Market Know-How 4Q 2024
Inflection Point
In 2024, roughly 4 billion people will have headed to the polls, reflecting the largest expression of political will in human history. The prevailing themes from this significant global electorate have been mixed so far, with several far-right victories across Europe while South Korea and Taiwan saw center-left parties take control of their respective legislative bodies. We believe what does appear consistent across all voter cohorts is anti-incumbency.
The US general election on November 5th will weigh the disparate platforms of two ideologically distinct parties. We believe the legislative differences between a Republican or Democratic sweep are stark. Each presidential candidate may also emphasize considerably different priorities via executive action. In common, the two parties face: inflation, tariffs, deficits, and roughly half a nation that will be displeased with the election.
From an investment standpoint, these political moments often may serve as inflection points for optimizing portfolio design due to potential legislative and regulatory activity, such as shifting tax codes. Importantly, while elections may provide opportunities for portfolio adjustments, we don’t see them as moments to move all-in or all-out of the market, as legislative gridlock precludes drastic and immediate change. In our view, economic growth, earnings, and time tend to trump politicians.
In this edition of the Market Know-How, we evaluate the intersection of markets and politics, noting potential action investors can take that may transcend the differences between candidates, including:
- Capitalizing on a ruptured world by taking advantage of increased industrial protectionism and supply chain reconfiguration.
- Building down-in-cap equity exposure as the likely domestic beneficiaries of US-centric trade policy.
- Actively navigating the fixed income landscape given the persistent fiscal trajectory of both parties.
Source: Goldman Sachs Asset Management. As of September 23, 2024.
Macro Views
US elections come at a time when the Fed begins a delicate "recalibration" of monetary policy, and the government faces large fiscal deficits. In this environment, the future US administration must carefully review its policy mix. While tariffs pose upside risks to domestic inflation and downside risks to trading partners’ growth, we see greater fiscal stimulus boosting growth with a unified government.
Source: Goldman Sachs Asset Management. As of September 23, 2024. “Fed” refers to Federal Reserve. Chart Source: Bloomberg and Goldman Sachs Asset Management. As of July 31, 2024. The economic and market forecasts presented herein are for informational purposes as of the date of this webpage. There can be no assurance that the forecasts will be achieved. Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.
Key Macro Insights
Taxes: Most expiring provisions of the Tax Cuts and Jobs Act would likely not be extended, while the policy’s permanent corporate tax reduction may be reversed, and higher taxes may be enacted on higher income brackets. Expansion of the Child Tax Credit may also be on the table.
Spending: A greater focus on community issues and social spending, such as expansion of education, healthcare, and other programs.
Immigration: A reduction in unauthorized immigration and tightening of border entry rules, though to a lesser extent.
Tariffs are expected to remain mostly unchanged, but more targeted towards certain industries such as semiconductors.
- US disinflation would likely persist, along with the expected FOMC rate cutting timeline.
- Corporate regulations may tighten, potentially impacting earnings and growth across US large cap companies.
- The impact of similar trade policies to the Biden administration under a Democratic sweep could also cause the US dollar to weaken, as disinflation progress enables the Federal Reserve to ease monetary policy.
Taxes: Expiring provisions of the Tax Cuts and Jobs Act would likely be extended at the individual level and potentially amplified at the corporate level.
Spending: Taxes and benefit spending would likely remain unchanged, while defense spending would likely increase.
Immigration: A reduction in unauthorized immigration and significant reduction in overall immigration flows appear most likely, in our view.
Tariffs are expected to increase, with the potential for a 10% across-the-board tariff and a higher tariff on China.
- US disinflation progress may stagnate under a Republican sweep, potentially delaying the Fed’s rate cutting timeline.
- Domestic workers may gain more bargaining power under tighter immigration policies, reducing labor supply while placing greater upward wage pressure on employers.
- Tariffs and tighter immigration policy could reduce the positive fiscal impulse to US GDP stemming from tax cuts, potentially resulting in an overall modest hit to GDP growth under a Republican sweep.
Market Views
While elections can impact markets and increase volatility in the short term, predicting election outcomes is extremely difficult. We therefore believe investors should focus on policy that may continue irrespective of outcome — like industrial protectionism and further economic decoupling from China — and on secular trends when building their portfolios.
