The United States is just a month away from what looks set to be one of the most controversial presidential elections. While the US has had its share of pivotal and drawn-out races, such as in 2000 and 2004, the dynamics of this election has set worldwide headlines ablaze unlike any other.
For one thing, nobody has ever won the White House with such low levels of popularity - the disapproval ratings for both Mrs Hillary Clinton and Mr Donald Trump outstrip their approval scores. And of course, Mr Trump's campaign has been notable for its unorthodox policy prescriptions on immigration, US debt, international security alliances and trade with China.
Crucially, US House and Senate elections are also at play. As the legislative agenda will be shaped in large part by the composition of Congress, the result of nationwide congressional elections will matter every bit as much to financial markets as who ultimately wins the presidency.
As we get closer to the Nov 8 showdown, heightened headline risk is expected in the near term as investors become increasingly nervous about a post-election sentiment rout.
A CLINTON PRESIDENCY A VICTORY FOR THE STATUS QUO
The most likely and "best case" scenario - at least in a near-term financial market perspective - is one in which the voters opt for status quo. That is, a Clinton victory and a divided Congress with the Democrats winning the Senate and the Republicans taking the House (a 60 per cent probability, according to UBS estimates). A Clinton administration will likely adopt most of Mr Barack Obama's signature proposals and positions, underpinning a continuation of current growth and inflation dynamics in the US.
For the US, this scenario would be seen as a modest positive for both US equity and bond markets - policy changes will be incremental in scope, suggesting that the trajectory of Federal Reserve rate hikes will likely remain gradual. While regulatory pressures will remain high for certain sectors of the economy, we expect a modest positive market reaction as investors discount more extreme scenarios. As this is our most anticipated outcome, we recommend investors to be long on US and emerging market equities against high-grade bonds and Swiss equities, respectively.
Asia's capital markets should benefit from this scenario. The Asian Dollar Index (ADXY) would likely post a modest, positive reaction alongside Asian risk assets. We are overweight on the equity markets of China, India and South Korea, while Singapore, Taiwan and the Philippines remain our key underweight positions.
This said, we think a Clinton victory and a Democratic sweep in Congress, admittedly a low- probability outcome, will be viewed negatively by markets. The prospects for a leftward lurch in the economic and regulatory agenda, exemplified by the policy leanings of the Elizabeth Warren and Bernie Sanders wing of the Democratic Party, will likely weigh on the most cyclically sensitive sectors of the markets.
A TRUMP WIN MOSTLY NEGATIVE FOR GLOBAL MARKETS
Despite his controversial political positions, Mr Trump is just behind Mrs Clinton in opinion polls. While the electoral maths is still stacked formidably against him, a Trump victory and Republican majority in both the House and the Senate are now a distinct possibility (25 per cent probability, according to UBS estimates), which would likely lead to higher policy uncertainty and market volatility worldwide.
If a Trump administration could close ranks with the Republican leadership, then progress could be made on a host of legislative initiatives, including a major overhaul of America's byzantine tax code, increases in infrastructure spending, an easing of regulatory burdens and a selective renegotiation of trade agreements. However, it's unclear if Mr Trump would pursue these initiatives, given the frequent clashes between the Trump campaign and Republican leaders.
Particularly at the onset, the threat of trade wars, draconian changes to immigration policies and ballooning deficits would preoccupy market participants. The immediate impact will likely be negative for global equity and fixed-income markets.
In particular, fears of US trade protectionism and geopolitical dislocation would thrust emerging markets into the spotlight; after all, Mr Trump has vowed to take aggressive action to reduce the US trade deficit, including imposing punitive tariffs and declaring China a currency manipulator.
Asian stocks and currencies too are likely to be rattled, and credit spreads would also widen as risk aversion takes hold. Currencies which are export-oriented - particularly Singdollar, Malaysian ringgit and Thai baht - or highly volatile - like the Aussie dollar, New Zealand dollar or South Korean won - could see steeper falls. The Singdollar, being a proxy for regional currencies due to its trade-weighted currency basket regime and better liquidity, could come under additional pressure from global investors looking to hedge their Asia FX exposure.
The yuan should be relatively stable initially, but this won't last if Mr Trump were to label China as a currency manipulator and impose trade tariffs, thereby hurting China's trade surplus.
A Trump victory could also hurt euro-zone equities as the US dollar would likely weaken against the euro in such a scenario. In contrast, safe-have assets such as gold, the Japanese yen and the Swiss franc could see an immediate boost. And given Mr Trump's environmental stance, his victory would be a boon for fossil-fuel producers.
POSITIONING AHEAD OF THE VOTE
In Asia, ahead of anticipated volatility and given the 26 per cent rise in Asia ex-Japan equities from February lows, we have slightly trimmed our tactical overweight positions in the region. Still, we remain overweight on Asian equities - gradually improving earnings fundamentals should underpin better markets over the next six to 12 months.
Globally, selected assets should also weather the US elections, regardless of outcome. Holding European dividend stocks - in the euro zone, Switzerland and Britain - and focusing on dividend quality and sustainability is one option since we expect interest rates to stay lower for longer globally.
Security and safety sectors in the US should benefit from both candidates' promise to increase security spending. And US inflation-linked bonds and US senior loans should also perform well as inflation expectations rise and the Fed moves closer to raising rates.
On the other hand, in both outcomes, lacklustre economic growth could still weigh on Mexican equities and the peso. Tepid growth in Mexico is likely to persist under Mrs Clinton and be exacerbated in the case of a Trump victory as risks rise about punchier protectionism.
In the end, a US president can never unilaterally impose his or her will upon the nation, especially without the support of Congress. So while the immediate impact on global markets from a Trump victory would likely be negative and investors should brace themselves for a surge of volatility, the effect will likely fade as market confidence in the US system of checks and balances returns. On a six- to 12-month view, we remain modestly risk-on in our global tactical positioning.
- The writer is the Apac regional head at the chief investment office of UBS Wealth Management.
