The global impact of the US election

We consider the impact of the US election for investors around the world, the potential market implications, and the best investment approaches in the lead-up to the vote.

22 Jul 2020

A global affair

Most national elections are not global events. The US presidential election is an exception. The US accounts for more than half of the MSCI All Country World index, and the US dollar is involved in nine out of 10 currency transactions worldwide. President Donald Trump’s victory in 2016 triggered the so-called “Trump trade.” Risk assets rallied, government bonds fell, and the US dollar initially strengthened as investors priced in a combination of lower taxes, looser regulation, and higher fiscal spending.

At the start of the year, it was President Trump’s election to lose, running on a strong economy and a 50-year low in the unemployment rate. The economic disruption caused by the coronavirus pandemic has changed that. Currently, the president’s approval rating has declined, and he lags former Vice President Joe Biden in the polls.

In this publication, we consider the impact of the US election for investors around the world, the potential market implications, and the best investment approaches to take in the lead-up to the vote. However, in the very near term, we think the most important point is that both parties have an incentive to provide further stimulus before the election.

The candidates have diverging policy platforms, so our focus has been to identify scenario-based investment ideas that could perform in the event either contender wins the White House and Congress—the so-called “Red Wave” or “Blue Wave” victories. A Blue Wave, for example, would likely benefit assets exposed to energy efficiency, smart mobility, and renewables both in the US and abroad. A Red Wave could benefit select energy and financial companies as the threat of tighter regulation recedes, while space and defense companies could also do well in a Trump second term. We also recognize that some investors prefer to keep politics out of their portfolios, and so we recommend ideas for investors who wish to remain more insulated from the main campaign issues.

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Our coverage of the 2020 US elections will continue throughout the months ahead.

United States

United States

What makes this election particularly important for the United States?

The two candidates clearly have different visions for the United States. In terms of fiscal policy, President Trump is likely to seek lower taxes in a second term, or to make permanent certain provisions of the Tax Cuts and Jobs Act that are scheduled to expire in December 2025. He would be more likely to ease the financial burden on corporations in order to stimulate economic growth. Former Vice President Joe Biden, by contrast, is more inclined to raise corporate tax rates, while prioritizing broad-based spending initiatives around the expansion of healthcare coverage, boosting minimum wages, and providing more federal support for housing and education. Both candidates are in general agreement on the need for more infrastructure spending, but Biden would be inclined to tie it directly to a “green” agenda.

The candidates also espouse contradictory views on the subject of regulation. President Trump would employ a more lenient approach to regulating the energy and financial sectors. Biden is likely to adopt a more stringent approach, especially when it comes to environmental protection. When looking at foreign policy, President Trump tapped into a deep well of popular discontent regarding free trade when he first ran for office. His subsequent preference for transactional agreements in lieu of strategic partnerships has been a hallmark of his first term in office. Biden, meanwhile, has a demonstrable history of favoring traditional alliances and multilateral treaties.

What is the potential market impact?

Policy uncertainty is always an unwelcome visitor to financial markets. Therefore, a close election contest would result in a higher degree of volatility. The expansion of absentee voting in many states is another important variable because it could delay the announcement of election results.

Fortunately, we don’t expect to see the same degree of market movement that was evident in March, when the pandemic reached the US. Even in a potential Blue Wave outcome, which has become a popular subject of investors’ concerns, we would expect the equity impact to be roughly neutral, as fiscal spending would offset much of the impact of incrementally higher taxes. We do see certain winners and losers, however, depending on the final outcome. Our full scenario analysis can be found in our previous ElectionWatch, “Preparing portfolios for November.”

What actions should investors take leading up to the election?

President Trump has certainly lost ground in recent weeks. The surge in coronavirus infections in battleground states has placed him at a severe disadvantage as he prepares for his party’s national convention. And while it may be tempting to go “all in” on an investment strategy that would benefit from a Biden administration, restraint is warranted. It’s still too early to conclude with certainty that we will see a transition of power in November. Modern US presidents have successfully exploited the benefits of incumbency in their reelection bids with remarkable frequency.

