US elections – Local manager research views

We do this with reliance on our tried and tested investment process and philosophy. We continuously remind all our clients of this as best we can – not just during election years. We continue to remind our clients that successful investing demands a price. But its currency is not rands and cents. The currency is volatility, fear, doubt, uncertainty and regret. The reality is that the more things change, the more they stay the same and staying invested within the appropriate investment mandate is the only way to achieve your goals over time.

We expect short-term volatility in the markets but at the end of the day, investment decisions will be based on our valuation principles, and we stand ready to allocate to undervalued assets and asset classes during the uncertain election times. We have demonstrated our ability to move quickly within our portfolios when we see large market price dislocations.

Given that the portfolios are already well diversified and positioned for an elevated risk environment generally (the US election is only one of many risks that lurk, both visible and invisible), we are not adjusting our portfolios in preparation for any particular presidential candidate to win. Importantly, the portfolios already have meaningful levels of liquidity with which to exploit any possible opportunities that a spike in market volatility might create.

However, as there are many cross-currents currently facing investors (local political dynamics and the MTBPS; global geopolitics and Chinese stimulus – as well as the recent BRICS event), focusing only on the impact of a US election outcome (which is not guaranteed to be released next week, should there be objections to the results), could see us miss the wood for the trees.

We therefore endeavoured to build robust portfolios that should be passable in most outcomes. To do this, we focused on:

•              Understanding the risk premium currently baked into asset classes and whether or not that is sufficient given all the risks on the horizon.

•              A high degree of diversification across asset classes, geography, individual security, and risk drivers with the key principle of having offsets in the portfolio.

•              Overlaying hedging strategies to protect on the downside.

•              Seeking preferential parts of the capital structure to invest in, again assisting in downside protection.

•              Having a larger bias than usual for higher quality companies with strong balance sheets

At the moment we are alive to the many risks, globally and locally, and are positioned relatively conservatively across all our multi-asset funds.

Trump administration scenario:

·         Republican control of both Congress and Senate would strengthen policy implementation capability.

·         Potential heightened trade tensions could create headwinds for emerging markets.

·         Focus likely to remain on America-first trade policies and protectionist measures.

Harris administration scenario:

·         Expected continuation of current Biden administration’s economic policies.

·         Maintenance of existing international trade relationships.

·         Continued emphasis on domestic industrial policy and manufacturing incentives.

·         Potentially more favorable environment for global trade relationships.

Given the significant uncertainty surrounding both the election outcome and subsequent policy implementation, we maintain our neutral positioning. We will reassess our strategic allocation once there is greater clarity on the political direction and specific policy initiatives.

We know that short-term market volatility is inevitable and even if one has perfect investing foresight, this won’t help to side-step portfolio drawdowns. We looked at a hypothetical portfolio of only guaranteed winners which shows that it too had to navigate meaningful drawdowns that took long to recover from. Unfortunately, volatility is the price of admission for successful long-term investors and elections bring volatility.

Any material weakness in local assets will more than likely create the opportunity to scale back into risk.  The cause for such a move could be overstated in the long-term, with the assumption that the worst policy promises were either part of electioneering strategies or at best could take long to implement, if indeed they come to pass (think trade tariffs, or cancelling of trade agreements).

Alternatively, a ‘sell-the-rumour’, ‘buy-the-fact’ sharp rally in the aftermath of the election could bring into play opportunities to rotate into longer-term diversified strategies with a view on the potential rising risk of a reflation cycle.

This type of volatility presents investors with opportunities but also pitfalls.

A Harris presidency is likely to maintain current policies, signalling continuity in both domestic and foreign policy. A second Trump presidency, however, we see as having a major impact on markets and the world order.

A Trump presidency could initially result in a stronger dollar for three reasons:

·         Proposed tariff hikes on trading partners (60% on China and 10-20% for all other countries) would lower demand for imports and improve the US trade balance.

·         The tariffs would be inflationary which would put pressure on the US Fed to keep short-dated interest rates higher, increasing rate differentials to other currencies.

·         Proposed capital gains tax reductions would lead to an even wider budget deficit resulting in increased issuance of US Treasuries and higher bond yields.

Over the medium term, however, we see potential risks for dollar weakening. Firstly, Trump has made comments that put a question mark around the independence of the US Fed under his presidency. Any doubts around this could shift faith in the strength of the currency. Secondly, we also see a risk that US protectionist policies will not only face retaliatory policies from trading partners, most notably China, but may also accelerate efforts by China and its allies to seek alternatives to the dollar and US Treasuries for recycling their financial trading surpluses. This includes moves to develop a new BRICS currency (dubbed “the Unit”). While we can’t see the dollar being replaced as the dominant reserve currency of the world, at the margin this could still mean a weaker dollar in the longer term.

·         Potential reduction in US foreign direct investment into emerging markets.

