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Insights

A message from MLC Asset Management's Chief Investment Officer

November 2020

Dear Advisers and Investors

After a tense few days of vote counting, Joe Biden has been elected the 46th President of the United States.

The larger story, however, is that the US remains a house divided.

Polarisation has been on the march over recent decades, but the Trump-Biden contest has underscored social and political divisions that are arguably worse than at any time since the Civil War.

Rather than inhabiting the same civic space, as they once did, the Republican and Democratic parties and their supporters now resemble two tribes in endless conflict spurred on by vitriol from new media platforms.  

Opinion has become more important than evidence and facts. For many non-Americans, who are admirers of the US, this is sorrowful.

Financial markets and a glass half full
 

So, given all this, what are the chances of Mr Biden getting his major policy proposals through Congress?

I’m going to take an each-way bet and make a pessimistic as well as slightly more optimistic case.

The Democrats lost seats in the House of Representatives, but kept their majority. Two run-off elections in Georgia on January 5 will determine the final make-up of the Senate.

Though Mr Biden surprised by edging out President Trump in Georgia, pundits, for now, are tipping Republican wins in the run-offs.

If that happens, he will face a continuing Republican Senate majority led by hardball leader Mitch McConnell who is not given to compromising with Democrats in Congress or the White House.

Mr McConnell refused to allow a Senate hearing of President Obama’s Supreme Court nominee Merrick Garland eight months out from the 2016 presidential election, but ushered through Amy Coney Barrett’s Supreme Court confirmation just weeks ago.

A President Biden could, like President Obama, be reduced to issuing executive orders that can easily be overturned by the following president.

Financial markets, however, may adopt a half glass full attitude because policy gridlock, for all its frustrations, will likely mean the extension of the Trump administration’s low tax regime.

There’s little chance of a Republican-led Senate accepting Mr Biden’s proposal to increase the corporate tax rate from 21% to 28%.

Likewise, Democrat hopes for a US$2 trillion spend on new infrastructure over 10 years for water, transport and green infrastructure and expanded internet access would have to be dramatically wound back, as would US$3 trillion public spending in housing, social spending and education and childcare.

Modest areas of agreement
 

But maybe the pessimists are too pessimistic. A feature of Joe Biden’s political life has been civility.

From back in 1972, when he first became a Democratic Party Senator for the small state of Delaware, Mr Biden has been a consensus-seeking politician. His style harks back to a more collegiate era in American politics, he’s a ‘reaching across the aisle’ kind of person who is courteous to political allies and opponents alike.

Moreover, his deep Senate relationships, including with Mr McConnell, might make incremental change possible, even if big breakthroughs are off the agenda.

Both parties took policies to the election that aimed to encourage ‘onshoring’ and to penalise companies from ‘offshoring’, so the implementation of these types of measures will probably have bipartisan support.

Implementing health care changes may also be possible as there was some commonality between the Republican and Democrat platforms.

America’s founders were fearful of potential concentrations of power and so created a constitutional order of strong checks and balances in which the legislative (Congress), executive (President), and judicial (US Supreme Court) branches were equal and separate.

So, getting things done, or more accurately, getting big things done, requires compromise. White-hot polarisation and its rejection of compromise has made this impossible, unless a single party control all the levers of power in Washington. That’s a rare occurrence.

Foreign policy and trade
 

While President Trump’s tone may have been abrasive, and his lack of regard for traditional allies unnerving, there’s likely to be more continuity than change in US foreign policy because any country, even one as singularly important as the US, only has so many geo-strategic options.

Maintaining a hard line on China has bipartisan support although the President does not need Congressional approval. However, a Biden presidency will probably take a more

multilateral approach to China. Tariffs are less likely to be a feature of his approach, and may

be traded off for greater access to the Chinese market for US companies.

A Biden administration will probably take a more multilateral approach to trade across the globe, as it does not require Congressional approval, apart from certain areas such as entering into new trade agreements. By the same token, strong protectionist sentiment amongst the American public means joining the Trans-Pacific Partnership, in which Australia is a member, is unlikely.

Share market implications
 

As I said in my pre-election commentary, investors believed that a ‘Blue Wave’ Democrat sweep could have led to a possible switch in the composition of US share market leadership.

This stemmed from a view that spending proposed by Mr Biden would boost economic activity and inflation expectations, which could reduce both the earnings and valuation premiums carried by growth stocks, and improve the earnings outlooks for cyclical stocks levered to economic growth.

But owing to the absence of a Blue Wave and expectations for broad continuity in tax policy, investors now believe that technology stocks that have driven US share market performance in recent years — such as Facebook, Google, Amazon, and Microsoft — will continue to enjoy strong support.

