Macro & Strategy - August 2024

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A Dramatic Turn of Events

To say that the U.S. election landscape saw a seismic shift in July would be an understatement. On the Republican side, we witnessed 1) a failed assassination attempt on Donald Trump, just days before 2) the Republican National Convention, where the former president was confirmed as the Republican nominee for the coming election and 3) announced that senator J.D. Vance would be his running mate in November.

The multiple speeches delivered at the convention, including Trump’s acceptance speech, featured some of the party’s major policies on the economy and taxation (be tough on trade partners, especially China, and pay for tax cuts with tariffs), on national security and immigration (bring the military back to man the borders, massively deport illegal immigrants and let other developed countries pay for their own defence) and on energy independence (drill, baby, drill!).

On the Democratic side, Joe Biden finally withdrew from the race after his disastrous debate with Trump in late June, amid increasing pressure from influential party members and a steady decline in the polls. The way was paved for Kamala Harris, who quickly launched her campaign after locking up the Democratic nomination and amassing $100 million in contributions on the first day. The Democratic National Convention will take place from August 19-22, when we’ll learn more about Harris’s platform, although it should not differ too much from Biden’s.

Trump in the driver’s seat, for now

As of late July, Donald Trump holds a lead in the polls. According to RealClearPolitics, Trump has a narrow lead with 47.8% of voter intentions versus Harris's 46.4%, a similar edge to what he previously held over President Biden. Looking at data from PredictIt, we find that the odds of a Trump win stand at about 49.0%, down from the peak of 70.0% on July 15, and Harris in the lead at 53.0%.

The polarization of the U.S. electorate in 2024, particularly around the figure of Trump, might very well be the determining factor once again. In our April 2024 piece, we highlighted how Trump's policies, especially his tax cuts and trade stance, have created a significant divide among voters. The polarization has manifested itself as strong, unwavering support from his base, often described as a cult-like following. This fervent backing means that Trumpism remains a potent force, regardless of broader public opinion. 

With the election about three months away, an eternity in politics, it’s possible that Trump peaked too early in the election cycle. While his lead remains sizable, especially in many swing states, any political race can see a shift of momentum, given enough time.

Recent polling data from RealClearPolling show a Republican lead in most key swing states, making the Electoral College math more difficult for Harris. For instance, in Arizona, Trump leads Harris by four points, while in Pennsylvania, he leads by two points. In states such as Michigan, however, his lead is narrower, reflecting the fluidity and competitiveness of such battlegrounds.

The swing-state polls highlight the tight nature of the race as of August 1.

These results do suggest, however, that the margins are not insurmountable for Harris, making the race difficult to call and emphasizing the importance of voter turnout and campaign strategies in the coming months.

The presence of a significant number of undecided voters further complicates predictions. Recent polling data indicate that close to 10% of voters are still undecided. When these undecided voters were asked which candidate they leaned toward, their support was split evenly between Trump and Harris.

The undecided-voter segment is crucial because their final decisions can sway the election outcome, especially in such a polarized environment. Historically, undecided voters in swing states have played decisive roles in close elections – hence the importance of continued campaigning and engagement until election day.

A few lessons from history on the risk of peaking too early

Historical election trends suggest that peaking too early can lead to a loss of momentum as the campaign progresses. Donald Trump himself showed that a large gap in the polls can be misleading when he surprisingly beat Hilary Clinton in 2016.

History offers a few other compelling stories. For example, Thomas Dewey was widely expected to win the 1948 presidential election, even prompting the famous erroneous newspaper headline “Dewey Defeats Truman.” Despite leading in the polls, Dewey lost momentum, and Harry S. Truman won a surprising victory by continuing to campaign aggressively until the very end.

Another notable example is the 1988 presidential race, in which Michael Dukakis held a substantial lead over George H.W. Bush during the summer. Dukakis’ campaign faltered, however, amid a series of missteps and effective negative campaigning from Bush, which ultimately reversed the race’s dynamics and gave Bush a decisive victory.

