The consequences of an unlikely Trump victory

Markets appear to be less than concerned about a potential victory by Republican candidate Donald Trump in the upcoming US presidential election after his troubles during the campaign.

But investors were also nonchalant about “Brexit”, the referendum to decide if Britain would remain in the EU, and were caught by surprise when voters turned their backs on Europe. So it might be wise not to put too much emphasis on what the market believes, even though evidence is pointing to a Democrat victory.

Monik Kotecha, the chief investment officer at Insync Funds Management, has some insights into the likelihood of a Trump victory.

“Since 1928, the S&P 500 has predicted 19 of the past 22 presidential election winners. If stocks are higher in the three-month period before the election, the incumbent party wins. Equity markets have sold off, historically, before a new political party takes over. Therefore we would expect a sell-off should Trump begin to emerge as the election winner,” he posits. At this time, the S&P 500 is near all-time highs.

Michael McCarthy, the chief market strategist at CMC Markets, says the market is very concerned about a potential Trump victory.

Small probability priced in

McCarthy says at this stage markets have priced in a small probability of a Trump victory. “After the first presidential debate, the market pricing of Trump’s potential election has receded. Markets are assessing somewhere between a 10 per cent and 30 per cent chance of his election.”

What’s hard to predict is the impact of a Trump victory on the US dollar. McCarthy says the assumption is that the central bank, the US Federal Reserve, is going to have more work to do and that means rate rises are a lot less likely, which could lead to a weaker US dollar.

“One of the major issues that came out of the first presidential debate for economists was the idea of tariffs, although [Trump] didn’t use that term. But talk of bringing American jobs back to America and keeping American jobs in America clearly indicated a tariff regime. Now that would be supportive of the US dollar,” he says.

A Trump victory would almost certainly produce a quick correction in equities markets. But investors will also be factoring in pre-election polling that indicates who will win. So markets will also respond before the event if it looks like Trump will succeed.

Outside the US, risk assets such as equities and currencies will come under pressure if Trump wins. Says McCarthy: “We could also see pressure on industrial commodities, in particularly the metals markets. Global trade over the last 12 months has been flat and currencies have fallen. So any further measures to stifle global trade are likely to be very bearish for shares, and industrial metals in particular.”

Gary Burton, a research analyst with FP Markets, says Trump is considered the wildcard entry in US politics.

“The election of Trump would immediately usher in uncertainty, [which is] the only certain market killer. My view is there would be a sell-off after the initial election win, if not in the days leading up to the election. The best gauge for how markets will react will be pre-election eve poll results,” he explains.

Trade agreements risk

Burton notes Trump has openly criticised manufacturers that have moved jobs to Mexico and other offshore regions, so there will be some market uncertainty around the treatment of such businesses.

“There is also considerable concern Trump may use his newfound powers to reverse established trade agreements. Many trading partners, like Australia, will be looking at the risk of losing the level playing field they fought hard to establish. Any sudden changes in this area will be viewed as a negative.”

But it’s not all bad news. “In uncertain times and with an uncertain currency and trade outlook, gold is likely to be in favour with global investors,” McCarthy says.

He adds that European investors tend to focus on local markets when there are concerns about the global growth outlook, which could prompt a rise in the euro. “We could see rallies in fixed-interest markets around the rest of the globe. Equities markets outside the US could also see support as investors speculate on a weaker US economy.”

Aside from a flight to gold, investors in Trump companies are likely to profit if he wins. Business-friendly legislation is also likely to be introduced should Trump prevail over Hilary Clinton.

“I suspect shorting markets or at least hedging portfolios might be the most popular trade, and that’s where we might see some pretty sophisticated reactions fairly quickly,” McCarthy notes.

Additionally, Burton says smaller manufacturers will benefit if Trump maintains his pre-election statements for cutting tax, while larger companies like Apple with an offshore tax domicile may see a benefit in returning some of their cash to the US.

There will be winners and losers no matter which side wins, and Kotecha says biotech and pharmaceutical sectors have the most at stake in this election based on Clinton’s rhetoric.

She has indicated she would act to contain aggressive drug pricing by pharmaceutical companies. So a Republican win might be good news for this sector, as it would take most of the pressure off drug companies’ pricing structure and could lead to a significant rally in the stocks.

Says Kotecha: “The defence budget is going up regardless of who wins the election, more so if the Republicans win.”

The threat of a $US15 ($19.85) minimum wage, which Clinton has supported, has weighed on the restaurant sector. So Kotecha says any Republican win will lift some of the headwinds that have battered food stocks.

“Trump appears to have a stronger negative stance on trade, which will be a drag on US and emerging market growth. Less trade would have the greatest impact on economies most dependent on exports. Trump’s proposed crackdown on illegal immigration could detract from growth and hurt government finances,” Kotecha says.

“Immigrants tend to be young and work. Since 2007, the foreign-born population has accounted for a significant part of growth of the US labour force. Curtailing this source of labour growth would subtract from growth and could push up wages.”