Impact of the U.S. elections on the markets

Sébastien: Hello and welcome to the In Your Interest podcast. My name is Sébastien Mc Mahon and since our friend Ashleay can't make it today, I'll be hosting this week's episode on my own. But I am with a very good friend. Welcome, Alex Bellefleur, Senior Vice-President, Head of Research of the Asset Allocation Team at iA Global Asset Management. So hello, Alex.

Alex: Hi, Sébastien. Thanks for having me.

Sébastien: Sure. It's a pleasure to have you. We'll be talking about the impact of the U.S. election on the markets. So, the election is in about a month. We're recording this at the end of September, so still some uncertainty, but we thought the time was right to discuss this on the podcast. So, you and I, we keep discussing macroeconomy. We keep discussing politics and the impact on our portfolios in the markets. So, I'm just going to send you the first question: What does this election mean for investors and markets?

Alex: Big question. So, I think it means a lot of things, and the main reason why that's the case is if you look over the last few years, fiscal policy has played an ever-greater role in both the economy and markets, as there's generally been an expansion of the role of government in the United States in economic policy. So, for example, if you go back to the first Trump presidency, what you saw at that time was a resurgence in protectionist measures to really put tariffs on China. When Trump launched a bit of a trade war with China, you'll remember his comment that trade wars were good and they were easy to win. And so he slapped massive tariffs on China. What you also saw under Trump was major personal and corporate tax cuts that really expanded the size of the U.S. fiscal deficit at a time of economic expansion. So, this was pretty new. We hadn't really seen this for many years. So, the role of fiscal policy was greater. If you fast forward to the Biden administration, what you saw there was that in response to the geopolitical and economic competition with China, you saw a massive resurgence of industrial policy. So, the Inflation Reduction Act led to a whole bunch of subsidies to economic, industrial sectors that were considered to be strategic: things like electric vehicles, batteries, solar panels, etc., to lead to the decarbonization of the economy and so massive expansion of government in the economy. So, when you look at this, in this particular election campaign, we have very large policy differences, I would say, between the candidates in terms of regulation or taxation. So, the Democrats generally are in favour of more environmental regulation and probably higher corporate taxes as well, whereas the Republicans are in favour of deregulation and lower taxes. But the other interesting aspect, there's actually a lot of similarities between the two candidates. I'm not hearing anyone talk about reducing the size of the deficit on the campaign trail. Both candidates have proposals that will likely expand the deficit from where it is, and that has a big impact on the economy. And secondly, in terms of protectionism, I would say that none of the two candidates are talking about reducing tariffs on China. I think, if anything, the trade war with China will probably get a little bit more intense going forward. So, in an environment that's potentially more inflationary, these policy differences, but also the things that are similar in terms of policy have a big impact on the economy, but also on the bond market, which is watching those elections with a bit of nervousness, I would say, at this point.

Sébastien: Yeah, you're completely right that markets are dependent on the outlook for growth and the outlook for inflation. And as you summarize very clearly here, this election can have an impact on both sides of the ledger. It could have an impact, accelerate or slow down real growth, and also could be inflationary or less inflationary. So, this is why the markets truly care about this coming election. Just like pretty much each one in the past, but this one might be a bit more loaded in terms of consequences here. And we've been discussing geopolitical aspects of this election and also the importance of geopolitics in today's world for the last few years now, could you maybe summarize how this election should impact the geopolitical scene?

Alex: Absolutely. So, geopolitics made a big comeback over the last few years with the Russia-Ukraine war and all the, I guess, the alliances that came out of it. I think looking ahead, probably the most important geopolitical dynamic that we're going to see is the increased competition between China, which is the rising power, and the United States, which is the incumbent or the established power. In the first Trump administration, as I mentioned earlier, a lot of tariffs had been put in place. But what was interesting is that Biden and the Democrats in the current presidential administration didn't roll back any of these tariffs. In fact, they adopted roughly the same approach as Trump, I would say, to dealing with China, which was to tackle the China “threat”, quote unquote, economically speaking, with trade restrictions, export restrictions and also import restrictions. So, if you look at how we are likely to deal with China going forward, my expectation is that you're going to see continuity. Maybe a slightly more aggressive approach in the case of Trump, but overall, I think both parties are very aware of the increased competition with China, and they're both sort of tackling this with trade restrictions. I would say that in terms of geopolitics, the other big topic right now is the Russia-Ukraine war. And this actually has implications for how the China-U.S. competition is going to unfold because of China's sort-of desire to reintegrate Taiwan into the People's Republic of China. In the case of Russia, Ukraine, I think that Harris is more likely to continue to help the Ukrainian war effort by funding the Ukrainian military, whereas Trump on the other side has said that he wants to end the war on day one and would likely lead to a peace settlement that would be much more favourable to Russia, where Russia would, quote unquote, “win” the war in Ukraine. If you link this back to the China-Taiwan issue in Asia, one could wonder whether the Trump approach would embolden China to potentially make a move on Taiwan over the next few years. The U.S. has historically cultivated a bit of a strategic ambiguity as to whether they would defend Taiwan in the case of a Chinese aggression. So, if you have a bad peace settlement for Ukraine, does that lead to China maybe adopting a more aggressive approach with Taiwan? This is of paramount importance because Taiwan is one of the biggest producers and exporters of semiconductors in the world. And, as we know, semiconductors go in literally every product that we consume now, from cars to computers to smartphones, etc. and this could have a big impact on global growth and global inflation. So, this is definitely something to watch going forward. How the two candidates talk about how to deal with the competition with China.

