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US elections and EM
The Emerging View
09 October 2020
Noise levels are likely to remain elevated in the run-up to – and possibly in the immediate aftermath of the upcoming US presidential election, but the post-election outlook should prove positive for EM assets by ushering in a period of more positive risk-sentiment, a long period of low US rates and a lower Dollar.
Analysis of US equity market performance around elections shows that investors have generally assigned too much credit to Republicans on the economy with stock markets running up ahead of Republican wins, but then disappointing afterwards. The opposite is generally true for Democrat wins, especially when Democrats overturn Republicans. This pattern is even more pronounced for EM equities with sharp rebounds, when Democrats overturn Republicans.
Post-election US domestic policy options – fiscal and monetary depend more on the outcome of the Senate race than the presidential election itself. If Democrats win the Presidency and control both houses of Congress they will be in position to legislate, including passing structural reforms and approving new fiscal stimulus. If Trump wins, but fails to hold the Senate he will be lame duck and political risk rises sharply, including impeachment risk. A Trump win with the Senate remaining in Republican hands is a continuity scenario.
Either way, the economy will be key in the next presidential term. The US economy is in the grip of a classic real exchange rate overvaluation, a late business cycle symptom. The prospect of yet more fiscal stimulus and monetary policies geared towards funding the fiscal deficit are a recipe for lower trend productivity growth and capital outflows. This bodes well for EM equities due to a strong relationship between EM equity outperformance relative to the S&P500 and the broad Dollar.