Written by LGT Crestone Senior Asset Allocation Specialist Matthew Tan
Transatlantic political volatility has accelerated sharply in the past month—snap elections have been held in the UK and France, heralding changes in government there. An assassination attempt on former US President Trump has added further uncertainty to the US political situation. Meanwhile, a poor debate showing by US President Biden shocked the Democratic party to its core and prompted a sharp re-pricing of US election odds. At the start of 2024, we heralded a year where investors would need to “navigate an alternative powerful force, namely politics”. That is now coming to the fore.
In this Special report, we outline the key political developments across the Atlantic thus far. We parse through the headline noise to identify the key aspects that investors should focus on in the run-up to 5 November, and outline some key actions investors should be taking as a result.
A series of political earthquakes have shaken establishments across France, the UK, and the US in recent weeks.
In the UK, the Labour Party has won an historic super-majority in a snap election held on 4 July, and now has a new prime minister in Keir Starmer. In France, snap elections have eliminated President Macron’s Parliamentary majority and resulted in a hung parliament that threatens political gridlock.
In the US, President Joe Biden’s re-election chances took a substantial blow after his poor performance in the first presidential debate with his Republican rival and former President Donald Trump. Meanwhile, the world is reacting to reports of an assassination attempt on Trump at one of his rallies in Pennsylvania over the weekend.
Beyond this, the US Supreme Court issued a ruling that grants broad legal immunity to presidents exercising their official duties, which has effectively scuppered the various criminal cases that have been brought against former President Trump. At the same time, it is raising significant concerns around the potential for abuse of power by future presidents.
Of these, the US political situation appears the most volatile, with a still-fluid and highly uncertain set of events playing out in real time.
While there has been some volatility in European assets in response to the snap elections, particularly in French equity and bond markets, US political developments were the major surprise of the past month. In the wake of President Biden’s poor debate showing, betting markets moved sharply to price in a roughly 60% chance of a Trump victory in the 5 November Presidential election, as well as rising odds that President Biden will be replaced as the Democratic presidential nominee (most likely by current Vice President Kamala Harris).
Meanwhile, the political situation in the aftermath of the attempted shooting of Trump remains very fluid. It is likely that volatility will remain high on both sides of the political aisle in coming days and weeks as these events play out. The Republican National Convention that begins this week will likely crown Trump as nominee. It should also reveal his running mate, another key political event to monitor.
We apply an objective constraints-based approach to parse through the noise and highlight what investors should focus on.
We appreciate that there have been strong personal and political reactions to these events, in the US and around the world. We cannot ignore these, but we also acknowledge our duty to best steward our clients’ capital with a steady eye on long-term objectives. Hence, we believe it is worthwhile to prudently evaluate the potential investment implications of these developments.
To tackle this, our investment strategy framework adopts a constraints-based approach to political and geo-political analysis that looks beyond policymaker preferences (i.e., what they say) and focuses on the material constraints that determine what they can actually do. This lets us parse through the news headlines to identify and evaluate the most relevant implications for economies and markets. As part of this, we have identified the following areas that we believe investors should pay the most attention to over coming weeks and months:
While presidential election polling dominates the headlines, we believe the congressional elections will be the key to assessing whether President Biden drops out of the race. The Senate is likely to turn Republican, but Democrats still have a chance of winning back the House of Representatives. Control of this chamber of Congress would go a long way towards ensuring appropriate checks and balances could be applied to a second Trump administration, likely limiting the extent of potential fiscal largesse that is worrying bond investors. We believe that Democrat concerns about the battle for the House of Representatives will be the ultimate fulcrum about which President Biden’s fate hangs.
Meanwhile, we recognise that politically motivated violence is incredibly difficult to assess and evaluate in real time and we profess no particular expertise in this regard. We will continue to actively monitor conditions, work with our trusted strategic partners and experts, and maintain an open and flexible mindset to adjust our views if we assess the political risks are becoming more macro or market-relevant.
Investors should have an eye on the US congressional elections, Iran’s own surprising presidential election result, the Supreme Court’s ‘Chevron deference’ ruling, and should fade European political volatility.
While all the attention has been focussed on the North Atlantic this summer, investors should keep in mind that it has been a truly global ‘year of the election’. In Iran, there was a surprise outcome with potentially significant geo-political implications, where the centrist and reformist Masoud Pezeshkian defeated hardline candidate Saeed Jalili. This result was particularly surprising because Pezeshkian was only permitted to run after Supreme Leader Ayatollah Ali Khamenei bowed to intense public pressure, and the regime threw its support behind Jalili during the campaign. As Marko Papic from BCA Research noted, this could be a sign that the Iranian political pendulum may be shifting back towards a reconciliation with the West.