Instead, investors should adhere to their strategic portfolio allocation for the long haul. There is ample time for tactical positioning in advance of the election. For those investors who want to get an early start, we have published stock lists that could benefit from either a Blue Wave or the less likely Red Wave scenario. The campaign will become more acrimonious around September, and tactical positions will become a more important consideration.

UBS Investor Sentiment spotlight

Investors in the United States

Source: UBS Investor Sentiment, 2Q 2020

Asia Pacific

Asia Pacific

What makes this election particularly important for Asia Pacific?

This election is likely to matter for Asia Pacific more than any in the past. Amid strained US-China relations, developments around trade, technology, and supply chain restrictions will be closely watched, not just with regards to China but also other export heavyweights like Japan, South Korea, Taiwan, and Singapore. In the meantime, Hong Kong is also emerging as a new geopolitical flashpoint. President Trump’s unorthodox approach to foreign relations has raised tensions, but Asian investors should not assume that pressure from the US would disappear if Trump were to leave office. Fundamentally, a great power rivalry now defines the strategic relations between the US and China. Regardless of who wins the White House, a strategy of China containment looks set to continue, driven not so much by protectionism but by national security considerations. Investors should be positioned for a future of increasing structural decoupling between the two economies. Still, Biden’s approach and tactics will likely be more nuanced, targeted, and collective, and importantly for markets, less volatile compared to Trump’s. For Japan and other Asian economies, whether the US rejoins the Trans-Pacific Partnership under Biden is of great interest, given the long-term impact on foreign direct investment. Human rights issues might also be an even greater sticking point under a Biden administration.

What is the potential market impact?

Unpredictable trade policies have led to volatility around corporate earnings. A Biden presidency might improve policy predictability, which alone could boost investor sentiment. And while tech restrictions could remain in place, Chinese stocks should benefit if imminent pressures around abrupt delistings of Chinese companies from US exchanges were to abate. Indian IT firms might also see a mild benefit if a Biden administration relaxes visa rules.

Changes in US corporate tax rates will impact Asian companies active in the US. When corporate taxes were cut under President Trump, Japanese carmakers benefited. A potential rise in taxes under a Blue Wave scenario would be somewhat negative, though any added stimulus in the US should be a boost to car and commercial vehicle producers, automation equipment suppliers, and potentially consumer tech supply chains.

For Asian currencies, a reduction in trade uncertainty and a potentially weaker dollar under a Biden presidency would be positive tailwinds. For Asian fixed income, the election’s impact on US rates will be a key driver. A Blue or Red Wave would likely result in a slightly larger increase in US interest rates and inflation expectations, thereby driving rates up in Asia Pacific as well.

What actions should investors take leading up to the election?

We expect short-term pressure on Japanese carmakers if a Biden presidency reverses earlier tax cuts, but a greener agenda would also favor environmentally friendly cars, where Japanese producers and Asian battery and equipment providers are world leading. Chinese solar companies should also benefit from the US quest for carbon neutrality by 2050. Asia ex-Japan ESG leaders—a promising investment theme in its own right—should see added momentum in a Biden win, as should our China smart infrastructure theme. If, under a Biden administration, the US pharma market opens up again to Chinese venture capital, it will benefit Chinese pharma and biotech companies with sufficient cash for product sourcing or company acquisitions in the US. On currencies, we favor the Indian rupee, and even if a wave outcome may temporarily delay spot appreciation, the yield is attractive and the Indian economy is poised to recover alongside regional ones. Asian investors should consider trimming US dollar exposure.

UBS Investor Sentiment spotlight

Investors in the Asia

Source: UBS Investor Sentiment, 2Q 2020

Europe

Europe

What makes this election particularly important for Europe?

Relations between the US and Europe have been more strained during the Trump presidency than at any time in recent memory. On trade, Europe has been caught in the crossfire of the US-China trade dispute, but is also experiencing its own tensions with the US. The threat of the US imposing tariffs on EU exports, particularly in the automotive sector, continues to linger.

