After sharp risk-off moves following the UK’s Brexit vote this June, UK equities experienced a dramatic turnaround over the summer.
The FTSE 100 has rallied by more than 15 per cent since its post-referendum nadir, largely as sterling depreciation has boosted the value of the index’s foreign earnings. Perhaps more surprisingly, the domestically focused FTSE 250 has rallied by more than 20 per cent, confounding expectations – for now – that a vote to leave would result in a blow to economic confidence and lead to a slowdown in UK growth.
But Brexit is only one of the political risks facing UK stocks this year. While the UK’s domestic political turmoil remains the primary focus for UK investors, the upcoming US presidential election is also an important consideration.
About 75 per cent of FTSE 100 earnings are denominated in US dollars, making the outcome of the Hillary Clinton versus Donald Trump circus and the resultant impact on the US dollar a key question for UK investors.
If anything, Brexit has accentuated this factor, with UK large caps having essentially become a glorified currency play, much as the Japanese market did with the advent of Abenomics. The outlook for the US dollar, and the role the US election plays in this, is essential to bear in mind when considering the potential for UK equities.
The dollar has rallied in the run-up to the US election, continuing its overall strengthening trend since May.Higher yields and the prospect of tighter monetary policy have supported this, particularly with policy so loose elsewhere.
However, we might see the dollar reverse some of these gains in the aftermath of the result – irrespective of who wins the presidency. A Clinton victory would likely lead to some consolidation, as markets priced in the immediate consequences.
Over the medium to long term, however, we would likely see further dollar strength, with the potential for more supportive fiscal policy to boost the economy and strengthen the case for tightening monetary policy. This would help to boost the US dollar against sterling, particularly if UK fundamentals weakened.
Yet if Mrs Clinton is the continuity candidate for dollar strength, Mr Trump is quite possibly its short-term nemesis. It is hard to see how the dollar would not sell off in reaction to a Trump win, with his nativist sentiment and economic isolationism clearly detrimental to the US economy.
As the chart shows, the FTSE 100 has been broadly flat in dollar terms post-Brexit, with the gains since June 23 having come about because of the depreciation in sterling. Yet in the event of a Trump victory, UK investors would risk being on the losing side of a dollar-sterling battle for the ugliest currency award.
While weaker sterling (and higher UK inflation) would undermine support for the domestically exposed FTSE 250, sterling strength would undermine the gains UK investors in the FTSE 100 have seen so far.
As a result of the better outlook for the dollar, a Clinton presidency would likely be beneficial for UK large caps. More widely, a Democrat victory would also represent a broad continuation of the US’s global role. This would also be supportive for internationally exposed UK companies, particularly those with emerging market exposure, which rely on the relative openness on the international system.
However, a Clinton presidency would not be without risks, particularly for the healthcare sector, which accounts for just over 11 per cent of the FTSE 100. Both the UK and global healthcare sectors rely on the US market as a significant driver of profits, which Mrs Clinton’s proposed pricing reforms could threaten.
This has already led US healthcare stocks to sell off this year, making them cheap compared to other defensive sectors. While I believe this is overdone given the restricting role of Congress, UK healthcare stocks have yet to price in any potential danger from a Clinton presidency.
There are other factors to consider too. Both Hillary Clinton and Donald Trump have promised higher fiscal spending, though Trump’s package is bigger. Whoever wins, both candidates’ commitment to public expenditure should be positive for US growth and have a beneficial knock on impact on global growth more broadly – providing either set of proposals get past Congress.
While the direct impact of US domestic growth on the UK might be minimal, it is particularly important that the economy of the UK’s primary trading partner remains healthy when existing trading patterns (that is, with the EU) are likely to face disruption.
Seen in this light, it could be argued that the UK is more exposed to US election risk than the numbers alone show. The direction of US foreign policy is also a factor to consider, particularly if a President Trump resulted in escalating trade and/or currency wars.
Yet there might be at least some benefits to a Trump presidency. Perhaps the greatest unknown would be his attitude towards a trade deal with the UK. Any potential opening would be well received by UK markets, which would price in wider optimism about future US and global trade relations. Mr Trump has already disagreed with Barack Obama’s warnings about UK-US trade post-Brexit, saying that the UK "would certainly not be at the back of queue". While he has been hostile about Chinese and Mexican trade, the UK’s natural strength in exporting services is unlikely to fire up the protectionist passions of blue collar workers.
The result of the US election and consequences for the US dollar are likely to have an impact of UK equities, with this largely being felt by the FTSE 100. The more domestically focused FTSE 250 should be comparatively well shielded, though it is worth remembering the US is still the UK’s largest export partner.
While both candidates are likely to see their policies watered down by Congress, a Clinton presidency would likely represent the greater risk for individual sectors, with a President Trump threatening wider risk-off moves.
James Bateman is chief investment officer of multi asset at Fidelity International
