US election uncertainty really hit financial markets over the past week as news of the FBI’s intervention saw average opinion poll support for Clinton over Trump decline to 1 to 2 points. This along with falling oil prices saw most share markets fall. While Chinese shares rose 0.4%, US shares fell 1.9%, Eurozone shares fell 4%, Japanese shares fell 3.1% and Australian shares fell 2%. Bond yields in major countries declined and gold rose on safe haven demand. While prices for metals and iron ore rose, oil fell on a strong US oil inventory build and fears OPEC won’t implement its deal to cut production. The $US fell on the back of election uncertainty and this along with higher metal prices saw the $A rise.

If the US election result is to be reasonably decisive – a big if! – we should have an idea who won by around 1-2pm (Sydney time) on Wednesday. What can we expect from investment markets? I tend to think the median American voter will reject misogynism, racism and narcissism and this combined with the Democrats natural advantage in the Electoral College favours a Clinton win, but following the narrowing in the polls over the past week it is now a very close call. Even if Clinton wins there is close to zero chance of the Democrats retaking control of Congress in a clean sweep. The last few weeks have seen shares sell off when developments favoured Trump and rally when developments favoured Clinton and get the jitters when there is talk of a Democrat clean sweep – suggesting investors favour a Clinton victory as long as it’s not a clean sweep. With US shares down 5% and Australian shares down 7% from August highs it seems investors have factored in maybe a 50/50 bet on the election outcome. Given all this:

  • A Trump victory would likely trigger a further initial bout of “risk off” with shares down by 5% or so (both in the US and globally) and safe havens like bonds and gold rallying as investors fret particularly about his protectionist trade policies triggering a global trade war. Australian shares would be particularly vulnerable to this given our high trade exposure (exports are 21% of GDP in Australia against 13% in the US). While the Fed would be less likely to hike in December if Trump wins the $A would likely still suffer from the threat to trade and the initial “risk-off” environment. A Trump victory to the extent that it leads to falls in investment markets and worries about a global trade war may also increase the chance of another RBA rate cut in Australia.
  • Beyond the initial reaction, share markets could then settle down and get a boost to the extent that his stimulatory economic policies look like being supported by Congress, but much would ultimately depend on whether we get Trump the pragmatist (who backs down on his more extreme policies, eg around protectionism) or Trump the populist. Congress along with economic and political reality can probably be relied on to take some of the edge of Trump’s policies to some degree, but this would take time.
  • A Clinton/Democrat clean sweep of the Presidency and Congress would likely also trigger a further bout of nervousness in US shares as it would be easier for Clinton to implement less business friendly tax and regulatory policies that would weigh particularly on US health, energy and financial stocks. This would likely be more focussed on US shares though with less of an impact on global/Australian shares. However, this scenario is now very unlikely.
  • The best outcome for shares would be a Clinton victory but with Republicans retaining control of at least the House as this would be seen as “more of the same”. This would likely see a decent relief rally in US, global and Australian share markets – particularly given that they are already technically oversold. While there may be concerns about her policies on income and capital gains tax and regulation, these would have little chance of getting through a Republican Congress. The downside is that if her win is narrow a Clinton presidency is likely to be weak with a poor mandate, ongoing controversy around the FBI investigation of her emails, issues around the Clinton Foundation and very low popularity. Against this background Congressional Republicans are unlikely to be particularly cooperative in implementing sensible policy changes. Historically, since 1927 US total share returns have been strongest at an average 16.7% pa when there has been a Democrat president and Republican control of the House, the Senate or both.

Source: Bloomberg, AMP Capital

Of course there is the question of what will happen if the result is unclear - either with no candidate winning the necessary 270 Electoral College votes or the result being so close that it’s contested as occurred in 2000 between Bush and Gore. Either result will likely see shares under pressure short term. In the first scenario, the House of Representatives will decide with one vote to each group of state representatives and since it will almost certainly have a Republican majority Trump will win. But get this: the Senate then chooses the vice-president from top two candidates so we could have Vice-President Clinton to President Trump! In the second scenario, the 2000 experience saw US shares fall about 8% and safe havens rally until a result was declared - but prior to the 2000 election shares had rallied (whereas now they have fallen) and the falls were likely affected by the tech wreck recession around that time.

Finally, while all this sounds a bit messy – just recall the fears around Brexit, which after a few days saw global markets move on to focus on other things with shares rebounding. And at least this time around there is less complacency ahead of the event. Global and Australian shares rallied into the Brexit vote, whereas this time around they have already fallen 3-5% over the last two weeks to price in maybe a 50% chance of a Trump victory and are already technically oversold and primed for a rebound if the news is good or uncertainty is reduced.

Looking beyond the boulder in the investment road that is the US election… the news over the last week or so has actually been reasonably good. This is most evident in business conditions PMIs, which rose in most countries in October both for services and manufacturing and are trending up after a soft patch earlier this year. This is good for profits and hence share markets. While it keeps the Fed on track to raise interest rates in December it’s a far more positive back drop (US election uncertainty aside) than was the case a year ago.

