Get ready to invest post-US election, urges Old Mutual’s Christine Johnson

Christine Johnson, manager on the Old Mutual Corporate Bond fund, says that whatever the outcome of the US presidential election, investors need to prepare for investment opportunities.

For financial markets, the US election in November is just the beginning. It concludes a year of startlingly binary events. Politics is the new economics so it’s fitting the year should end with such a colossal event.

The US constitution, for better or worse, is about checks and balances. Neither party is likely to win outright power. Whichever side takes the presidency, Congress is likely to be split, with the Republicans dominating the House of Representatives and the Democrats the Senate. That still leaves two immensely powerful bodies outside the electoral cycle. The Supreme Court, where appointments are for life, remains predominantly Republican, while the Federal Reserve is chaired by an out and out dove, Ben Bernanke – but he is due to retire at the end of 2013.

Republicans are traditionally seen as the party of low-taxes, light regulation and business friendly government – it was interesting to see how well equity markets and especially Bank stocks responded after Romney’s perceived win at the first presidential debate. That effect is amplified in the bond market as he’s also seen to be against continuing quantitative easing. Indeed either of the candidates he’s likely to prefer as Fed chairman would likely be much more hawkish in their monetary policy stance than Bernanke.

Further magnifying all these effects is the notorious ‘fiscal cliff’ – the expiration of both Bush-era tax cuts and the temporary postponement to spending cuts could knock as much as 4% off US GDP. A Republican win would likely buy some breathing space as there would be cross party support for further extensions and postponements while the new president finds his feet.

Conversely – a Democrat win would be seen as increasing the chance of hitting the fiscal cliff – at least for a time. Allowing the Bush-era tax breaks for the wealthy to expire would be a bargaining chip for the Democrats and a way the Republicans could allow a notional tax rise without being seen to condone it. This presents us with the paradoxical situation where Obama, a tax-and-spend Democrat, would be seen as bad for growth and good for Treasuries. Obama’s choice for the Fed is likely to be as dovish as Bernanke, which if nothing else would provide policy continuity.

And that’s just the open stages. Fiscal stability can’t be postponed indefinitely. Investors shrugged off the downgrade to the US credit rating last year, but further avoidance will only result in further downgrades and sooner or later the consequence will be a rise in yields as Treasuries lose their risk-free status.

What about those tax cuts? Even if they’re kicked into 2013, they too still need to be resolved. If the Republicans are serious about being the party of ‘smaller government’, that means less spending, including in areas which the Republicans favour, such as the military. Meaningful spending cuts would favour Treasuries, but it is uncertain whether the pace of cuts would be sufficient to make up for an end to QE.

From an investment point of view, we would emphasise liquidity and flexibility. The eurozone has given us experience in dealing with high impact, binary macro events. We know there will be risks, but we also know there will be opportunity.


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