Source: Goldman Sachs Asset Management. As of September 23, 2024. Chart Source: Bloomberg and Goldman Sachs Asset Management. As of September 5, 2024. Chart shows annual S&P 500 performance from 1933 through 2023, broken down first by which party was in control of the US Presidency, then by the composition of US Congress. The left three bars show performance under a Democratic President across different congressional control and the right three bars show performance under a Republican President across different congressional control. For the composition of US Congress, “Democratic” refers to a unified Congress where both chambers are controlled in majority by Democrats, “Divided” refers to a situation where no one party controls both chambers of Congress, and “Republican” refers to a unified Congress where both houses are controlled in majority by Republicans. “Low/High Range” refers to the difference between the worst performing year and the best performing year historically under each of the six different potential regimes. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Past performance does not guarantee future results, which may vary.
Given both candidates’ focus on fiscal expansion, we believe US equities may do well under both a Harris and a Trump presidency, but different market pockets might benefit to a different degree. Tariffs would create a headwind to the performance of stocks with high international revenue exposure such as the big tech companies. By contrast, small caps would probably do better given that they are more domestically-orientated. Other DM equities, especially in Europe, look vulnerable to the threat of tariffs, in our view.
The equities of many emerging markets may be sensitive to tariffs given US revenue exposure, their supply chain linkages to China, and their historical beta to China equities during past episodes of tariff announcements. Equities in China, Korea, Taiwan, Mexico and Brazil are the most exposed, while equities in India appear the most insulated against potential US tariff risks.
Recent bouts of market volatility have been primarily driven by macro data surprises, market illiquidity and systematic trading. However, fundamentals remain intact. We believe volatility may remain elevated through the elections but should subside once election results are finalized. Nevertheless, volatility also may beget investment opportunities, and at the very least, investors looking to navigate through political uncertainty may be better served by staying invested.
The impact on rates of forthcoming elections will largely depend on the magnitude and nature of the fiscal plans. That said, in both a Democratic and a Republican sweep scenario we would expect higher long-term Treasury yields and a steeper yield curve due to fiscal expansion. However, under a Republican presidency, tariffs may flatten the curve if they were viewed as a negative shock to productivity and growth.
Given our expectation of a US soft landing, and the fact that the Fed may cut rates by more than other central banks in the short term, we believe that the US dollar should weaken from here. That said, in the event of a Republican win, tariffs would likely strengthen the greenback against most major currencies. The main exception is the Japanese yen which may appreciate further as the BoJ continues to normalize its monetary policy.
Given our expectation of a US soft landing, and the fact that the Fed may cut rates by more than other central banks in the short term, we believe that the US dollar should weaken from here. That said, in the event of a Republican win, we believe tariffs would likely strengthen the greenback against most major currencies. The main exception is the Japanese yen which may appreciate further as the BoJ continues to normalize its monetary policy.
Implementation Solutions
Economic Security
From Integration to Fragmentation: After decades of increasing global economic integration, we believe the world is facing geo-economic fragmentation. Given bi-partisan support towards industrial protectionism, we believe this trend is only likely to strengthen regardless of the outcome of the forthcoming US elections. While the cost for the global economy may be high, we believe increased focus on economic security by governments and corporations is sparking a realignment in global trade and capital flows, which we believe offers an unparalleled investment opportunity. The US is at the epicentre of a lot of these changes. Since the onset of the US-China trade tensions, the world’s largest economy has been progressively reshaping its supply chains to reduce the dependence from China, particularly for advanced technology products.
Source: United States Census Bureau, and Goldman Sachs Asset Management. As of September 23, 2024.
Investing In The Age Of Protectionism: As part of its supply chain reconfiguration, the US government is providing funding and financial incentives to build onshore manufacturing capacity in strategic sectors like semiconductors and clean energy. We believe the US has also been a key recipient of the redirection of global foreign direct investment flows (FDI) away from geographically- and geopolitically-distant countries. Tensions are increasingly rising, leading countries to further diverge along geopolitical fault lines, we believe these trends will only intensify, creating unique long-term investment opportunities in supply chain, resource and national security.
Source: OECD, IMF and Goldman Sachs Asset Management. As of September 23, 2024.