·         Risk of capital repatriation to the US given potential tax incentives.

·         Possible slowdown in cross-border investment flows.

·         Higher risk premiums for emerging market assets.

·         Potential pressure on emerging market currencies.

·         Reduced portfolio flows from US institutional investors.

Sequencing matters: Economic and market impacts will depend on the order and magnitude of these policies, making it challenging to assess the combined growth and inflation impacts.

The clearest equity market impacts are via changes to tax policy and tweaks to the Inflation Reduction Act, while macro impacts are likely to be largely a result of policy choices in areas like tariffs and immigration (as well as tax or fiscal policy).

It is probably a stretch to say that all emerging markets will be at risk of significant outflows if Trump wins with a ‘Red sweep’, but it would at the same time also be naïve to think a material further weakening of USTs will not be followed at least partially, in sympathy, by emerging market debt markets. Again, our opening remarks stand. If SA sells off aggressively on a US election outcome, in all likelihood such a move should be seen as a fade. Many of the policies Trump has threatened, will be tough to implement, or at least may take some time. Markets will eventually find something else to be either cheerful about or fearful of.

In summary then, in the days following the election, all bets are off the table in trying to call direction or magnitude of moves – which is why we are being tactical in our approach into the election. But in the weeks that follow, the dust should eventually settle, with fundamentals coming to the fore again.

Sentiment towards emerging markets that are dependent on foreign investment is also vulnerable to potential geopolitical instability under a more unpredictable and hostile US foreign policy driven by the motto “America First”.

On the other hand, a continuation of existing policy under a Democratic win would provide more certainty and could support increased foreign direct investment into South Africa.

Geopolitical risks remain heightened as a result of the ongoing conflict in the Middle East and the Russia-Ukraine war; a big election year creates further uncertainty (the result is usually market price dislocations); and increasing polarisation and protectionism is likely to be inflationary. It also increases political risk. Gold has been strong in response to geopolitical risk and moves by the US to weaponise the US dollar after the Russian invasion of Ukraine.

Regarding other commodities, demand should outstrip supply for many of the industrial (green/AI) related sectors in years to come.

In a reflating economic environment, the outlook for commodities should become more constructive, irrespective of who occupies the White House.

To the extent that a Trump presidency indeed leads to increased protectionism, higher trade barriers and increased uncertainty, this would likely have a negative impact on both investor confidence and global economic activity, which could also slow demand for commodities. However, increased tensions could also see a short-term demand boost from a desire to rebuild strategic commodity reserves.

·         High probability of broad-based import tariff implementation.

·         Potential significant increase in trade barriers across multiple sectors.

·         Likely negative implications for global trade volumes and economic growth.

·         Risk of retaliatory measures from major trading partners.

Harris administration:

·         Expected continuation of current multilateral trade approach.

·         Lower likelihood of aggressive tariff implementation.

·         Focus on strategic trade relationships while maintaining existing frameworks.

·         More predictable global trade environment.

These differing trade policy stances could have meaningful implications for global supply chains, corporate profitability, and international capital flows. We continue to monitor these developments and their potential impact on portfolio positioning.

However, such tariffs will inevitably be reciprocated by the nations they are imposed on, and result in a trade war which escalates trade restrictions between the countries involved. Economically, this disrupts global supply chains and increases costs for businesses and consumers and slows down economic growth.

Higher import costs are inflationary and reduce consumer spending, while exporters face reduced demand. Over time, prolonged trade wars harm all involved, reduce international cooperation and encourage a shift toward protectionism. It is hard to predict how a trade war develops over time, to the extent it escalates or deescalates.

If Harris wins:

·         More supportive environment for emerging markets like South Africa.

·         Stable global trade framework benefitting SA’s export sectors.

·         Enhanced focus on green energy transition, aligning with SA’s renewable energy goals.

·         Possible increased investment in SA’s critical minerals sector, given clean energy push.

·         More predictable policy environment, supporting international investment flows.

If Trump wins:

·         America-first manufacturing policies could boost demand for SA raw materials.

·         Higher US rates could highlight SA’s attractive yields.

·         Increased global uncertainty might support gold and PGM prices.

·         Regional trade relationships could become more important.

These opportunities would need to be viewed alongside SA’s domestic reform progress and global market conditions.

The US Fed surprised by cutting rates by 50 bps in one move – although the US economy remains in good health, inflation is seen as low enough; and we do not anticipate interest rates going anywhere near levels reached in the period of zero rates.

South Africa may also benefit on a relative basis from trade deflections in terms of lower import prices, as China would look to replace lost demand for its products. However, this may hurt certain local manufacturing that will be unable to compete with lower prices.

However, South Africa’s largest trading partner is China so any slowdown in China is likely to also be negative for South Africa’s economy. Thus, we see a Harris presidency as the most positive for local markets.