The US presidential election campaign, which culminates today, has been extraordinary – marked by Joe Biden’s withdrawal as a candidate, the assassination attempts on Donald Trump and the abandonment of various electoral norms. For all the drama, the election remains finely balanced – especially in the crucial swing states. An election that’s too close to call, but what impact will it have on the world’s financial markets?
Surprises from history
Received wisdom might suggest that wins by the Republicans – the ‘party of business’ – lead to the best outcomes for the US stock market. But history paints a somewhat different picture.
Although Donald Trump made great play of the S&P 500’s performance during his administration, the US market underperformed its Chinese counterpart on his watch.
The stock market outcomes from previous Republican administrations tell a similar story. During the presidency of George W Bush (Junior), both emerging markets and China outperformed the US equity market. And although the Chinese market wasn’t yet established as a destination for global capital, emerging markets also outperformed under George HW Bush (Senior).
By contrast, the US stock market outperformed its global peers under Joe Biden, Barack Obama and Bill Clinton.
It would be naïve to argue that these outcomes depended solely on the party affiliation of the president. As we shall see, the US Federal Reserve’s independent monetary policy tends to be much more significant for the wider world than whoever occupies the White House.
Nevertheless, US fiscal policy and other government initiatives have played a part in determining the relative performance of US and international equities – as have a range of external events.
The US as global rate-setter
Tighter monetary policy is a hurdle for the US stock market. But high US interest rates and a strong US dollar tend to weigh more heavily on the performance of international markets – and especially emerging market equities.
After a slight contraction in the first quarter of 2022, the US economy continued to grow robustly even as interest rates rose to reach their highest level in over 20 years. During that period, the US growth machine sucked in capital from around the world, attracted by higher yields, and the US equity market has priced itself on that basis.
Meanwhile, an increasingly digitalised economy is intrinsically less vulnerable to higher borrowing costs, which have less impact on businesses reliant on software rather than physical assets. With the Fed having now started to cut interest rates, the stage is set for further domestic dynamism after a period of remarkable resilience.
But the Fed is also the world’s interest rate setter. The 10-year US treasury bond is often seen as a benchmark for global interest rates. Higher US yields lure investors away from riskier assets (i.e., those outside the US), even as higher borrowing costs dampen economic growth in countries that lack America’s remarkable dynamism.
Conversely, when US rates and yields fall, they have a significant positive impact on international markets – emerging equity markets especially.
Contrasts and common ground
A win for Kamala Harris would create some uncertainties. We have scant indication of her views on trade and the economy, for instance. But clearly, a Harris presidency would mean a greater degree of continuity than a Trump one.
In a split with recent precedents, however, a Harris presidency could be more likely to be positive for international markets and emerging markets in particular. That’s because a continuation of Biden-era policies is likely to give the Fed room to bring down interest rates further.
Some of Harris’ policies could weigh on certain sectors of the US stock market. Her anti-monopoly proposals could affect some of the technology giants that have led the market in recent years. Healthcare companies and producers of fossil fuels would also feel pressure from government policies on pricing and the environment, respectively. Against this, the consumer sectors would be likely to benefit from Harris’ proposed tax relief for lower earners.
Under a second Trump presidency, a key concern for global investors would be his proposals for higher tariffs, especially on Chinese goods. These would be likely to have an inflationary effect and could potentially arrest the Fed’s nascent rate-cutting cycle. This would result in renewed strength in the dollar, with the negatives for emerging markets that that entails.
The policies that Trump has outlined would have roughly the opposite effect to Harris’, with support for fossil fuels and big tech at the expense of the consumer, who would be hurt by the higher inflation caused by tariffs.
There are commonalties too. Both candidates look set to increase the US deficit; the Fed appears unalarmed by this. And both are proposing extensive tax cuts, albeit with different targets.
What comes next?
Despite all the excitement and uncertainty surrounding the election, our focus in the coming months will be on the Fed rather than the White House. The winner of the Electoral College is unlikely to be a major factor when the Fed’s Open Markets Committee mulls over what action to take at its November and December meetings.
Political rhetoric does not always become reality and the new president’s policies will take time to feed through into the hard data that informs the Fed’s decisions.
For investors, the worst outcome could be either party winning complete control of the legislature and executive – removing the checks and balances that come with a split. But in recent US history, ‘unified’ government tends to be fleeting; it has occurred in just six of the past sixteen years.
This has important implications. A lack of Congressional support could impede Trump’s programme of tariffs. More broadly, a split Congress would be likely to lead to more ‘horsetrading’ and consensus-building, with, eventually, more moderate outcomes.
Either a Harris presidency or a Congress-constrained Trump should leave the Fed room to loosen monetary policy further in the coming months. And from their current elevated levels, US interest rates have a long way to fall.
Lower US rates and, consequently, a weaker US dollar should feed through to lower rates worldwide and growing interest in the potentially higher returns on offer in emerging markets.
Lending from foreign banks to emerging market companies usually rises when lower US rates make such loans more attractive, allowing economic activity to accelerate.
A weaker dollar also tends to raise demand for commodities such as oil and metals, boosting both their prices and the equity markets of the countries that produce them – many of which are emerging markets.
For these reasons, falling US rates have historically translated into stronger returns from emerging market equities, which typically outperform their developed counterparts during rate-cutting cycles.
One exception might be China. The fortunes of the world’s largest emerging market are increasingly dependent on domestic drivers rather than external forces. We are still waiting to see how Beijing’s recent stimulus measures will play out beyond the initial excitement; in the meantime, investors might be best advised to consider China separately from other emerging markets.
Finally, a sustained rate-cutting cycle in the US is also likely to benefit mid-cap stocks in many markets. Mid-cap stocks tend to respond more vigorously to rate cuts than their large-cap peers – not only because they tend to have a greater proportion of floating-rate and shorter-term loans, but because they benefit from the unleashing of animal spirits as investors take heart and allocate away from bigger, safer choices.
We have already seen signs of this in the US, where the stock market rally has begun to broaden out beyond the mega-cap tech stocks to areas where valuations are less eyewatering. Once the dust from the US presidential race settles, there could be much more of this to come around the world.
Michael Browne is chief investment officer of Martin Currie. The vies expressed above should not be taken as investment advice.