Polls apart? What will the US election mean for global markets?

A Republican reversal?

We have noted that emerging market equities outperformed US equities under George HW Bush. A major factor in this was the Brady Plan¹, which helped developing countries restructure their debt after a wave of defaults² – notably in Latin America. The Brady Plan encouraged these countries to implement economic reforms, making their markets more attractive to international investors. In doing so, it accelerated the wave of liberalisation that swept across emerging markets after the end of the Cold War.

Meanwhile, the US economy underwent a recession in 1990³, which dampened the performance of its own market even as the potential of emerging markets was unleashed.

The next Republican presidency, that of George W Bush, was also marked by US-led efforts to reform and internationalise emerging markets, in this case China. In December 2001, Bush signed a proclamation granting China permanent normal trading relations with the US. This facilitated China’s entry to the World Trade Organisation and led to increased foreign direct investment.

Throughout Bush Junior’s tenure, China focused on investing in its domestic economy and infrastructure at a time when the US was increasingly preoccupied with the ‘War on Terror’. On top of this, the bursting of the ‘dot-com’ bubble cast a long shadow over the S&P 500’s performance. Its impact was compounded by the global financial crisis of 2008, which entirely erased the recovery the US stock market had made since its trough of 2002.

The period was also characterised by significant technological advancements, including the rollout of broadband, with a surge in demand for metals such as copper. The accompanying commodity boom benefited producers in emerging markets, as did China’s rapid urbanisation.

In some important respects, Donald Trump’s presidency marks a break with his Republican predecessors. Where the Bush presidencies had both focused on engagement with emerging markets and China, Trump took a markedly protectionist stance, characterised by his imposition of heavy trade tariffs on China. But with Beijing pumping in economic support and fiscal stimulus, the Chinese economy proved resilient. Chinese shares were also seen as undervalued3, which helped to boost stock prices in Shanghai, Shenzhen and Hong Kong.

At the same time, we should note that the MSCI ACWI ex US, EAFE and EM indices underperformed the S&P 500 during Trump’s presidency. China aside, non-US stock markets struggled with wider disruptions of trade, the strength of the US economy and dollar, and the very robust performance of US technology stocks.

Democrats – making their own luck?

When we look at the relative strength of the US stock market under the Democrats, we might observe that there’s an element of luck in the timing of events. The S&P 500’s strikingly robust performance under Bill Clinton owed much to his administration’s focus on fiscal discipline, reducing the deficit and promoting technological innovation.

These contributed to economic expansion and in turn led to strong stock-market returns. But it was also under Clinton that the dot-com bubble was allowed to inflate. Bush Junior’s very narrow victory over Al Gore meant that a Republican administration had to absorb the aftermath.

Barack Obama began his two-term presidency in 2009 in the wake of the global financial crisis and the midst of the Great Recession. His swift response, in the form of the Recovery Act, helped to kickstart the longest bull market in US history⁴.

We might note that Obama’s stimulus packages and the Fed’s programme of quantitative easing can be seen to have done more for the US stock market than the economy itself; growth remained relatively subdued even as shares sustained their long upward march.

The strong performance of the US market under Joe Biden stands in marked contrast to much of the rest of the world, with negative returns from emerging markets – especially China – and subdued returns elsewhere.

The Biden presidency has been characterised by massive external disruptions, including the latter stages of the Covid pandemic and Russia’s invasion of Ukraine. But the US market coped much better than its international peers with the rampant inflation and high interest rates that followed.

The US as global rate-setter

That brings us to a key point. Tighter monetary policy is a hurdle for the US stock market. But high US interest rates and a strong US dollar tend to weigh more heavily on the performance of international markets – and especially emerging market equities.

Here, we should acknowledge the extraordinary dynamism of the US economy, which has allowed it to withstand tighter monetary conditions. After a slight contraction in the first quarter of 2022, the US economy continued to grow robustly even as interest rates rose to reach their highest level in over 20 years⁵.

During that period, the US growth machine sucked in capital from around the world, attracted by higher yields, and the US equity market has priced itself on that basis. Meanwhile, an increasingly digitalised economy is intrinsically less vulnerable to higher borrowing costs, which have less impact on businesses reliant on software rather than physical assets⁶. With the Fed having now started to cut interest rates, the stage is set for further domestic dynamism after a period of remarkable resilience.

