Market underpricing US election risks

It is almost over. Barring the unforeseen, Mrs Hillary Clinton looks likely to clinch the Democratic Party's nomination for the United States presidency, while Mr Donald Trump seems on track to nab the Republican one against the wishes of party elders.

The campaigns have grabbed headlines around the world and generated considerable debate among political pundits.

However, the jostling for position ahead of the November US presidential election has hardly created a stir in financial markets.

Investors are still pre-occupied with the same woes that ailed them long before US politics took centre-stage - low interest rates, poor global economic growth and weak oil prices, just to name a few.

One investment strategist here, DBS Bank chief investment officer Lim Say Boon, even credited Super Tuesday last week, as Mr Trump and Mrs Clinton triumphed over their rivals, with helping to give the global equities markets a big boost.

The outcome had been anticipated, he wrote. It's not that the markets like Mr Trump so much as that they had expected him to win. Ditto for Mrs Clinton. The market would have been surprised by a strong showing for her rival Bernie Sanders.

Still, one big question is whether investors are greatly underpricing the risks from the US presidential election which will, after all, determine who runs the world's most powerful economy for the next four years. Aren't investors being a tad too complacent?

Four years ago in the heat of another US presidential election, investors could afford to be sanguine as discussions on President Barack Obama and his Republican challenger Mitt Romney would sometimes be reduced to trivialities such as the nominees' body language or how well they debated each other.

But it is obvious from how the panicky Republican elite is trying to stop Mr Trump from clinching the nomination that gale-force winds of change are blowing.

The conventional wisdom is that voters want drastic change, so they are flocking to Mr Trump and, to some extent, Mr Sanders, as they don't like the country's direction.

As cable TV CNBC commentator Larry Kudlow observes, while the US economy has been growing at 2 per cent, the US middle class is getting nothing out of it.

"Not surprisingly, the middle class is getting cranky and angry. And people are voting for significant change," he said.

For investors, if US voters choose Mrs Clinton as president, that would mean preserving the status quo as she favours incremental reforms, rather than the sweeping changes envisaged by her rivals.

This is because she would be a "known known" - to use a term coined by former US defence secretary Donald Rumsfeld. Given her record as senator and secretary of state, investors know what to expect from her as president.

Stock markets fared well under her husband, Mr Bill Clinton, when he was president between 1993 and 2001, and despite her own anti-Wall Street rhetoric, Mrs Clinton is the most market-friendly option available for now.

But even if she wins the presidency, the popularity of the campaigns waged by Mr Sanders and Mr Trump would suggest that there is now a considerable constituency in the US embracing isolation as middle-class Americans blame foreigners for the increasing pressure on their living standards.

And this is where investors should sit up and watch US developments with great caution, rather than enjoying it like the reality TV shows in which Mr Trump used to star.

Mr Trump would be an "unknown unknown" - to use the words of Mr Rumsfeld - the sort of wild card that worries investors.

His best claim to the presidency is that unlike other candidates who might be influenced by their wealthy backers, he cannot be bought and he boasts about how much money he has. "I'm not using lobbyists. I'm not using donors. I don't care. I'm really rich," he said at the start of his campaign.

But so far, his public pronouncements in the economic realm offer little solace to investors that it would be business as usual if he takes over. If taken seriously, his remarks would trigger alarm bells.

Mr Trump has said that he wants to slap punitive tariffs on imports from countries taking "unfair" advantage of free trade. He has talked about tariffs ranging from 35 per cent to 45 per cent.

Mr Trump has also repeatedly said he wants to retaliate aggressively against nations "killing" the US on trade. Three of the four he has named so far - China, Japan, South Korea and Mexico - are in Asia.

He is also the most explicitly protectionist candidate in the running, promising to make sure that Americans buy US-made cars and to force Apple to relocate its iPhone manufacturing from China. He also denounced trade deals that the US had signed and pledged to tear them up.

Given the manner that he and other candidates have been able to make political capital out of American disillusionment with globalisation, this has forced even Mrs Clinton to come out against the Trans-Pacific Partnership - a trade pact among Pacific Rim countries she once championed as secretary of state.

One explanation for why investors are treating the US election with nonchalance, for now, could be because they are betting that US voters will come home to Mrs Clinton as she is the best qualified person for the job, even though they may not like her.

As to their lack of reaction over Mr Trump's many inflammatory remarks, one line of reasoning is that he is a self-described dealmaker taking outrageous policy positions in order to set markers for future negotiations with other nations and the US Congress, where he can rely on experts to get the job done.

But that may be too complacent a position to take. As former US treasury secretary Lawrence Summers observes, a concern that the US is becoming protectionist and isolationist could easily undermine confidence in many emerging markets and set off another financial crisis.

The forces of creative destruction that have been disrupting old and entrenched businesses are now disrupting old and entrenched political rules in the US.

The world will never be quite the same again. Investors should not take the emergence of the likes of Mr Trump lightly.

A version of this article appeared in the print edition of The Straits Times on March 07, 2016, with the headline 'Market underpricing US election risks'. Print Edition | Subscribe