4 - Donald Ducked
Donald Trump loses November’s election, causing corporate taxes to rise appreciably in the US
Consensus view: At present, bookies indicate 10/11 odds (i.e. approximately a 50% probability) of the incumbent US President winning re-election come November. History
would suggest the prevailing economic conditions are the most important factor for his success. In this respect, Mr. Trump has a huge advantage: unemployment is at a record low; wages are rising briskly; chances of a recession in 2020 are put at about 25% by the US Federal Reserve. This has helped his popularity with “the base” to remain remarkably stable. While most expect this to be a year full of rhetorical fire and fury, policy continuity is the default position for most investors.
What the consensus view is not pricing in: Usually, established Western democracies see policies tilt between “centre-left” and “centre-right”. This time may well be different, with a Democratic victory predicating a substantial leftward lurch in public policy, and thus a big increase in current taxes. Remember, President Trump slashed corporate taxes dramatically in 2017; a return to even the pre-Trump status quo will cause post-tax corporate earnings to contract.
Potential market reaction:
Macro: A Democratic victory will see a substantial rise in corporate taxes no matter who wins the party nomination. Of course, should it end up being Bernie Sanders (i.e. 8/1 odds, about 11%) or Elizabeth Warren (i.e. 14/1 odds, about 7%), a dramatic shift is likely. Taxes will rise on corporations, as well as top earners.
Asset allocation: This would certainly cause a contraction in US corporate earnings, which would lead to a sell-off for US equities, and very likely global markets too. The risk-off rotations would cause a rush to US government bonds, which would see yields fall dramatically. In the longer term, more aggressive public spending in the US, particularly on infrastructure and skills-based training, would boost productivity.
Our positioning: While government bonds offer poor value in absolute terms – yields are relatively low compared to their history – they continue to be critical in offsetting risks from equities and other risk-assets in multi-asset portfolios. These risks are more effectively offset with a longer-duration positioning, supporting our move from “short” to “neutral” duration across Government Bond holdings. However, we would aim to be quick to reallocate back into equities when valuations are cheap, momentum turns positive and sentiment is still oversold.