Source: Bloomberg, AMP Capital

Major global economic events and implications

US data was good. Personal spending saw solid growth in September, the ISM manufacturing conditions index rose adding to evidence that the manufacturing sector is healthier and the non-manufacturing conditions ISM remained strong, the trade deficit narrowed and October saw payroll employment growth of 161,000 new jobs, a fall in unemployment and a further pick up in wages growth. While faster wages growth (albeit from a low base) is bad for profit margins it’s actually good for profits as it boosts household income, consumer spending and hence corporate revenue. Meanwhile there were no surprises from the Fed which left interest rates on hold as expected but expressed more confidence on the economy and inflation and indicated that the case for a hike has continued to strengthen. The solid October jobs report provides another green light for the Fed. Bottom line: barring a shock (eg. a Trump win or bad data) the Fed remains on track to hike in December.

Revenue growth and better margins have driven an end to the profit recession in the US. The US profit reporting season is now over 80% done with 75% of companies beating on earnings and 55% beating on sales. Profits are on track to be up in the quarter, up on a year ago and up relative to the last high in 2014.

Eurozone growth continued in the September quarter at a moderate pace of 1.6% yoy with a rising trend in business conditions PMIs and confidence readings pointing to a possible pick up ahead. However, with core inflation remaining low at 0.8%, headline inflation just 0.5% and unemployment remaining high at 10% pressure on the ECB to extend it quantitative easing program beyond March next year remains.

The UK High Court’s requirement that the British parliament approve the triggering of Brexit is unlikely to stop it but reduces the chance of a hard Brexit. Meanwhile the Bank of England is now on hold. Both are short term positive for sterling.

There was no surprise from the Bank of Japan which left monetary policy unchanged. It’s already doing open ended quantitative easing anyway until inflation exceeds its 2% target.

Chinese manufacturing and services PMIs rose in October and are actually trending up adding to confidence that Chinese growth has stabilised.

Australian economic events and implications

In Australia, as expected the RBA left interest rates on hold with inflation in line with expectations and its inflation and growth expectations little changed from three months ago as confirmed in its Statement on Monetary Policy. Short of a shock – eg financial turmoil in response to a Trump victory or a run of very soft economic data - it’s hard to see the RBA cutting interest rates at its December meeting. However, with housing construction likely to slow next year, an expected slowing in house price momentum leading to fading wealth effects, falling full time jobs a concern for consumer spending, credit growth slowing, inflation risks skewed to the downside and the likely need to offset regulatory driven pressure on banks to raise mortgage rates, we are allowing for another interest rate cut in the first half of next year.

Australian economic data was a mixed bag. On the strong side the trade deficit fell sharply driven by the surge in coal prices, non-residential building approvals are rising solidly, business conditions PMIs rose in October and September retail sales saw a decent gain. But against this, retail sales volumes were soft in the September quarter, home building approvals fell sharply and credit growth is slowing. Momentum in Sydney and Melbourne home prices remains strong according to CoreLogic but its weak to moderate elsewhere and the Melbourne Institutes’ Inflation Gauge showed weak inflation continuing into the current quarter. Bottom line: the risks remain skewed to rate cuts.

What to watch over the next week?

Globally, all eyes will be on the US election, but apart form that it will be a relatively quiet week with Chinese trade and inflation data and Australian confidence data being the main areas of interest.

In the US, small business confidence (Tuesday) and consumer sentiment (Friday) may show an election related dip but data for job openings (Tuesday) is likely to remain solid.

Chinese trade data for October (Tuesday) is expected to show some improvement in exports and imports and consumer price inflation (Wednesday) is likely to edge up to 2.1% year on year and producer price inflation is expected to rise further to 0.9% yoy as higher commodity prices feed through.

In Australia, business conditions and confidence as measured by the NAB survey (Tuesday) are expected to hold at above average levels, but consumer confidence (Wednesday) may dip slightly. Housing finance (Thursday) is expected to continue to slow falling another 3% or so. Speeches by RBA officials Ryan and Debelle will be watched for any clues on interest rates.

Outlook for markets

We remain cautious on shares in the short term as event risk is high given the US election, the Italian Senate referendum & Austrian presidential election re-run (both on December 4) and ECB and Fed meetings in December. Bond yields could also see more upside in the short term. However, after any further short term weakness, we anticipate shares to trend higher over the next 6-12 months helped by okay valuations, continuing easy global monetary conditions, moderate economic growth and the shift from falling to rising profits for both the US and Australian share markets.

Still ultra-low bond yields point to a poor medium term return potential from them, but it’s hard to get too bearish on bonds in a world of fragile growth, spare capacity, low inflation and ongoing shocks.

Commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield by investors.

Dwelling price gains are expected to slow, as the heat comes out of Sydney and Melbourne thanks to poor affordability, tougher lending standards and as apartment supply ramps up which is expected to drive 15-20% price falls for units in oversupplied areas around 2018.

Cash and bank deposits offer poor returns.

The outlook for the $A has become murky. A shift in the interest rate differential in favour of the US as the Fed remains on its path to hike rates should see the long term trend remain down and the $A normally overshoots on the downside after the bursting of commodity price booms and this remains our base case. But against this, the stabilisation and rising trend in some commodity prices and the continued gradual nature of Fed rate hikes suggest ongoing upside risks in the short term. The danger is that the latter will threaten the rebalancing of the economy and the best defence against this is for the RBA to revert to a clear easing bias even if it never acts on it.

Eurozone shares fell 0.7% on Friday and the US S&P 500 fell 0.2% as US election uncertainty continued to weigh along with a further fall in oil prices. Reflecting the weak global lead ASX 200 futures fell 0.6% so I expect another weak open for the Australian share market on Monday driven by US election fears with the ASX 200 likely to fall 25 to 30 points.