Rising risk of a progressive left US Democratic presidential candidate
A key political risk for equities in 2020 was triggered in September. After much pressure from her party and grass roots support, Nancy Pelosi, the Democrat leader of the House of Representatives (HOR) finally began a formal impeachment inquiry into President Trump over the alleged withholding of US foreign aid to the Ukraine in exchange for a probe into Democrat rival Joe Biden. The motion could pass in the HOR because the Democrats hold the balance of power, but they would then need a two-thirds majority in the Senate (the other legislative chamber in the US bicameral system) to convict President Trump and remove him from the White House. Considering that the Republicans hold a 53-seat majority in the Senate, it would take at least 20 Republicans to vote against the president, a move that seems unlikely at present.
A secondary consequence of the impeachment inquiry is that it has reduced public support for Joe Biden in opinion polls and boosted the popularity of Elizabeth Warren, a keen advocate of impeachment. Critically, Elizabeth Warren now has enough momentum that the betting market places her as the favourite to win the Democrat presidential candidacy.
In policy terms, Joe Biden is seen as a moderate Democrat willing to provide bi-partisan support to Congress and, as such, a fairly market-friendly presidential candidate. Elizabeth Warren, on the other hand, is the leading progressive left candidate, after support for Bernie Sanders has dwindled, possibly over concerns of his health and unfavourable messaging to the public. Elizabeth Warren’s policies are a risk to markets
as they largely focus on the economy and include tax increases, tighter regulation, wealth redistribution and possible restrictions on share repurchases.
Specifically, the sectors that look vulnerable are healthcare — where Elizabeth Warren wants to impose price controls on pharmaceuticals — and the tech industry, where she aims to break-up large cap tech stocks like Amazon, Google and Facebook. Energy could also be hit by a ban on fracking, while banks would be sensitive to greater regulation and falling bond yields if a flight to safety sell-off in equities occurred. It is worth noting that healthcare, tech, energy and financials account for just over 50% of the S&P 500 stock market index.
Markets will have a better idea on the likely candidate in March-April 2020 when the bulk of Democratic primaries are scheduled. Should Elizabeth Warren pick-up a sizeable number of delegates to cement her nomination as Democrat presidential candidate, US (and global) markets could well struggle to perform.
However, should Elizabeth Warren tone down her leftwing rhetoric to move closer to the centre ground, then markets may take a more sanguine view of this political risk. We will continue to monitor the situation.
No deal Brexit tail risk has been lowered
UK Prime Minister Boris Johnson finally agreed a Withdrawal Agreement (WA) with EU leaders at a summit in mid-October. The legislation entailed in the WA also passed (in principle) its early stages in the House of Commons. This is the first time since the referendum in 2016 that an EU approved deal was backed by a majority of MPs in Westminster.
The Brexit deal removes the controversial Irish backstop that failed to pass parliament under Theresa May’s premiership and replaces it with a protocol that puts Northern Ireland in a dual customs union with the EU administratively and the UK legally. Under this deal the UK and EU will give a firm commitment not to have physical infrastructure at the border between Ireland and Northern Ireland, as well as no customs and regulatory checks.
Looking forward, the new arrangement allows the UK to negotiate trade deals with the rest of the world when the transition period ends in December 2020. Boris Johnson’s deal also removes legally binding minimum standards on tax, competition, state aid and social and environmental policy applied to the whole of the UK that were in Theresa May’s WA. Instead, these level-playing field standards only apply to Northern Ireland and will be negotiated as part of the UK’s future relationship with the EU, linked to the UK’s level of access with the single market. Essentially, the ground has been laid for a much looser trading and economic arrangement between the UK and EU.
The key message for investors from the government’s Brexit deal is that the tail risk of a no deal Brexit has been reduced. Assuming a Conservative majority in the upcoming general election, the economic agenda of “Borisnomics” (see our September Investment Outlook) could bolster growth through a combination of ending austerity and deregulation. Our base case is that the UK leaves the EU with a deal and we expect overseas’ investors to step-up interest in UK stocks. Specifically, we favour UK domestics (as captured by the FTSE 250 index) to outperform internationally-focused stocks, as broadly represented by the FTSE 100 benchmark index. That’s because; i) FTSE 250 stocks offer higher forward consensus Earnings Per Share growth of 6.2% over the next 12 months versus 5.7% for FTSE 100 constituents and ii) FTSE 250 stocks tend to outperform FTSE 100 when sterling appreciates, since overseas earnings are lowered when translated back into a stronger domestic currency.