The US Presidential Election: May 24

Global equity markets largely rose in May as US treasury yields fell the most in five months after the Federal Reserve’s preferred inflation indicator showed signs of cooling. While the US personal consumption expenditures (PCE) index rose 0.3% in April, as economists expected, the core PCE index, excluding the more volatile food and energy components, moderated from 0.3% to 0.2% month-on-month. US nominal personal income growth also decelerated from 0.5% to 0.3% over the same period which helped soothe some concerns that progress on disinflation might have stalled. Declining wage growth has also resulted in fewer excess savings and scarcer consumer credit which should temper aggregate demand growth in the coming quarters. The renewed inflation sentiment saw US equity markets have a particularly strong month, with the S&P 500 up almost 5% and the NASDAQ up about 7% (Chart 1).

Investor interest in artificial intelligence continues to support equities, with over half of the S&P 500’s gain attributed to Nvidia which posted gains of 26.8%. Investors are also increasingly concerned about concentration risk in the index given only six West Coast technology firms accounted for 76% of total gains. During the month, stock market volatility generally abated with the VIX index – which tracks the implied volatility of the S&P 500 -hitting its lowest levels since 2019. US 10-year Treasury yields fell slightly in May helping support fixed income markets, while global long-dated bond yields remained largely flat (Chart 2).

Meanwhile, the Australian Dollar slightly picked up to $US66¢ by the end of May, while the local equity market posted a modest gain of just under 1%. The inflation outlook in Australia is quite different to that of the US, as the monthly CPI rose 3.6% in the 12 months to April, up from 3.5% in March. Housing continues to make up a large component of this increase amid elevated construction costs, with transport also closely following. The Australian Fair Work Commission announced a minimum wage hike of 3.75%, which was in line with expectations and slightly above the Q1 annual inflation rate of 3.6%. This increase is below the 4% level economists had warned would pose an upside risk to inflation and have hawkish implications for monetary policy. The Reserve Bank of Australia is likely to maintain interest rates at their current level for the foreseeable future until we see some softening in CPI data.

Trump Verdict Destabilises Election

With five months to go until the November US presidential election, we may see increased share market volatility if Trump remains ahead and investors focus on the risks of a new trade war under his term. Playing into this possibility is Trump’s recent conviction of 34 felony charges by a 12-person jury in a New York State Court on May 30 for falsifying business records. This carries a maximum sentence that could result in prison time; however, Trump’s legal team will appeal the verdict so it is unlikely that Trump would be in jail before the election later this year. Polls prior to Trump’s conviction suggested that 15-25% of Trump’s likely voters would reconsider if he were convicted of a crime, which could result in a slump in Trump’s polling against Biden in the coming weeks. Biden has been trailing Trump by 1 to 2 points in terms of favourability (Chart 3) which also puts Trump at a higher probability of winning if the polls are accurate. On the other hand, historical records indicate that incumbent presidents tend to be re-elected if there is no recession in the two years before the election (which is currently the case for Biden) and the economy has been strong so far.

What does this mean for Australia? It’s still too early to predict who is most likely to win the election so we will look at the implications if Trump is re-elected. Trump would look to make the 2017 corporate and personal tax cuts permanent and possibly lower them further. He is also threatening to impose a 10% tariff on all imports and a 60% tariff on all imports from China which would take the average US tariff rate from around 2.5% to a huge 17%. Biden has also maintained Trump’s China tariffs and recently announced that he would add to them (though not to the extent Trump would). This is part of a broader global trend towards protectionism and deglobalisation that would negatively affect China. As an open economy with high trade exposure to China, Australia could be vulnerable if a global trade war intensifies under a Trump victory, as it could weigh demand on Chinese exports. An OECD study showed that Australia could suffer a 1.2% reduction in GDP due to a 10% reduction in global trade between major countries. Resources shares would likely be the most at risk and the Australian Dollar could potentially fall if this eventuates.

Portfolio Positioning

While it is interesting to observe the financial markets and speculate on who will win the next US presidential election, we should not be making drastic portfolio changes in response, particularly given how quickly investor sentiment and polls can change. Markets are quite efficient in the short term, meaning they can capture information in stock prices faster than the average investor can act on any perceived arbitrage opportunity. Accordingly, we prefer to take a longer-term view when it comes to asset allocation and portfolio construction decisions at LBP.

The preservation of capital by maintaining a multi-asset class portfolio that is sufficiently diversified across all asset classes, regions, sectors, and fund managers remains our key objective.  We seek to construct a portfolio that derives its return from various factors (equity, currency, momentum, value, growth, and interest rates) as it will perform more robustly during periods of economic recession and heightened volatility.

LBP continues to maintain its slightly defensive positioning, seeking relative value in private debt to provide investors with a good income stream given the current level of global yields. We also consider other alternative investments such as royalties that focus on the top level to provide stable income. Private markets also typically have a lower sensitivity to market movements that can help smooth returns. There remains a meaningful allocation to listed and private equities, and real assets while we continue to explore divergent and convergent strategies in alternative investments to provide further portfolio diversification.

Ultimately, it is a robust investment framework, and remaining invested through the cycle that will play the biggest role in preserving wealth. Investors should continue to emphasise the long-term goals of income generation and capital appreciation to protect real wealth.