By Nick Stanhope, senior portfolio manager at Morningstar Wealth.
This year has an unprecedented number of global elections, with more than 60 countries holding an election, covering approximately half of the world’s population.
Perhaps most significant amongst these elections is the US presidential election this coming November. Whilst creating many hours of television footage and newspaper column inches, what is the likely impact for investors?
Going back as far as 1933, stock markets have tended to rise no matter which political party has been in power in the US. In fact, there have only been two presidential terms where the US market has ended lower than where it began.
This was under Richard Nixon and George W Bush, who suffered market reactions after the Watergate scandal and the terrible events of 11 September 2001, rather than economic policy.
Whilst data suggests that returns have been higher in years when Democrats how won the presidency, the following year returns have been stronger during Republican presidencies. But in truth, there has been no strong correlations that are helpful for investors.
What has tended to matter more are the level of stock market valuations and the strength of the economy. That is not to say that policy do not have an impact, it is just very difficult to predict ahead of the event.
To cloud the issue yet further, in certain areas there has been much greater policy alignment than the political party’s rhetoric suggests.
Take China for example – President Biden has not only maintained the Trump-era tariffs but has recently announced measures to escalate them further ahead of the election in a bid to protect US jobs.
Should Trump win in November, his ability to repeal policies such as the Inflation Reduction Act will also be heavily influenced by whether the Republicans manage to win both the Senate and the House of Representatives. Our ability to second guess policy changes ahead of the event is arguably no better than the flip of a coin.
For us, valuation is the starting point. The price you pay matters foremost, followed by a thorough analysis of the economic fundamentals.
When we invest our clients’ money, we prefer to focus on those things that are knowable, assessing the likelihood of potential outcomes rather than betting on a single outcome.
Although Chinese equities today are deeply unloved and investors are fearful of a more belligerent approach from the US, we believe much of this has already been reflected in the price. Valuations continue to trade towards the very bottom of their range.
This has been driven by a deterioration in corporate profitability brought on by a combination of harsh Covid-19 lockdowns and the communist parties crusade against private sector companies that were deemed to be operating within a quasi-monopoly or against consumers best interests. Most notably, big internet tech companies and property developers.
Since the end of the lockdowns, the Chinese government has pivoted towards a pro-economic recovery, even if it has not matched global investors expectations.
Corporate profitability we think can normalise from the current cyclical trough. Given the low sentiment, any news that is less negative, can have an outsized impact on returns.
Whilst we do not rule out further tariffs should President Trump triumph in November, we think the upside potential from here is in our favour versus the risks.
We like the more domestically orientated sectors, such as communication services and consumer discretionary stocks, where the investment case is much more about a recovery in China than their ability to compete internationally. Many of these companies are not only well managed but also dominant franchises exhibiting strong competitive advantages.
Similarly, the UK is expected to hold an election by early 2025. Given the indebtedness of the country and the weak growth, most commentators do not believe that politics will have much of an impact on the economy.
However, what we notice is that UK equities have derated ever since the result of the EU referendum was announced, with the valuation gap only widening during Covid. This has not been helped by the domestic pension fund sector steadily and consistently divesting from the asset class since the 1990s.
Whilst the UK market has benefitted from a higher rate environment, the valuation gap has remained consistently wide. Our analysis shows that the UK is a market of global stocks, not a market of UK domestic companies, with only 19% of revenues coming from sales to the UK, with many being global market leaders.
In recent years, the UK stock market has had to contend with a collapse in the perception of stability as the governing party has fought with itself over how to capitalise on the benefits of Brexit.
Similarly to China, the bar has been set low, and any recovery in perceptions can only serve to improve sentiment from international investors, whilst in the meantime, we own a basket of globally facing companies, many of whom are world class if not leaders.
In conclusion, whilst we do not dispute that elections can impact markets, trying to second guess market moves is very hard, if not impossible.
