Short term investment considerations will understandably be dominated by an assessment of the implications of the Republican victory in the US election. Given the intensity of the media’s focus on the election, it would be easy to develop an exaggerated view of the election’s importance for financial markets. However, for the most part, elections, and geopolitical events more generally, rarely have long lasting effects on financial markets.
The fact that the election result has been decisive, with the result largely in line with prior market consensus, should be generally supportive for equity markets. A Republican victory implies a supportive environment for the corporate sector and removes the possibility of higher corporate tax rates. Forecast company earnings should be largely unchanged following the election, and, as such, the implications for share markets are likely to be limited. Whilst it could be argued that increased tariffs are ultimately bad for economic growth across the globe, this will take time to play out and there is a reasonable possibility that the appetite for restrictive trade initiatives will dilute over time.
As has been widely predicted, a Republican victory may result in higher inflation and higher interest rates than would otherwise be the case. Tariffs are inflationary and increased government spending can also place upward pressure on prices. Additionally, immigration restrictions and deportation could drive higher wages. To a large extent, however, movements in bond yields in recent weeks may have already taken this higher inflation into account, with equity markets absorbing this change without any major shock to valuation. A higher interest rate regime may, however, make it less likely that interest rate sensitive assets such as listed property continue their upward path.
One theme that may develop now that the election has passed is a renewed focus on the US budget deficit and the large bond issuing program that is required to fund this deficit. Despite the economy being buoyant, the US Government is running an annual deficit equivalent to 6% of the size of the economy and this deficit looks set to increase to meet pre-election spending plans. With more bonds required to be issued, the increased supply may cause bond prices to fall (and yields subsequently increased). An anticipation of this renewed focus on bond issuance may help explain the significant increase in yields that took place in October.
For Australian investors, the upward movement in bond yields over recent weeks may be the most significant election related opportunity that has been presented. Australia has a weaker growth trajectory than the US economy, with a much lower government budget deficit. As such, it could be argued that Australian bonds offer less risk than those of the US - yet are currently providing a higher yield. Longer term Australian bond yields are now higher than the cash rate and the likelihood that cash rates will fall in 2025 remains high, thereby making the margin available in longer term bonds all the more attractive.
At Prosperity, we work with clients to build portfolios that adapt to evolving challenges and opportunities. If you’d like to discuss how this may impact your financial strategy, please feel free to reach out.