But the Fed is also the world’s interest-rate setter. The 10-year US Treasury bond is often seen as a benchmark for global interest rates. Higher US yields lure investors away from riskier assets (i.e., those outside the US), even as higher borrowing costs dampen economic growth in countries that lack America’s remarkable dynamism.

Conversely, when US rates and yields fall, they have a significant positive impact on international markets – emerging equity markets especially. So, as we look to the polls on November 5, a key question is this: which candidate’s policies are likely to be more conducive to a sustained regime of lower interest rates?

Contrasts and common ground

A win for Kamala Harris would create some uncertainties. We have scant indication of her views on trade and the economy, for instance. But clearly, a Harris presidency would mean a greater degree of continuity than a Trump one.

In a split with recent precedents, however, a Harris presidency could be more likely to be positive for international markets and emerging markets in particular. That’s because a continuation of Biden-era policies is likely to give the Fed room to bring down interest rates further.

Some of Harris’ policies could weigh on certain sectors of the US stock market. Her anti-monopoly proposals could affect some of the technology giants that have led the market in recent years. Healthcare companies and producers of fossil fuels would also feel pressure from government policies on pricing and the environment, respectively. Against this, the consumer sectors would be likely to benefit from Harris’ proposed tax relief for lower earners.

Under a second Trump presidency, a key concern for global investors would be his proposals for higher tariffs, especially on Chinese goods. These would be likely to have an inflationary effect and could potentially arrest the Fed’s nascent rate-cutting cycle. This would result in renewed strength in the dollar, with the negatives for emerging markets that that entails.

The policies that Trump has outlined would have roughly the opposite effect to Harris’, with support for fossil fuels and big tech at the expense of the consumer, who would be hurt by the higher inflation caused by tariffs.

There are commonalties too. Both candidates look set to increase the US deficit; the Fed appears unalarmed by this. And both are proposing extensive tax cuts, albeit with different targets.

What comes next?

Despite all the excitement and uncertainty surrounding the election, our focus in the coming months will be on the Fed rather than the White House. The winner of the Electoral College is unlikely to be a major factor when the Fed’s Open Markets Committee mulls over what action to take at its November and December meetings. Political rhetoric does not always become reality, and the new president’s policies will take time to feed through into the hard data that informs the Fed’s decisions.

For investors, the worst outcome could be either party winning complete control of the legislature and executive – removing the checks and balances that come with a split. But in recent US history, ‘unified’ government tends to be fleeting; it has occurred in just six of the past sixteen years⁷

This has important implications. A lack of Congressional support could impede Trump’s programme of tariffs. More broadly, a split Congress would be likely to lead to more ‘horsetrading’ and consensus-building, with, eventually, more moderate outcomes. Either a Harris presidency or a Congressconstrained Trump should leave the Fed room to loosen monetary policy further in the coming months. And from their current elevated levels, US interest rates have a long way to fall.

Lower US rates and, consequently, a weaker US dollar should feed through to lower rates worldwide and growing interest in the potentially higher returns on offer in emerging markets. Lending from foreign banks to emerging-market companies usually rises when lower US rates make such loans more attractive, allowing economic activity to accelerate.

A weaker dollar also tends to raise demand for commodities such as oil and metals, boosting both their prices and the equity markets of the countries that produce them – many of which are emerging markets. For these reasons, falling US rates have historically translated into stronger returns from emerging-market equities, which typically outperform their developed counterparts during rate-cutting cycles.

One exception might be China. The fortunes of the world’s largest emerging market are increasingly dependent on domestic drivers rather than external forces. We are still waiting to see how Beijing’s recent stimulus measures will play out beyond the initial excitement; in the meantime, investors might be best advised to consider China separately from other emerging markets.

Finally, a sustained rate-cutting cycle in the US is also likely to benefit mid-cap stocks in many markets. Mid-cap stocks tend to respond more vigorously to rate cuts than their large-cap peers – not only because they tend to have a greater proportion of floating-rate and shorter-term loans, but because they benefit from the unleashing of animal spirits as investors take heart and allocate away from bigger, safer choices.

We have already seen signs of this in the US, where the stock-market rally has begun to broaden out beyond the mega-cap tech stocks to areas where valuations are less eyewatering. Once the dust from the US presidential race settles, there could be much more of this to come around the world.