In a surprising twist, US President Joe Biden ended his re-election bid, endorsing Vice President Kamala Harris as the Democrat presidential candidate. This unexpected move sent ripples through financial markets, leaving investors scrambling to gauge whether it boosts or diminishes Donald Trump’s chances of reclaiming the White House.
In the wake of Biden’s announcement, the ‘Trump trade’ has re-emerged, sparking gains in small cap, financial and energy sector equities as investors price in a potential Trump victory.
The election uncertainty is stirring investor anxiety. The prospect of sweeping changes to foreign and fiscal policies and regulation and increased trade protectionism under a Trump presidency adds to the complexity. While betting odds and polling offer some insight, the narrow margins in key swing states make the outcome highly unpredictable.
Three scenarios
A Democrat President with a gridlocked Congress would likely maintain the status quo, with Republicans continuing to stymie significant new policies, as seen since the 2022 midterm elections. This policy gridlock scenario appears the most neutral for markets in the short-to-medium term, in our view. However, risks from unilateral executive actions remain.
Investors, therefore, should focus on the risks associated with a Republican President or a Republican sweep of both houses of the US Congress as these scenarios would mark a substantial departure from the current status quo.
If Trump regains the White House but faces a divided Congress, the impact on markets could still be significant. Trump's use of executive orders to bypass legislative gridlock could lead to major policy shifts in trade, immigration, and energy policies. During his first term, Trump issued over 200 executive orders, averaging 55 a year, the highest among presidents since 1977.
A second Trump term could see heightened protectionism leading to broader trade conflicts. Trump has proposed 60 per cent tariffs on Chinese goods and 10 per cent on others. These measures could raise the average US import tariff to around 16 per cent and increase inflation by around 1.8 per cent over two years.
While the initial impact seems modest, second-round effects and supply shocks could be significant, straining global trade and increasing market uncertainty.
Shock scenario: A Republican clean sweep
A Republican sweep of the White House and both houses of the Congress could bring significant policy changes. These potentially include further cutting corporate taxes (the 2017 corporate tax cuts are permanent) and making individual tax cuts permanent. These policies would boost corporate profits and consumer spending but could widen the fiscal deficit, in turn driving bond yields higher, while hurting the dollar.
A Republican administration might also deregulate sectors such as energy and finance and generally encourage more business-friendly regulation under new Federal Trade Commission and Department of Justice leaders.
Reversing Biden’s environmental policies could boost fossil fuel production, while easing vehicle emissions standards could favour traditional automakers over EV manufacturers.
Tighter immigration policies
Immigration policies could also see drastic changes under Trump. While President Biden’s tighter border rules have not had a major impact on reducing immigration, Trump could enforce stricter controls, impacting labour supply and pushing up wages and inflation and ultimately delaying Fed rate cuts.
Industries reliant on immigrant labour, such as agriculture, F&B, and construction, could face higher costs and operational challenges.
Trump’s aggressive foreign policy could exacerbate global tensions. Increased scrutiny on US financial and military aid might lead to reduced support for Ukraine, potentially emboldening Russia. Threats to withdraw from NATO could test the alliance’s unity, while a less-involved US military engagement abroad might aggravate China-Taiwan tensions.
These moves could drive up defence spending by NATO allies and increase market volatility.
Market implications
From a market perspective, Trump’s policies could initially favour US assets and the USD. The 2018-19 trade conflict saw the Chinese yuan depreciate, offsetting some of the tariff impact. A strong dollar could also weigh on cyclical currencies, given the global growth drag from increased uncertainty. Financial, small cap, and energy sector equities might see short-term gains from deregulation, although economic conditions are likely to drive longer-term moves.
A Democrat President with a divided Congress is the most market-neutral scenario, ensuring policy continuity in infrastructure, clean energy, and technology investments. However, the 2017 personal tax cuts are likely to expire in 2025, and stricter financial regulations could impact banks and asset managers.
Antitrust enforcement on technology sector leaders is likely to continue. Policies supporting clean energy and infrastructure development will likely persist.
Navigating uncertainty
Historically, US election years see higher volatility as investors seek protection. Yet, US equities have usually performed well, with the S&P 500 index posting negative returns in only six of the last 24 election years, averaging 7.5 per cent returns.
Markets tend to favour the status quo, delivering better returns when the incumbent party retains the presidency. They also perform well during periods of a divided Congress.
This time, the outcomes of the US House and Senate elections will crucially influence short-term market performance. A divided government could see Trump leveraging executive powers on trade and tariffs, affecting global equities, especially in Europe and China.
In the event of a Republican clean sweep, monitoring the sequence of policies will be crucial. Prioritising immigration and tariff restrictions over tax cuts could negatively impact risk assets.
For investors, staying strategically invested across geographies and assets, while remaining adaptable, can help reduce portfolio volatility and position for growth, regardless of the election outcome.
