congress and the senate. Considering a range of outcomes is required by carefully discounting campaign rhetoric to various degrees. Estimating post-election policy impact, at this stage, is an exercise in awareness rather than high conviction action.

We are disciplined, strategic investors that aim to achieve long-term wealth creation for our clients. This anchor ensures that our portfolios stay within their long-term target weightings through a process of rebalancing.

Deeply held investment convictions, sound temperaments gained from navigating multiple market cycles, and structures and incentives that reward patience and perseverance, support our long-term focus.

We eschew impulsive trading driven by reactions to short-term market movements recognising that such behaviour is wealth-eroding. Nonetheless, we are acutely mindful of occasions when market events of potentially great severity can, if unheeded, undermine years of accumulated returns. Our risk-aware practice keeps us vigilant to possible threats enabling us to play defence and offense equally in such situations.

Defensive positioning ahead of potential threats protects clients’ capital while offensive positioning at those same times is expressed by configuring portfolios to acquire assets discarded by stressed market participants. By doing this, we can take advantage of market dislocations to position portfolios for strong future performance.

One of the ways we do this is by leaning on the capabilities of our experienced internal derivatives team. Their insights and skills enable us to add highly cost-effective protection strategies designed to cushion client portfolios from the full impact of market ructions, while simultaneously positioning them to participate in upside potential.

We successfully implemented these strategies in the past, including option protection on the US sharemarket during the shock associated with the COVID-19 outbreak in early 2020.

No doubt we will be leaning on them in more future situations.

Learn more

MLC Asset Management applies its knowledge and experience, with the aim of delivering the best possible investment results for institutional and retail clients in Australia and globally. For more information, please visit our website.