The US Supreme Court issued a ruling ending the long-standing judicial practice known as the ‘Chevron deference’ last month. In a nutshell, the ‘Chevron deference’ gave wide latitude to government agencies in interpreting laws and enacting regulations where the statutory language passed by Congress is deemed ambiguous. By ending this practice, the Supreme Court has opened the door to legal challenges aimed at rolling back federal regulations and executive actions, including those covering environmental, consumer, and potentially presidential actions. While poorly understood, we think this ruling has the potential to be significantly impactful for legislation, regulation, and corporations over the long term. As with most judicial rulings, it could act both ways: it may open up legal challenges to Biden administration regulations (unleashing a wave of deregulation), but could similarly provide an avenue for Democrats to challenge a future Trump administration (for example, on tariffs).
While the Labour party in the UK has an historic super-majority, the UK’s ‘first-past-the-post system’ means there is not a strong electoral mandate for the Labour party to enact substantial policy shifts. In addition, we believe UK policymakers are well aware of their material policy constraints, particularly after the recent experience of Liz Truss (whose radical fiscal agenda spooked markets, forcing her resignation). In France, while the headlines again are focussing on the far-left and far-right parties, we would note that a combination of ‘centrist’ parties (centre-left, centre-right, and Macron’s party) still hold an overall majority in the French Parliament. In addition, we assess the risk of a French budget blow-out and/or concerns about the Eurozone project as very low. France is a key pillar of the European Union, and has no incentive to flout agreed-upon fiscal rules. Furthermore, the European Central Bank has already proven that it will do ‘whatever it takes’ to support the Eurozone—that question was settled in 2012.
A prudent assessment of a potential Trump 2.0 points to tax cuts, concerns for Fed independence, tighter immigration, more tariffs, and more geo-political volatility.
Noting the high level of uncertainty still at play, our assessment of the likely material constraints that a second Trump administration might face leads us to focus on the following key investment-relevant implications investors should prepare for:
Our 2024 investment strategy review has helped us prepare strategically for such an increasingly uncertain world.
Most importantly, do not panic. Rather, we encourage investors to adopt a similar exercise of parsing through the noise and thinking through the facts in an objective manner, as we have outlined above. Having taken all these factors into account, we have reviewed and remain broadly comfortable with our current strategic and tactical asset allocations (which as discussed below, considered this political instability in our outlook). That said, we acknowledge the fluidity of the current situation, are actively monitoring developments, and stand ready to make adjustments if and when our assessments change.
As part of our 2024 investment strategy review, we have positioned our strategic asset allocations for a higher growth, higher inflation, and more volatile world. This includes an uplift to our (already significant) allocation to alternative assets, particularly in areas like infrastructure that are keyed into secular growth thematics. We have also increased our preference for global equities, and re-emphasised our preference for high quality active managers, who have the skills and expertise to navigate an increasingly uncertain world.
On a tactical timeframe, we are overweight fixed income, credit, and equities, as we see supportive fundamentals and a central bank easing cycle that should cement a near-term peak in interest rates and underpin corporate sector performance. The factors driving these decisions are listed below. We encourage investors to review these with regards to their own positioning:
There are still almost four months to go until 5 November. As we have learned well over the last few weeks, a lot can happen in that period that could affect the US presidential and congressional elections.
On a tactical timeframe, investors should not lose track of supportive macro fundamentals (which still matter more than politics at this stage).
Investors should also not lose track of the macro-economic fundamentals. They still matter for markets, and our firm belief is that they still matter more for markets on a six- to 12-month timeframe than political or geo-political shocks. Our assessment of these continues to be broadly supportive: US economic growth is (finally) moderating, embedding a disinflationary backdrop there that supports a likely first cut by the Fed in September. The Eurozone and UK economies are in the midst of a cyclical upturn after their monetary policy-induced slowdowns last year (proving that raising interest rates does work, just with long and variable lags). Additionally, disinflation in those regions is supporting cutting cycles by their central banks.
Our current assessment of the investment implications of Trump 2.0 are tilted towards (1) higher term premia for US Treasuries to reflect a poor structural fiscal position; (2) higher nominal growth due to tax cuts and a likely deregulatory bias; and (3) the potential for ongoing de-dollarisation that could put downward pressure on the US dollar over the longer term. These views are broadly in line with our current positioning and strategic bias to prefer overseas assets. This also results in a preference for the small- and mid-cap space, as well as staying broadly constructive on the outlook for growth assets (in line with our macro views above).
We have spent the best part of a year refreshing our secular investment outlook and enhancing our investment strategy processes to prepare for the more uncertain world we believe we are entering, which includes an era of more political and geo-political volatility. These views (and the actions summarised above) are already embedded into the strategic advice that we provide to our clients.
We continue to actively assess macro and political developments, and stand ready to act to steward clients’ portfolios, should the need arise.
Political shocks like the ones we have witnessed in recent weeks are almost impossible to predict in isolation and extremely difficult to evaluate. However, we believe that astute investors can navigate these events by adopting an objective, disciplined, and deliberate approach, which enables them to (i) assess the over-arching secular backdrop in which these shocks are taking place, and (ii) prudently consider the risks and opportunities of each event.
Having outlined our assessment and positioning in regards to these developments, we re-iterate that in a more uncertain world, we are maintaining a flexible and nimble approach to our tactical asset allocation, and stand ready and willing to shift our positioning in response to the evolving risks and opportunities across financial markets.