Reasons for this include big tax increases being off the cards and low likelihood of higher government spending and thus monetary policy will have to do more of the heavy lifting. This should put a cap on both short and long-term interest rates, which favours longer duration equity assets such as technology companies.

Finally, investors believe that working-from-home consumer behaviour and practices will become entrenched, which will be another tailwind for technology companies.

By contrast, segments of the market that would have benefited if Biden was able to enact his full policy agenda, such as renewable energy, are likely to lose favour, at least in the short term.

How we’re positioning client portfolios
 

In managing client portfolios, we’re mindful of the need to steer them through near-term risks while also setting them up for strong long-term performance. We need to cater for many and varied possible futures when positioning our portfolios.

A protracted US election, including President Trump’s pre-election threat to contest the outcome through the courts are short-term risks we’ve been alive to and this is reflected in ‘participate and protect’ derivatives strategies that we have in place across MLC’s retail, multi-asset portfolios1.

At the same time, we believe that there are structural changes taking place across economies that may eventually cause global inflation to be higher than current unusually low expectations.

Those changes include companies now looking to bring production closer to home, including on-shoring. Governments are under pressure to ensure security of supply of essentials, such as medical equipment and pharmaceuticals.

In other words, we may be transitioning from lowest-cost, ‘just in time’ production to relatively higher-cost, ‘just in case’ production. This type of de-globalisation will result in higher wages and prices.

With that in mind, we are increasingly seeking exposure to a diverse set of assets that offer some degree of inflation protection at a reasonable cost. Gold has a strong relationship to inflation, but is expensive to own outright, at least relative to its own history.

While an elevated gold price does not preclude us from owning the precious metal, it does force us to hedge against a falling gold price. Our retail, multi-asset portfolios1 have accrued meaningful gains from holding gold over the past several years.

By protecting the portfolios from losses while the gold price remains elevated, we’re able to preserve profits the portfolios have already made, while maintaining exposure to further upward price movements.

While gold can be an expensive inflation hedge, cyclical stocks that rely heavily on economic growth and commodities currently offer cheaper ways of benefiting the portfolios from a reflation scenario.

Emerging markets and miners are examples of sectors where this type of approach makes sense, and we continue to research other investments with similar properties.

Warm regards,

Jonathan Armitage
Chief Investment Officer, MLC Asset Management

 




1 MLC retail, multi-asset portfolios comprise MLC Wholesale Inflation Plus, Horizon and Index Plus portfolios available through the MLC Investment Trust. 

[3] If you buy an options contract, it grants you the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date. A put option is bought if investor expects the price of the underlying asset, such as a share, to fall within a certain time frame. A call option is bought if an investor expects the price of the underlying asset, such as a share, to rise within a certain time frame. Because of this, options are used for hedging purposes to manage risks.  [1] The Investment Futures Framework is MLC’s unique scenario-based portfolio construction approach applied to manage the MLC multi-asset portfolios, also known as the “MLC Investment Trusts” —including MLC Wholesale Inflation Plus, Horizon and Index Plus portfolios.

[2] A put option is a contract that gives an investor the right, but not the obligation, to sell shares of an underlying security at a set price at a certain time. A put option is typically a bearish bet on the market, meaning that it profits when the price of an underlying security goes down.

 

Important information

This information is provided by MLC Investments Limited, ABN 30 002 641 661 AFSL 230705, “MLC” or “we”. MLC is a wholly owned subsidiary within the National Australia Bank Limited Group of companies (“NAB Group”). No company in the NAB Group guarantees the capital value, payment of income or performance of any financial product referred to in this communication, nor do those products represent a deposit with or a liability of any member of the NAB Group.

This information included in this communication is general in nature. It has been prepared without taking account of an investor’s objectives, financial situation or needs and because of that an investor should, before acting on the advice, consider the appropriateness of the advice having regard to their personal objectives, financial situation and needs.

MLC is the issuer of units in the “multi-asset portfolios” (MLC Wholesale Funds) mentioned in this communication — MLC Wholesale Inflation Plus funds, Horizon funds and Index Plus funds. The Product Disclosure Statements (PDSs) for the MLC Wholesale Funds are available on request by phoning 132 652 or on our website at mlcam.com.au. You should consider the relevant PDS before deciding whether to acquire or continue to hold units in a fund.

Any opinions expressed in this presentation constitute our judgement at the time of issue and are subject to change. We believe that the information contained in this presentation is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made at the time of compilation. However, no warranty is made as to their accuracy or reliability (which may change without notice) or other information contained in this presentation.