Like a good Hollywood thriller, the US election kept us in suspense all week with plenty of plot twists and turns. Billions of people around the world spent days glued to their screens, as the vote count was drawn out by a high voter turnout and a large increase in mail-in ballots.
Though some of these still need to be tallied, and the tightest races could be subject to a recount, Joe Biden secured enough Electoral College votes to emerge as the new President Elect on Saturday.
Financial markets had expected a somewhat different result, pricing in a sweep of the White House, Senate and House of Representatives by the Democrats. This would have allowed the Biden-Harris administration to quickly unleash a massive fiscal stimulus package, providing much-needed support for the US economy.
Although the Democrats retained control of the House, it was with a smaller majority. The Republicans have so far managed to hold on to their narrow majority in the Senate, but two tight Senate races will have to be re-run in January, so the path forward is not entirely clear yet. A split Congress (between the House and Senate) often leads to nothing much happening on the policy front.
However, investors quickly warmed to the idea of Congressional gridlock. For one thing, the Republican Senate leader Mitch McConnell has indicated that he is ready to reopen stimulus talks. However, whatever is agreed on is likely to be smaller than in a ‘blue wave’ scenario.
The other benefit, for investors, of a split Congress and the stalling of far-reaching policy changes is that the apple cart is unlikely to be upset.
Specifically, corporate tax rates are unlikely to rise, and Biden will not be able to appoint a Treasury Secretary who is potentially hostile to Wall Street. And while Biden is likely to continue Trump’s tough stance on China, his style is less shoot-from-the-hip and more measured and predictable. Investors love predictability.
The net result is that risk assets surged after an initial wobble when it seemed that President Trump might pull off another upset victory.
Equities rallied, the dollar fell, the rand broke decisively through R16 to the dollar and South African bond yields declined sharply. (Bond yields and prices move in opposite directions.)
Chart 1: Major equity benchmarks in 2020
Source: Refinitiv Datastream
Clearly the election matters a great deal to Americans, but also to the rest of us. The US is just such a large and powerful country that its internal politics inevitably impact the rest of us. That is not necessarily how all Americans want to see it, but it is the reality.
On financial markets, the US influence is direct and substantial. American bond and equity markets make up half of their respective global totals.
The dollar is the world’s most used and trusted currency by a long shot, and virtually all markets use the US interest rate curve as a direct or indirect reference point.
However, this does raise the interesting question of how important individual leaders are. Do they really shape the destinies of their nations and the world? More specifically for our purposes, does it matter to your investment returns who the president or prime minister of a given country is?
You could just as easily ask how important the CEO is to the share price returns of a company. CEOs would obviously like you to believe they are absolutely indispensable and deserving of their generous pay cheques and bonuses.
Finance professors and business management experts have debated this point for ages. It seems that the individual in charge matters a lot sometimes, and other times not much.
As a result, some fund managers will only invest alongside management teams they rate. Others focus less on individuals and more on the underlying brands, business model or industry dynamics. Still others are outright hostile to company leadership.
Historians have long debated the extent to which history is shaped by individuals versus deep structural forces. The 19th century historian Thomas Carlyle popularised the ‘great man’ theory of history, placing leaders as the heroes and villains at the centre of historical narratives.
In contrast, Karl Marx and his followers believed the actions of individuals were greatly constrained by their geographical, economic and cultural settings. ‘Men make their own history’, Marx argued, but only ‘under circumstances existing already, given and transmitted from the past‘.
There is of course truth in both theories. No one can deny the extraordinary individual contributions of Nelson Mandela, Mahatma Gandhi or Joan of Arc.
The divergent performances of neighbours Burundi and Rwanda in the past three decades also has a lot to do with the leadership of Paul Kagame, Rwanda’s president.
Similarly, individuals like Hitler and Pol Pot are personally responsible for sowing death and destruction. Without Hitler, it’s unlikely World War 2 and the holocaust would have happened. But it was Germany’s defeat in World War 1 that created the political climate that led to Hitler’s rise to power.
By the same token, no one can say that only Gandhi could have led India to independence. The desire to rid India of British rule was shared by millions of his compatriots, while Britain’s own weakened state after World War 2 meant the end of its empire was inevitable.
Of course, the reason why debates such as these can never be settled is that historians, like other social scientists, including economists, cannot conduct controlled experiments.
We can therefore never be absolutely sure what might have happened in the presence or absence of some particular catalyst.