Sébastien: Yeah, and we've been discussing the presidential election here. But also, let's not forget that in November, polls are suggesting that we could have a change in the leadership in the majority in the Senate and also in the House of Representatives. And, you know, the U.S. government – we've discussed it a few times in the past in this podcast here – it's quite different from the government setup in Canada. So, if we have a landslide win for the Republicans or the Democrats, then that would be when you would have the most impactful scenarios. But we are looking right now, if you look at the polls, at probably a divided government and divided governments tend to be, let's say, more friendly to the markets, or at least markets tend to prefer that. So, can you explain the kind of market scenarios that we could see in those cases? And after that, you know, talk about how our team as investors, how we position currently for any given one of those scenarios?

Alex: Of course, you raise a great point, Sébastien. The balance of power in Congress is likely more important than simply knowing who's going to be the president, because in order to implement an economic agenda, the president needs a unified Congress in their favour. So basically, if you have a divided Congress, it's going to be very difficult to push forward a very aggressive fiscal agenda either way. Currently, as it stands, if you look at how markets are pricing in those probabilities, the scenario of a Republican sweep where you have a Republican president, a Republican House and a Republican Senate is estimated at about a 30% probability. And the scenario of a Democratic sweep is estimated at about a 20% probability. If you look at the Republican sweep, that's probably a more inflationary environment. So what you would likely see in this case is personal and corporate tax cuts and expansion of the government deficit. And you would likely see a lot more Treasury bond issuance in this case, which might push long-term interest rates a little bit higher. In the case of the Democratic sweep, what you're likely to see is probably corporate tax hikes and more environmental regulation, which would be seen as a little bit more negative for corporate profits, but potentially a little bit less inflationary than the Republican agenda. So how are we positioning ourselves in this context? Look, currently the result is extremely uncertain. If you look at probabilities, in terms of winning the popular vote, the market thinks that there's a little bit more of a chance of Harris winning the popular vote. But as we know, the election isn't decided on the popular vote. It's decided in the Electoral College, which actually favours the Republicans a little bit. So, it's very hard to have a lot of conviction in terms of who becomes president. And for that reason, I would say that our approach currently is to not take a huge bet either way and more to build portfolios that are resilient in a different variety of economic environments to avoid being too dependent on the result of the election. That being said, we remain very much in tune with trends in polls, in the pricing of those probabilities, and we're ready to act. For example, if we were to see that there was a big pro-Trump tendency in the polls, one thing we might do would be to take positions that are a bit more inflationary in portfolios. So, things like commodities, maybe underweighting government bonds, overweighting more cyclical stock market sectors in order to benefit from that. If we were to see Harris sort of break out in the polls and, you know, do better and potentially show that she was becoming president, one thing we might do would be to go a little bit more overweight bonds and, you know, to the extent that there might be a bit less inflation than in a Trump scenario. For example, if Democrats were to control Congress, which, as I mentioned earlier, is seen currently at about a 20% probability, you might see corporate tax hikes. And the equity market may not necessarily like that going forward. So, it would favour bonds, I would say, over stocks. So that's roughly where we are: I would say that it's very difficult to have a lot of conviction right now. It's pretty much 50/50 at this point. But we watch this very closely and remain ready to act in any case.

Sébastien: Yeah. And as you said, we're recording this at the end of September. It's still pretty much a coin toss. The momentum seems to be favouring Kamala Harris now. But, you know, it's an eternity in politics, 4 or 5 weeks that are left before we have the election. So, thank you very much, Alex, for simplifying a topic that is complex. I think everyone listening to this will appreciate and will feel enlightened on the impact of the U.S. election results on the markets.

Alex: You're welcome. Thanks for having me.

Sébastien: So that concludes today's episode. A big thank you to our listeners as well. Don't hesitate to write to us if you have any questions. And in the meantime, we'll see you next week.

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