investment insights
Politics and markets: navigating the edge of reason
Key takeaways
- President Biden's withdrawal shifts the focus of the presidential race to Kamala Harris and again changes US election dynamics
- A second Trump administration would likely be more inflationary, leading to a potential rise in the dollar, higher long-term bond yields, and a steepening of the US yield curve
- Challenges to the global political order stress the importance of a strategic asset allocation framework that generates the bulk of portfolio returns
- Solid guiding investment principles can help navigate volatile markets. An active approach can mitigate the risks of wealth destruction, and add portfolio value.
President Joe Biden’s decision to withdraw from the race for the White House alters the odds for November’s election. In this article, I take the opportunity to examine the immediate political stakes in the US, and how uncertain geopolitics underline the need for investors to stay focused on fundamental principles.
Mr Biden’s 21 July announcement puts the spotlight on Vice President Kamala Harris, to whom the president gave his backing as the Democratic Party’s nominee. It sets up a very different race for the election. The assassination attempt on Donald Trump and his choice of running mate, JD Vance, only served to consolidate an already-building lead for the Republican candidate, and increased the Democratic Party’s panic. It remains to be seen whether Democrats will now unite around Ms Harris. Beyond the politics of presidential personalities, the wider margins for the balance of power within Congress are slim, and will change on the basis of just a handful of seats in the House of Representatives or Senate (see table).
In the wake of the announcement, US S&P 500 equities futures were slightly higher, short-term Treasury yields rose, while five-year and longer-dated notes fell, and the dollar was little changed against the euro. The possibility of a second Trump presidency in recent weeks increased scrutiny over his policy ambitions, including any hints of changes to the Federal Reserve’s independence. The potential for a second Trump term also triggered a rotation in equities that benefitted small capitalisation stocks, and the energy sector, over growth names. We might now see that begin to unwind. We expect markets to be volatile in the three months head, as investors weigh policy proposals.
Political uncertainties will continue to support demand for the dollar as a haven, possibly all the way through the Democratic Party’s process for confirming Mr Biden’s replacement at the 19-22 August National Convention.
A second Trump administration would, we believe, be more inflationary. It may see the US currency appreciate further as the dollar would probably rise on expectations that 2025 would deliver additional tax cuts, ‘America-first’ import tariffs, and the potential for stricter immigration policy to tighten the job market. Such inflationary pressures would trigger higher long-term bond yields and a steepening of the US yield curve. This is one reason we prefer German Bunds to US Treasuries, while holding global bond exposures at strategic levels. In equities, we continue to prefer markets outside the US, where valuations and market concentration risks are lower. We hold US stocks at strategic levels.
Braving the New World
America is not the only nation choosing a new leader. This year, elections in around 70 nations give half of the world's population the ability to select new governments. The stakes are exceptionally high, and the need for skilled leadership hasn’t been this acute since the toppling of the Berlin Wall.
Yet many nations may feel shortchanged. Acrimonious campaigning now spans nations, elections and referenda, increasingly normalising disingenuous political arguments, and even dishonest claims. Beyond Mr Biden’s frailty, the whole system seems to be weakening globally.
For its part, the United Kingdom has started a new chapter after years of political chaos and market upheaval. Its economy has struggled to find form and the Labour government faces tough challenges. In France, Emmanuel Macron has struggled to keep the liberal centre viable amid a groundswell of public support for right- and left-wing parties.
Indeed, hardliners with strict immigration policies and vocal critics of the establishment have gained ground across Europe, not just in France and Italy. Germany is also vulnerable. Its coalition resolved a months-long crisis by hammering out a budget, which still needs approval from parliament. This underscores a critical aspect of Europe’s current leadership crisis, where short-term economic interests and brinkmanship overshadow commitments to national and energy security, and broader responsible governance. Such schisms seem feeble when contrasted with the consequences of war on Europe’s borders.
Even in financial markets, equities at multiple all-time highs this year can seem to defy reason. A handful of mega cap stocks drove S&P 500 outperformance last year, masking broader trends in the US economy and corporate world. There are signs that this market concentration and leadership may now be waning, but it reflects a wider trend in global leadership: an emphasis on immediate economic gains and technological advancements at the potential expense of long-term stability and responsibility. How far can we take AI and can we reestablish a sense of generational solidarity? Answers to such questions are elusive.
Guiding investment principles
As investors, we need strong guiding principles. Asset managers too often implicitly assert special insights into the chaos of the world’s markets. The reality is that we earn our keep by instilling composure and resilience into the life savings in our care. Navigating turbulence depends on processes, structures, and discipline. A robust strategic asset allocation is a framework on which the bulk of portfolio returns depends. It provides a steady hand for tactical decision making, while ensuring that we deliver on our long-term objectives.
In my experience, markets tend to be driven by trends and themes – as we see today. We must work hard to understand them: bull markets thrive on trends that investors buy into, whereas bear markets are triggered by shocks and recessions. Today’s markets are choosing to focus on a healthy macroeconomic backdrop and largely disregard geopolitical risk. Recovering growth, disinflation and falling interest rates, coupled with significant public spending on infrastructure and innovation, are cushioning geopolitical risks. A new capital expenditure boom – in part driven by strategic competition between the US and China – has, for now, bolstered economic resilience.
Yet things can change quickly. A fractious world short of global leadership appears willing to gamble away what only a few years ago was a broad consensus on the aspirations of liberal democracy, and the markets that depend on it. Political event risks are here to stay, with significant implications for portfolio construction. Political disruptions can affect all regions and sectors. They can also lead to market concentration, as a changing political landscape produces winners and losers on a corporate level.
In this context, an active management approach that identifies the true risks can mitigate the wealth destruction that comes from sanctions, relocations, and tariffs – and add value in portfolios by diving below surface trends. This stands in stark contrast to the trend towards passive investment. I also believe that portfolios can be made more resilient by including thematic allocations built on secular trends that transcend traditional regional and sectoral allocations. And as a new world order takes shape, investors need to be careful to anchor their portfolio allocations in assets and countries governed by the rule of law. So stay alert. Investment success will require a lot of persistence in a hot political summer.
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It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication.
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