US trade winds
In the US, over the next few months we anticipate an increase in political uncertainty that has the potential to dampen valuations, temporarily at least.
Although our analysis tells us valuations have been higher on average 15% of the time during the past 20 years, US valuations are notably higher than in other regions.
That said, the equity risk premium does seem to be factoring in elevated uncertainty. The market-implied equity risk premium on the S&P 500 came close to reaching financial crisis levels in February. It remains near a two-year high today, and even a slight retracement would realise considerable upside in stock prices.
A Trump or Clinton clean sweep, of the Executive, House and Senate, could herald a protectionist turn for US trade policy that would lower long-run expected returns on US equities due to a weaker outlook for productivity growth, which is the driving force behind any developed economy. Long-term asset allocators should take note.
Pre-empting what tariffs will be applied to which goods is a hugely speculative task, so we prefer to analyse the scenario via a ‘shock’ increase in economic uncertainty.
After all, a drastic change of trade policy would cause uncertainty over all facets of the trade process. A regime change would likely result in the postponement of expansion plans as well as general belt tightening.
Our analysis suggests that a one standard deviation shock increase in uncertainty renders US GDP between 1-2% lower after two years, relative to what it would have otherwise been; the impact could be worse still given the limited scope for monetary policy.
The spectre of the election aside, the macro environment continues to appear robust, although Q3 GDP may present a peak.