From Integration to Fragmentation Section Notes: Chart shows the percentage point change in share of US imports from the aforementioned regions from between 2017 – 2024 June. Please see additional disclosures at the end of this document. There is no guarantee that objectives will be met. Investing In The Age Of Protectionism Section Notes: Chart shows FDI inward stock to the US and World ex-US from 2005 to 2023 predicted. Foreign direct investment (FDI) stocks is the total level of direct cross-border investment over time. Inward FDI stock is the value of foreign investors' equity in and net loans to enterprises resident in the reporting economy. World FDI flows are based on available data at the time of update as reported to the OECD and IMF for the year ended or the latest available year . World ex US is World inward FDI stock minus US as defined by OECD. Past performance does not predict future returns and does not guarantee future results, which may vary.
Small Caps
Poised For Protectionism: As this current election cycle concludes and we shift from campaign promises to policy execution, newly elected officials will likely begin implementing their proposals, leading to increased fiscal spending and investment in domestic industries. Investors looking to capitalize on these new fiscal initiatives might find opportunities in small-cap companies, as their domestically-focused business models may allow them to quickly monetize on these new developments, especially in a monetary easing environment given their greater share of floating rate debt. Historically, small caps have outperformed their large cap counterparts by an average of 3% in the 12 months following US presidential elections, reflecting their sensitivity to economic growth, which is typically supported by increased government expenditure.
Source: Bloomberg and Goldman Sachs Asset Management. As of September 23, 2024.
Small Beginnings: Beyond the elections, we expect small caps to continue to benefit from interest rate cuts by the Fed. While some of the potential policies put forward by the presidential candidates, such as the imposition of broad-based tariffs, could prove inflationary, we think there is enough disinflation in the US economy to ensure that the Fed doesn’t need to change course materially regardless of the outcome of the elections. Given that 30% of Russell 2000 debt is financed via floating rates, compared to just 5% for the S&P 500, we believe lower rates should feed through faster, providing a significant tailwind for small caps in the next year. With current valuations offering an attractive entry point, we think now is the time to invest in small caps.
Source: Bloomberg, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management. As of January, 2024.
Poised For Protectionism Section Notes: Chart shows Russell 2000 and S&P 500 performance in the 12 months after each of the past 10 US presidential elections. Small Beginnings Section Notes: As of January 2024. Chart shows the debt composition of the companies making up the S&P 500 Index and the Russell 2000 Index. The S&P 500 represents the US large-cap universe, and the Russell 2000 represents the US small-cap universe. Past performance does not predict future returns and does not guarantee future results, which may vary. For illustrative purposes only.
Treasury Markets
An Uncertain Fiscal Future: The US is known for its large primary deficit, the future of which is both unsettling and unsustainable. We believe the rising cost of interest payments that the US must make on its debt is another growing concern with no solution in sight. Given neither political party has demonstrated a clear commitment towards improving the deficit problem, markets may begin pricing in the burden of this debt and its interest expense. As a result, investors may seek a higher premium for the longer end of the curve or an increased appetite for intermediate duration profiles. While US Treasuries remain a key component of portfolios, investors may find enhanced compensation from taking an active approach.
Source: United States Congressional Budget Office and Goldman Sachs Asset Management. As of September 4, 2024.
Finding a Footing: A wide range of fiscal outcomes may still occur depending on growth, rates, and policy. We believe strong GDP growth, an AI productivity boost, and demographic expansion are all factors that may limit the degree of rising debt over the next 15 years. As for borrowing costs, although a -1pp deviation from the CBO’s baseline projection would slow the growth of debt over the next 15 years, this would not be meaningful enough to improve the US’ fiscal standing. The next political administration would need to also responsibly manage public finances in tandem with US economic strengths to mitigate the risks of high debt. Although the US is continuing down what may be an unsustainable path, we believe its resilient growth, the dollar’s standing as a world reserve currency, and its leadership in innovation may support future efforts to grow in a financially sustainable manner.
Source: United States Congressional Budget Office and Goldman Sachs Asset Management. As of September 23, 2024.
An Uncertain Fiscal Future Section Notes: As of September 4, 2024. “GDP” refers to Gross Domestic Product. “CBO” refers to Congressional Budget Office. Finding a Footing Section Notes: Chart shows the potential impact to Federal debt held by the public as a percentage of GDP from a 1pp increase or decrease in borrowing costs from the CBO’s baseline projection until 2040. “pp” refers to percentage point. “AI” refers to Artificial Intelligence. The economic and market forecasts presented herein are for informational purposes as of the date of this webpage. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this webpage. For illustrative purposes only.