The US is a very important market for European companies, both in terms of production and as an end-market. The largest European companies, on average, have around 15% of their asset base and generate around 20% of their sales in North America, most of it in the US. The impact of the elections on US economic growth, taxation, the trade conflict, and the US dollar would impact corporate earnings and the equity market.

The taxation of digital companies is another area that will be affected. The EU has chosen to approach this issue through multilateral channels via the OECD, although it is also pressing ahead with it unilaterally. The measure is meeting stiff resistance from the current administration, but this may change if the US presidency also changes.

What is the potential market impact?

All paths point to a weaker US dollar against the euro and a stronger British pound in the months ahead. The election will give investors much to mull over, and a period of uncertainty could help the dollar’s safe-haven status to hold ground.

Depending on how the election turns out, various European industries will be affected. On the trade front, export-driven sectors including certain industrial companies, automakers with complex global supply chains, and luxury goods brands will be impacted. Should tariff fears reemerge, the market would react negatively as we think this headwind is currently only marginally priced in. Beyond trade, US policy direction on healthcare may affect the pharma sector, which includes some of Europe’s largest companies by market capitalization. Given the importance of the US market for their profitability, any election outcome perceived to be unfavorable to drug pricing would affect the sector and the overall European market.

What actions should investors take leading up to the election?

Investors should consider investing in sectors and companies that have little or no US exposure, or otherwise would not be affected by any election outcome. These are often in the more domestically oriented sectors like utilities, or in the more stable and defensive sectors like consumer staples. Investors should also look at some of CIO’s long-term investment themes like genetic therapies or automation and robotics, which are driven by structural trends like increased urbanization, aging, population growth, and a less globalized world, rather than by election outcomes. Investors may also consider strategies, if they are able to implement them, that aim to benefit from increased volatility in the run-up to the elections by optimizing either the entry price into certain investments, or earning a decent yield while they wait. Last but not least, investors could focus on areas that should do reasonably well in any election outcome, such as companies and sectors exposed to infrastructure and technology investments.

Independent of the strategy they pursue, investors should diversify across asset classes, regions, sectors, and companies. Having a well-diversified global portfolio reduces the overall volatility linked to any election outcome.

UBS Investor Sentiment spotlight

Investors in Europe (except Switzerland)

Source: UBS Investor Sentiment, 2Q 2020

Switzerland

Switzerland

What makes this election particularly important for Switzerland?

As a small, open economy, Switzerland is dependent on having stable trade relations with other countries. Goods and services exports account for around two-thirds of Switzerland’s gross domestic product, and the US is one of its most important and growing export markets. Switzerland is also the seventh-largest foreign direct investor in the US. The US presidential election is therefore important for Switzerland and its many large international companies, especially during the current cycle when the vote will influence the direction of policy issues such as foreign trade and taxation. The outcome will also determine how the US administration will view the Swiss National Bank’s currency market interventions going forward. Having conducted up to CHF 100bn worth of intervention since the start of the pandemic, the SNB has hit all three thresholds for the US Treasury to brand the country a currency manipulator.

What is the potential market impact?

Periods of heightened uncertainty and political risk tend to create pressure on the Swiss franc to appreciate due to its status as a safe-haven currency. This may be more pronounced if the source of the uncertainty involves the ultimate safe-haven currency, namely the US dollar. The dollar-franc exchange rate has traded between 1.02 and 0.95 over the last five years and recently moved below this trading range. We may therefore see bouts of CHF strength in the run-up to the election. We think a new lower trading range between 0.90 and 0.95 is likely to be established over time.

Apart from currency strength, Swiss equities may be affected by a renewed flare-up in trade rhetoric ahead of the election. Most of the Swiss Market Index’s multinational companies generate only a small portion of their earnings in their home market, so rising trade tensions usually don’t bode well for them. Also, potential changes to corporate tax policy would affect Swiss listed companies, as we estimate that their tax exposure to the US account for up to a quarter of their total corporate taxes. On the other hand, the Swiss Market Index has a defensive sector bias, being dominated by pharmaceuticals and consumer staples while IT-related stocks are significantly underrepresented in the index.