For investors to understand how leaders shape policy, it is important to know how power is wielded formally and informally.
In the US system, for instance, the president has great leeway to conduct foreign policy, but their domestic agenda and spending plans typically need approval from Congress. And their federal system of course means state and local governments have control over a range of functions.
For instance, Florida, a conservative state that supported Donald Trump in both 2016 and 2020, nonetheless was among the first states (the eighth) to vote in favour of a $15 per hour minimum wage.
The medieval king Canute of Denmark famously (and probably apocryphally) tried to demonstrate to his flattering courtiers that he had no control over nature by putting a throne on the beach and ordering the incoming tide to stop. The tide, of course, did no such thing and the king got wet.
As much as politicians can impact markets, market forces can act as an unyielding tide of their own. In modern economies, the consumer, not the sovereign, is often king.
Technological change, once it gets going, can confound the most determined leader. To use another American example, Donald Trump is a climate change denier who rolled back environmental protections and promised to ‘Make Coal Great Again’. But after an initial improvement, the US coal industry has declined further under his watch in terms of production, demand and employment.
The shift towards clean energy has proven more powerful than even the US president. While it has been aided by changing regulations at state and local level, it is market forces that have ultimately played a huge role.
Renewable energy is cheaper, and consumers and investors increasingly care about their carbon footprints. Coal has also faced stiff competition from cheap natural gas. Although also a fossil fuel, it burns cleaner.
Chart 2: US coal output and employment
Source: Refinitiv Datastream
Of course politicians love taking credit for things they had little to do with, while shifting the blame whenever things go wrong.
Trump in particular claimed every market rally as evidence of his brilliance. As investors we need to be careful not to connect things that may be unrelated. Correlation is not causation.
Take a local example. Local equities returned 15% per year during the disastrous Jacob Zuma years. In contrast, equity investors who bet on Cyril Ramaphosa cleaning up after his predecessor (sometimes with one hand tied behind his back) have so far lost money.
Nobody would say President Zuma was good for the market, or that President Ramaphosa is the reason equities have declined since 2018. Zuma just happened to start his term as global equities bottomed after the Global Financial Crisis in 2009.
Towards the end of his term, the market was largely propelled forward by Naspers and a weak rand. In contrast, the Ramaphosa presidency has had little by way of tailwinds, and a massive headwind in the form of COVID-19 and a global recession.
One of the questions that will now be asked in the media and by other commentators is how a Biden presidency will impact South Africa. The short answer is it won’t affect us much directly.
For one thing, South Africa is never high on any US President’s agenda. But more specifically, for South African investors, the most important person in Washington DC remains the Federal Reserve Chair, not the occupant of the Oval Office.
In May 2013, the musings of Fed Chair Ben Bernanke were enough to send our bond market into a tailspin (the so-called taper tantrum). The prospect of tighter US monetary policy set the scene for several years of pressure on local bonds and the rand, though our own political and policy mistakes contributed too.
Chart 3: South African 10-year government bond yield, %
Source: Refinitiv Datastream
As it happened, the Fed held a monetary policy meeting last week. Since the Fed is independent and tries hard not to appear to be influenced by politics at all, a policy change was unlikely.
Chair Jerome Powell reiterated his concern that the ongoing COVID-19 surge in the US posed a risk to the economy. (Due to all the election drama, few noticed the record rise in daily new cases.)
The Fed also emphasised the need for further fiscal support. If this is not forthcoming, the Fed is likely to step up its own support measures. That implies a low-for-even-longer interest rate environment, which should take pressure off local interest rates and the currency by supporting flows to emerging markets.
Global not local
There’s a saying among election veterans that ‘all politics is local’. For South African investors, ‘all markets are global’. The events of the past two weeks are reminders that our markets are driven by global forces.
First it was the sharp sell-off as COVID-19 cases surged in Europe and several countries re-imposed some form of lockdown. Then it was the positive response to the US election. Local developments, such as the Medium Term Budget, had little impact.
South African equities, bonds and the currency are ‘risk-on’ assets that tend to do well when global investors are feeling positive about the world. Given that all three are on the cheap side compared to historic valuations, the potential upside is substantial in a risk-on global scenario.
South Africa’s political and economic fundamentals do matter, they just don’t matter as much as locals suppose.
The other side of the coin is that if the global outlook worsens, South African investments are often knocked disproportionately as investors seek the safety of the US dollar and Treasuries. For this reason, it makes sense to be appropriately diversified across local and global asset classes.