Markets – November 2024
First negative month of market returns since April
Market volatility returned in October as investors positioned for an uncertain outcome from the US Presidential elections.
2024-2025
US election outcome requires investors to recalibrate
The challenge for investors is always about playing with the cards you’ve been dealt. The outcome of the US election underlines this approach.
The Republicans managed a clean sweep of the White House, the Senate, and most likely the House. This gives President-elect Trump the strongest mandate to implement his policies, which are focused on cutting taxes, lifting tariffs, and tightening US borders.
Elon Musk will likely be appointed as head of a new government agency, with the strategic aim of reining in the massive federal government budget deficit.
The biggest issue here is the uncertainty about how aggressive the cuts to government expenditures are and how this will affect the economy.
Musk is on record suggesting that his target is to cut $2T from the budget. But removing such a large amount of spending from the economy would have significant growth implications if not replaced by other positive accretive outcomes, such as productivity enhancements.
How aggressively will Trump’s policies be implemented?
Trump has touted an across-the-board 10% import tariff and a targeted 60% tariff on Chinese goods.
This would improve the US fiscal position, by generating revenue from taxes on imported goods. But it is also a direct tax on US consumers.
The tax generated from higher tariffs would not cover the lost revenue from extending the personal income tax cuts implemented in Trump’s first term, or the proposed fall in the corporate tax rate to 15% for US-produced profits.
Trump is inheriting a very different starting point
- The US share market trades at record levels and offers little downside protection
In 2016 in Trump’s first term, the PE was 16.8 times. In Clinton’s first term, it was 13.9; in Obama’s 10.4.
Price and valuation multiples are at decade highs, implying investors are prepared to pay more now for future earnings.
This has resulted in the equity risk premium for US shares to be close to zero. The equity risk premium is the excess return an investor earns when they invest in the stock market over a risk-free rate. This return compensates investors for taking on the higher risk of equity investing.
The gap between the earnings yield on the S&P500 and the ten-year US Treasury has fallen to close to zero. Usually, the spread is around 3.
- America’s federal fiscal fundamentals are as poor as they have ever been
The US federal debt is 104% of GDP, which is at record levels relative to GDP (Second World War aside). In comparison, Australia’s debt to GDP currently stands at 44%.
Rising debt servicing costs are growing at a rate that now sees the annual expenditure on interest at $882bn, compared with spending on defence at $874bn.
Despite strong economic growth and low unemployment, the annual federal deficit is close to 7% of GDP – a level usually seen when the economy is in recession.
- Trump’s election promises will increase the federal deficit further
The Committee for a Responsible Federal Budget estimates that Trump’s policies will add an extra 17% to federal government debt by 2035, increasing the debt-to-GDP to 142%!
Bond markets are on watch
Bond markets are monitoring the sustainability of the US fiscal position amid concerns that the budget has little room to provide a cyclical buffer should the economy experience any type of recession.
The prospect of escalating debt is likely to put upward pressure on Treasury yields at some stage.
However, the issue for investors is that when this might occur is unknown. Trump has in the past threatened the Fed’s independence. If he were to act on his threats, it may trigger a quicker upward jump in interest rates.
Time will tell if the election result is the catalyst for bond markets to worry about US deficits. Should they do so, the markets will dictate investor sentiment about Trump’s second term.
Trump’s election could lead to a seismic shift in several areas. His signature policies most likely to be implemented include tax cuts, tariff increases, deregulation and larger deficits.
This is a mixed bag for investors. But markets are pricing in a continuation of the US equity run without anticipating any downside risks.
With risk premium on US assets already unattractively low, this lopsided expectation carries a high risk of disappointment.
Sources: ASX, The Australian, Bloomberg, CBA, Morningstar, Minack Advisors, Westpac & The AFR
Kauri Wealth Management is a Fee for Service investment advisory business and as such my advice is built around ongoing personal relationships with my client base. Personalised independent advice is backed up by a breadth of industry knowledge.
I accept a limited number of new clients each year and would be happy to discuss this further with you. Please don’t hesitate to contact me.
Russell Lees
Senior Adviser
Phone: +61 439 852 963
Email: russell@kauriwealth.com.au
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