What actions should investors take leading up to the election?

First, Swiss investors should closely monitor the currency dimension. Should the dollar-franc exchange rate move above 0.96, one should consider hedging dollar positions in a portfolio; on the other hand, drops to or even below 0.90 might be used to add dollar exposure or to unhedge existing positions. Second, we advise diversifying portfolios by regional and sectoral exposure as a way to protect them against election-specific risks. For a typical Swiss investor, this means seeking winners in other markets such as Asia, or in European sectors that have a competitive edge as outlined in our latest “Doing business in Europe” report. Swiss investors with a strong home bias typically are significantly underinvested in the IT sector, and should therefore consider investing along the lines of the recommendations in our “The Future of the Tech Economy” report.

UBS Investor Sentiment spotlight

Investors in Switzerland

Source: UBS Investor Sentiment, 2Q 2020

Emerging markets

Emerging markets

What makes this election particularly important for emerging markets?

We expect the US elections to impact emerging markets through three main channels. First, changes in key US macroeconomic variables. Emerging market assets are sensitive to US GDP growth, inflation, interest rates, and the overall direction of the US dollar, all of which will likely be influenced by the outcome of the election, particularly in the event of a Blue or Red Wave. That said, it is not unusual for emerging market assets to experience strong price moves in the immediate aftermath of the election and later return to their equilibrium levels. This can create opportunities, but also risks. Second, trade policy. US presidents have the authority to shape the country’s commercial relationships with the rest of the world, and the US has exerted great influence on the overall path of global trade policy in the postwar era. This matters greatly for emerging markets, as their share of world trade today roughly equals that of developed countries. Finally, geopolitics. The way the US handles its relations with China, Mexico, Venezuela, Russia, Turkey, and Saudi Arabia, among others, could be quite different depending on who wins the presidency.

What is the potential market impact?

Taking the above factors into account, an outcome of a unified US government—irrespective of who is elected president—is more likely to result in macroeconomic developments that are more favorable to emerging market assets than a divided government would. These could include higher expected fiscal spending, faster growth, and higher inflation expectations and interest rates.

A divided US government—one that makes enacting tax and spending legislation more difficult—would likely result in a more muted macro impact. Geopolitical tensions between the US, China, and other major emerging markets will continue to exist irrespective of the election outcome, but a Biden presidency may reduce US external policy uncertainty, improving the visibility on the outlook for emerging economies. The former vice president may be more reluctant to use tariffs as a trade policy tool, and seems likely to take a more globalist approach, both of which would be supportive of emerging market assets. Who sits in the Oval Office in January 2021 therefore matters for emerging markets.

What actions should investors take leading up to the election?

Investors should build portfolios resilient enough to perform well in a wide range of scenarios, rather than take concentrated positions that would benefit in a particular election outcome. Emerging market assets should play a central role in such portfolios, as they help mitigate home bias, promote geographic diversification, and tend to contribute to higher returns than a portfolio without them. In our baseline scenario, we expect equity returns in emerging markets to surpass those of other markets in the coming years, as reflected in the 9.2% annualized total returns on the asset class factored in our Capital Market Assumptions.

Emerging market fixed income should continue to deliver solid risk-adjusted returns. More tactically, we maintain US dollar-denominated emerging market sovereign bonds as one of our most preferred asset classes. Their 5.5% yield, based on the JPMorgan EMBI Diversified index, provides good carry in a yield-starved world, and we think further spread compression is likely as countries bring the virus under control while commodity prices trade higher in the coming quarters. That said, following the 250-basis-point spread compression the asset class has experienced since late March, it would pay to be more selective. Oil and gas bonds, for example, provide opportunities across the rating and maturity spectrums.

UBS Investor Sentiment spotlight

Investors in Latin America

Source: UBS Investor Sentiment, 2Q 2020

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