Pricing in the election

Recent data shows that markets have been leaning toward higher odds of a Trump victory, as illustrated by the relative outperformance of Goldman Sachs’ and Bank of America’s baskets of stocks favouring Trump’s policies over those favouring a Democratic win.

Even though the charts above indicate that markets have been pricing in a Trump win, the challenge is to identify just how much is currently in the price. The market’s recent performance definitely reflects investor expectations vis-à-vis the November election, but broader economic factors, such as the Fed’s actions and inflation trends, remain at play. Although the Trump basket’s outperformance indicates market optimism about his policies, it’s crucial to consider the broader context of economic indicators that are equally influencing market movements.

What makes the analysis tricky is the timing of the latest print on U.S. inflation, published on July 11; it came in more Fed-friendly than expected and led to a repricing of rate-cut odds for 2024.

Even though rising odds of a Trump win have most likely helped the recent steepening of the yield curve (more pressure on the Fed from the White House and looser fiscal policy), we can also argue that the cooling of inflation in recent months has done even more to steepen the curve so far.

So, setting expectations for the behaviour of markets depending on who leads in the polls is not trivial, although we would expect to see heightened volatility in some segments of the market:

1. Small caps: Small caps posted a historic bout of outperformance in July, before retreating later in the month. If a Trump win becomes more likely, we should expect small caps to retake the lead owing to expectations of tariffs, pro-business policies and deregulation. It’s worth noting, however, that the small cap rally after Trump’s surprising 2016 win was violent but short-lived.

2. Big tech: Both Trump and Vance have been vocal about big tech’s perceived censorship of conservative content on social media over the years. The prospect of a Trump win would probably mean headwinds for Wall Street’s best-performing sector going into the election, given the increased scrutiny and regulation to be expected afterward.

3. U.S. dollar: The prospect of a Trump win would most likely prop up the U.S. dollar in the lead-up to the election, amid expectations of looser fiscal policy, higher rates and a potential increase in tariffs.

4. High-tax companies: Companies with higher effective tax rates should outperform because Trump’s expected continued tax cuts would enable them to benefit from reduced tax burdens.

5. Yield curve: If Trump keeps the lead, we expect the yield curve to steepen further. Long-term yields are likely to rise on increased deficits and fiscal stimulus, while the short end of the curve may settle lower, owing to risks of presidential pressure on the Fed to maintain accommodative monetary policies.

Our current positioning

We have maintained an overweight position in equities relative to cash, although the scale of our overweight is gradually decreasing. The corporate earnings outlook is positive, especially in industries driving artificial intelligence development, and in goods-focused sectors, with the end of corporate inventory destocking. Even so, earnings expectations have set a high bar for potential positive surprises, fostering the risk of investor disappointment.

Our preferred equity market is Japan, with its strong earnings outlook, corporate reforms geared to greater profitability, favourable monetary policy and historically undervalued currency.

We are reducing our underweight in fixed income owing to improved prospects for this asset class. Recent inflation data in the United States and Canada indicate substantial progress toward the 2% target, with both goods and services inflation on the decline. Moreover, labour-market conditions on both sides of the border have cooled significantly, leading central banks to express growing confidence in the potential for rate cuts. Even though central banks continue to rely heavily on data, the overall dynamics now provide stronger support for fixed income. Should ongoing data confirm recent trends, we intend to increase our exposure to this asset class selectively in the coming months.

Furthermore, we are maintaining an overweight position in gold. Geopolitical tensions and central bank allocations have supported the metal thus far. Moreover, the start of the U.S. presidential election campaign has introduced a new factor that is buoying gold: fiscal risks.

Both U.S. political parties indicate limited interest in pursuing fiscal consolidation in the coming years, with the Democrats pushing for increased government spending and the Republicans advocating for deficit-increasing tax cuts. Even though significant fiscal deterioration appears less likely without unified government control, investors may seek to hedge against this possibility by increasing their gold allocations, potentially bolstering its price.