Inflation continues to be a key issue for voters in elections
around the world. Our CIO and Chief US Equity strategist explains
its potential influence on the upcoming US presidential election,
and how investors may react to potential outcomes of this race.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief US Equity Strategist. Along with my
colleagues bringing you a variety of perspectives, today I'll be
talking about the consequences of elections on policy and
markets.
It's Monday, July 8th at 2:30pm in New York.
So let’s get after it.
Several important elections around the world have taken place
with important implications for policy and markets. Most notably,
elections in India, Mexico, the UK and France have all garnered
the attention of investors.
While these elections are unique to each country, there does
appear to be a growing focus on the issue of economic
inequalities and immigration. While these inequalities have been
building for decades, the COVID pandemic and policies implemented
to deal with it have ushered in a higher focus on these
disparities and a general level of uncertainty about the future
on the part of many citizens.
Of all the changes affecting the average person most adversely,
inflation stands out as the most challenging. While the rate of
change on inflation has been steadily falling since 2022, the
price level of a number of goods and services remains
challenging for many. Prices for basic items like food, shelter,
healthcare, insurance and utilities are 30 to 50 per cent higher
than they were pre-pandemic. Offsetting some of this increase has
been the rise in home equity and financial asset prices, but this
only helps those who are asset owners. Fixed rate mortgages have
also been a notable positive offset to rising prices and interest
rates. For many, there is a natural arbitrage between these
pre-existing, historically low mortgage rates and money market
rates. Once again, such an arbitrage is only available to
those who have large piles of cash.
In our view, these dynamics further the case that inflation is
going to play a major role in this year's upcoming U.S. election
much like it is having an impact globally.
The recent US Presidential debate prompted inquiries from
investors on what a potential Trump win or a potential Republican
sweep could mean for markets. Based on initial market reactions
and our conversations with clients, there is a consistent view
that both growth and longer-term interest rates could move higher
under this outcome. This has led to a greater appetite to rotate
one’s equity portfolio toward value and cyclical stocks, which
also worked leading into the 2016 election. Market expectations
for fiscal expansion, reflation and less regulation under a Trump
Presidency support such moves.
However, we think there’s also a couple of important dynamics to
consider. First, we would argue that the cycle is more mature
today than it was in 2016 as evidenced by the two-and-a-half-year
decline in the Conference Board Leading Economic Indicator
and the nearly 2-year inversion of the yield curve. Given a later
cycle environment is historically a backdrop where the market
pays up for quality and liquidity, we advise staying up the
quality curve and away from small cap cyclicals, which worked in
2016. In short, the state of the business cycle right now is more
important than the election outcome. As such, we think investors
should stay selective within cyclicals.
Second, the market welcomed a reflationary playbook in 2016.
Inflation was not a headwind to consumers in the way it is now,
and the US economy was recovering from a global
manufacturing recession, the recovery of which was aided by
the prospects of a pro-fiscal/reflationary policy regime. Today,
inflation is a notable headwind to consumers as discussed
previously and fiscal sustainability dynamics remain top of mind
for the bond market.
Thanks for listening. If you enjoy the podcast, please leave us a
review wherever you listen, and share Thoughts on the Market with
a friend or colleague today.
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