Summary: In the bigger scheme of things, the US election should be considered by investors as a short-term disruption. But there are potential longer-term structural implications, depending on who wins.
Key take-out: An inflation surprise shouldn’t be overlooked. The imbalance that exists between North Asian and Western economies is structural, and will have to be resolved at some point in time.
Key beneficiaries: General investors. Category: Strategy.
Predicting the outcome of popular votes is becoming increasingly difficult it seems.
A majority of pundits and pollsters have forecasted that Donald Trump will not win the Republican nomination, that the 2015 British parliamentary election would yield a close result and that Brexit wouldn’t pass – all of which turned out to be wrong, of course.
Nate Silver, who successfully called the outcomes in 49 of 50 states in the 2008 US Presidential election, and 50 out of 50 in the 2012 one, currently gives Hillary Clinton an 87 per cent chance of winning. Note that the popular vote is predicted to be much closer (Clinton 49 per cent vs Trump 43 per cent), but the chance of Clinton winning, by any margin, appears at the time of this writing to be quite significant.
However, knowing that any election (and this one in particular) can yield a surprise, and that a 13 per cent probability is still statistically significant, it is our responsibility to take an impartial look at the economic and portfolio implications of both outcomes.
Doing so is a necessary but perilous exercise for several reasons. For once, candidates rarely keep their election promises, so using their program as a starting point has its shortcomings. Furthermore, predicting the long-term economic outcomes of policy changes is another imprecise “science” that specialists tend to get wrong as often as right.
Luckily for us, in this particular instance, there’s much to be learnt from the broad strokes of each candidate’s plan, the positions that define them and on which they have (so far) not wavered.
The Clinton and Trump economic policies
For the sake of simplicity, let’s define Clinton as the “continuation” candidate, who is most likely to pursue policies in line with those of the Obama administration and those that preceded it. On the other hand, Trump’s signature economic policy seems to be his willingness to impose tariffs on low-cost producers like Mexico and China, thereby reversing decades of progresses towards freer global trade.
Let’s take a step back and acknowledge the existence of two economic models: the “Western” one, notionally based on free market economics, and the “North Asian” one. The latter has been used to various degrees and at various times in countries such as Japan, China, South Korea, Taiwan, Thailand and Vietnam. It is characterised by a planned economy where the primary objective is full employment rather than profit maximisation.
That is a seemingly small, but very important difference. If the government’s primary goal is to give a job to the vast majority of the working age population, it needs to produce a lot of “stuff” to keep all these people employed. Therefore, it also needs to sell all of this “stuff”, no matter the price.
The North Asian economic model therefore tends to produce goods at uneconomic prices, with which freer market economies can’t compete. How they are able to achieve this could be the subject of an entire separate article, but suffice is to say that reliance on cheap and plentiful credit (often from the very same developed markets which buy their products) is a necessary component.
Starting in the 1990s, North Asian economies have gradually integrated themselves in the international trade system, which has logically led to them gaining market share in manufactured products away from Western-styled economies. This story should now begin to sound familiar and its link to the US election more obvious.
Blue-collar workers have gradually lost their jobs and their earning potential has diminished, turning a middle-class into a population of disaffected voters. Like other populist politicians in Europe before him, Trump has tapped into this anger. Whether opportunistically or accidentally, he has accurately identified the origin of their problems and is offering to reverse them.
What would be the immediate effect of tariffs on Chinese goods? Among other things, it would increase the goods’ prices, leading to a rise in inflation. And this is where the problems start, because financial markets are by and large priced for a “lower-for-longer” scenario, that is, lower growth and lower inflation. Interest rates are low, sovereign bond prices are high, equity markets trade on elevated valuations, long duration assets (such as properties and infrastructure) are prised, all based on a low inflation scenario which Trump’s election could overturn.
The portfolio implications
Now let’s focus on portfolio implications. You’ve probably heard us say that as a long-term investor, you should focus on the long-term return potential of your investments and disregard shorter-term disruptions as much as possible.
An inflation surprise should not be overlooked as market “noise”, but the US election certainly is. In other words, the imbalance that exists between North Asian and Western economies is structural, and will have to be resolved at some point in time, one way or another.
Trump’s election may or may not be the trigger, but the possibility of an inflation surprise exists regardless, and could just as conceivably occur under a Clinton administration. The powers of American presidents are actually quite constrained and they are victims rather than shapers of economic forces.
We’ve started accounting for the possibility of an unexpected rise in inflation over a year ago by reducing exposure to sovereign debt and properties in the InvestSMART diversified portfolio.
As always, we continue to monitor these long-term factors and may make further changes if required, but that is unlikely to occur as a result of the November election, regardless of how much markets over-react in the short term.
Jonathan Tolub is a director of InvestSense.