2024 US Elections: The Impact of Inflation

Inflation continues to be a key issue for voters in elections around the world. Our CIO and Chief US Equity strategist explains its potential influence on the upcoming US presidential election, and how investors may react to potential outcomes of this race.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity Strategist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the consequences of elections on policy and markets.

It's Monday, July 8th at 2:30pm in New York.

So let’s get after it.

Several important elections around the world have taken place with important implications for policy and markets. Most notably, elections in India, Mexico, the UK and France have all garnered the attention of investors.

While these elections are unique to each country, there does appear to be a growing focus on the issue of economic inequalities and immigration. While these inequalities have been building for decades, the COVID pandemic and policies implemented to deal with it have ushered in a higher focus on these disparities and a general level of uncertainty about the future on the part of many citizens.

Of all the changes affecting the average person most adversely, inflation stands out as the most challenging. While the rate of change on inflation has been steadily falling since 2022, the price level of a number of goods and services remains challenging for many. Prices for basic items like food, shelter, healthcare, insurance and utilities are 30 to 50 per cent higher than they were pre-pandemic. Offsetting some of this increase has been the rise in home equity and financial asset prices, but this only helps those who are asset owners. Fixed rate mortgages have also been a notable positive offset to rising prices and interest rates. For many, there is a natural arbitrage between these pre-existing, historically low mortgage rates and money market rates. Once again, such an arbitrage is only available to those who have large piles of cash.

In our view, these dynamics further the case that inflation is going to play a major role in this year's upcoming U.S. election much like it is having an impact globally.

The recent US Presidential debate prompted inquiries from investors on what a potential Trump win or a potential Republican sweep could mean for markets. Based on initial market reactions and our conversations with clients, there is a consistent view that both growth and longer-term interest rates could move higher under this outcome. This has led to a greater appetite to rotate one’s equity portfolio toward value and cyclical stocks, which also worked leading into the 2016 election. Market expectations for fiscal expansion, reflation and less regulation under a Trump Presidency support such moves.

However, we think there’s also a couple of important dynamics to consider. First, we would argue that the cycle is more mature today than it was in 2016 as evidenced by the two-and-a-half-year decline in the Conference Board Leading Economic Indicator and the nearly 2-year inversion of the yield curve. Given a later cycle environment is historically a backdrop where the market pays up for quality and liquidity, we advise staying up the quality curve and away from small cap cyclicals, which worked in 2016. In short, the state of the business cycle right now is more important than the election outcome. As such, we think investors should stay selective within cyclicals.

Second, the market welcomed a reflationary playbook in 2016. Inflation was not a headwind to consumers in the way it is now, and the US economy was recovering from a global manufacturing recession, the recovery of which was aided by the prospects of a pro-fiscal/reflationary policy regime. Today, inflation is a notable headwind to consumers as discussed previously and fiscal sustainability dynamics remain top of mind for the bond market.

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