Insights

Although foreseen by our US & Geopolitical strategists, a “Red Sweep” now makes the macro environment more volatile. After convening for our BCA Live & Unfiltered meeting, we offer three main takeaways.

First, 2024 is not 2016. To begin with, a Trump victory is less of a surprise. Moreover, the macro context differs. The 2016 economy was the result of a tepid recovery, while the 2024 economy is cooling down from a period of overheating. The world needed reflation back then, but not now. Markets are more sensitive to any hint of stimulus, as seen recently in the UK bond market.

Second, the Trump victory and market reaction strengthens our recession case. Higher bond yields tighten financial conditions for an already cooling labor market and a global manufacturing recession. Trade tensions will only weaken global growth.

Finally, we put together a playbook for what a Trump 2.0 presidency will look like across asset classes. While the short-term mood is to go long risk, we recommend positioning for incoming global headwinds.

According to BCA Research’s Geopolitical Strategy service, seven surprises with non-negligible odds could tip the scale in favor of Republicans for the White House by November 5. One of them is a war between Israel and Iran.

Iran is still highly likely to retaliate against Israel. The Biden administration’s ceasefire talks have floundered since Hamas killed some Israeli hostages. Since then Israel has struck Iranian targets in Syria and Hezbollah targets in Lebanon, including a commander of the Radwan Force.

• Iran transferred short-range ballistic missiles to Russia in another sign that the Biden administration is failing to keep relations stable and achieve a ceasefire.
• Israel’s attack on Hezbollah confirmed our colleagues’ base-case view that the war would spread beyond Gaza but not all the way to a regionwide war centering on Iran and the Persian Gulf.
• The attack on a Saudi oil tanker in the Red Sea (not to mention the Greek tanker) proved that the current trajectory of conflict is causing minor oil shocks. These incidents can become larger or more frequent while remaining “minor” from a global macro point of view. But they could also become “major” under the wrong circumstances.
• Our colleagues pegged the risk of “major” oil shocks at 37% for this year. It should go up after the election. Major shocks would involve Iranian attacks on significant oil supply and distribution in Iraq or the Persian Gulf region, whether preemptively or in reaction to Israeli or American attack.
• It is possible for Israel to agree to a ceasefire with Hamas and still escalate with Hezbollah or even Iran, and for this to happen before the US election. Israel is focused on its long-term security and the Biden administration may not succeed in restraining Israel now that it is mobilized and has an opportunity to strike Iran and its proxies.

According to BCA Research’s US Political Strategy service, there is a strange quirk about Walz and the state of Nebraska that could have national consequences in the black swan scenario of an electoral college tie.

Walz was born in Nebraska, even though he has lived in, represented and governed Minnesota. Nebraska divides its electoral votes across congressional districts, unlike every other state but Maine. This gives Democrats the chance to pick up a single electoral vote in this red state due to Omaha, the state’s second congressional district.

If Harris and Walz lose Georgia, Arizona, and Nevada – where Republicans have been polling well – yet capture one electoral vote in Nebraska, then they will win 270 electoral college votes to 268, avoiding an electoral college tie of 269-269.

A tie would pitch the decision to Congress where Republicans would prevail due to majority of state-led delegations to Congress.

On the other hand, if Harris wins Arizona and Nevada (due to women’s rights and being from the West), yet loses Georgia, and then loses Pennsylvania in part because she did not pick Shapiro as her running mate, then Trump will win the election with exactly 270 electoral college votes.

Most likely Trump will win Arizona, Georgia, and Nevada, reducing the election to the sole question of Pennsylvania. So if Democrats lose Pennsylvania, then it will be blamed on her decision not to pick Shapiro.

This risk is so obvious that the Democratic wonks and campaign gurus clearly believed that Walz would make a greater material impact than Shapiro on swing voters across the Midwest, namely Michigan and Pennsylvania, and Nebraska was a cherry on top.

According to BCA Research’s US Equity Strategy service, the stock market outperformance in 2024 thus far is an unusual pattern in election years. The historical data imply that the market will suffer a spill if investors come to believe the incumbent party will change.

The spike in volatility in recent weeks coincided with a surge in the odds of party change (e.g. Republican victory), which confirms this historical framework. Volatility will continue to increase in the near term, especially if the incumbent party fails to regain momentum after changing nominees. Stocks will fall if the incumbent party is poised to fall.

Investors should expect US assets to outperform global peers. By contrast, the market usually rallies after elections, relieved that uncertainty has dissipated.

After the election, the market faces a different question: 2025 will mark a new year with new policies that may or may not affect the markets, depending on the capability and interests of the next government (hawkish or ultra-hawkish trade policy, gridlock or full sweep).

It is impossible to untangle the Trump trade from the ubiquitous expectation of an imminent rate cut and a soft landing. Our hunch is that Real Estate and Homebuilders outperformed for that reason. However, Trump’s immigration reform will be a headwind for the industry as it will increase labor costs, hitting its bottom line.

The Trump trade, i.e. Small Caps, Regional Banks, and Industrials, runs against the BCA view of slowing economic growth that favors defensive assets. And of course, a Trump victory is far from a certainty.

According to BCA Research’s Geopolitical Strategy service, Trump’s agenda is structurally inflationary and would eventually be needed to be discounted by markets, if he wins.

Most retail investors – and many clients – seem to believe that Trump will win and the stock market will boom. Opinion polls show Trump leading in swing states. The market rallied when he won in 2016 on the expectation of tax cuts, which eventually boosted corporate earnings. Trump is proposing tax cuts again.

Three things to remember:

A relief rally is the norm after elections because uncertainty is removed.

If recessionary dynamics give Republicans full control, then the market will cheer tax cuts and other stimulus designed to aid the recovery.

If the economy expands and Biden loses anyway, then the bond market may revolt against Republican fiscal stimulus. This is the “Liz Truss” scenario, which is now becoming widely discussed.

The important point is that Trump’s agenda is structurally inflationary. Hence Trump and the Federal Reserve will eventually clash – and the president has the power to remove the Fed chair, however controversial it may be.

Whatever happens initially, the market will eventually need to discount another uptick in inflation.

According to BCA Research’s Bank Credit Analyst service, trade policy under a second Trump presidency represents one of the greatest cyclical risks to investors.

A key question for investors is whether tariffs are prioritized early in the administration or saved for later. Our colleagues expect the former. An early legislative priority on immigration over tax cuts, alongside the rapid imposition of new tariffs, would be the worst alignment for risky assets.

Being barred from a third term, Trump would lack electoral constraints in his second term. In 2019, the Trump administration escalated the trade war with China, which weighed heavily on the global manufacturing sector. Then, when the 2020 election began to loom, Trump pivoted and started negotiating the Phase One trade deal with China.

During a second term, if China does not offer structural concessions, Trump will not be forced to conclude a Phase Two deal. Thus, his campaign threats of tariffs “more than” 60% on Chinese imports could materialize – and they may not be watered down in 2028. The impact of a true 60% flat tariff on all imports from China would bring the overall US import tariff rate to 10%, back to 1940s levels. They would dwarf the total increase in tariffs that occurred during the first Trump administration.

One optimistic take about Trump’s trade policy is that he views tariffs as a negotiation tool, and not as something that will stand permanently. The first counterpoint to that view is that China and other countries may not offer structural concessions. The second counterpoint is that tariffs can have a very significant impact on economic growth even if they are only in effect temporarily. That is because large and damaging trade actions are typically met with retaliation, which is theoretically rational, even if it constrains economic activity.