Will a change of president hit US equities?

The last few years have seen the US stock market perform exceptionally well. The S&P 500 is up 85% over five years, with the technology-heavy Nasdaq Composite up 115%. This contrasts with China and the UK, where the main equity indices are both up 11%, and the pan-European Eurostoxx 600, which is up 32%. Only Japan has done better as it continue to recover from its decades-long slump, with the Nikkei 225 getting back to its 1990 record high.

The main reason the US market has done so well has been the stellar performance of its leading technology stocks. Outside China, the US has made the digital revolution its own – and has dominated in world markets. The US has led in online shopping, search, data storage, downloaded entertainment, social media and software to run most businesses. The US has produced the popular consumer products of the wave of change, with smart phones, tablets and laptops.

Whilst faster economic growth does not guarantee good equity market performance, it is helpful to companies seeking to expand their revenues and profits. US growth this century has been around double that seen in Europe, with the US above 2% a year and Europe above 1%.

US technology has kept on delivering

Artificial intelligence (AI) became the stardust of the market last year, as it first loomed large in coverage of technology stocks. Its supporters set out how it would add to the turnover and margins of the main US companies that were early adopters. It would boost Nvidia, Amazon, Meta Platforms, Alphabet and Microsoft – as these businesses supplying the chips, software, data centres and the services that AI spawned. Apple too could join in, adding AI features to its iPhones and iPads.

Some argued that AI could be very expensive, requiring huge sums of investment capital. They queried how all this investment could be remunerated, wondering if people would pay for these new services to adequately reward the pioneer, large-scale investors.

They were right to warn about the high costs of data centres and new software and systems, but wrong to underestimate the strength of customer bonds to the technology giants. The big companies have various ways to ensure they get paid for their extra service. Just as Alphabet had found plenty of advertising and service revenue to flow from offering a basic free search service, so Apple could charge more for more powerful phones and services.

Microsoft already charged for packages of software and could include the extended offering with appropriate pricing, whilst Amazon Web Services had business customers used to contract payments. All benefited from the continuing move to online advertising. A mixture of selling the equipment through contracts for services to advertising revenues are used, with a bias towards charging business customers more and allowing individual consumers more of a basic free or lower-priced service.

The most recent quarterly results showed these trends still delivering good growth rates of turnover and profit for the majors. There were some statements to remind investors that AI requires substantial investment and that there are limits to the growth rate the companies can achieve. There was nothing to imply an end to their run of success in developing new services, extending their number of worldwide customers and, above all, getting closer to their customers so they pay for more service one way or another.

The US lead keeps extending – cheaper energy

Technology is not the only reason why the US economy in recent years has outperformed the European Union (EU), UK and Japanese economies by a wide margin. The development of cheaper, domestic-produced fossil-fuel energy is part of it.

Under President Donald Trump, the US expanded its output of domestic oil and gas substantially. Oil output is running more than 50% higher than it was in 2016. The abundance of onshore gas offered a relatively cheap source of power for industry, homes and power stations. With the Ukraine war and the decision of European countries to end their dependence on Russian gas, the US was offered a lucrative export business across the Atlantic.

Whilst President Biden came to office expecting to cut back fossil fuel use as part of his commitment to net-zero policies, in practice he allowed some new discoveries to be opened and saw oil and gas output increase, although at a slower pace of advancement than under his predecessor.

Meanwhile, German industry was struggling with more expensive energy, compounded by EU policies to charge business for the carbon costs. Given the high level of automation in modern manufacturing, energy is often the main cost in production after raw materials and components.

Onshoring and protectionism

Both the Democrats and the Republicans have favoured policies in recent years that promote the US as a prime destination for industrial investment. Keeping energy costs relatively low is an important part of this policy. Whichever candidate is elected as president, they are likely to continue with protectionist policies that favour US industry and investment.

Both Kamala Harris and Donald Trump say tariffs they will continue to use tariffs and the importance of US defence alliances will be leveraged in places such as Taiwan and Israel to promote US industry. Both will use some subsidies and/or tax breaks. Whilst there is an overall loss for the world from more protectionism, the US is well placed to get some local benefits out of these policies to offset some of the losses.

The defence/industrial complex

The US has the world’s largest military budget which makes a direct and indirect contribution to US GDP and growth. Much of the industrial activity to provide ships, planes and weapons is undertaken at home for national security reasons, reducing the import component and directly creating jobs. The US spends a lot on research and development, often with spin off activities that produce private-sector products.

It also means the US can attract more export orders for the military equipment it is prepared to sell to its allies as US weapon systems are often based on more advanced technology and capabilities. Many countries apply different competition and purchasing rules to their defence activates than to the rest of government procurement, wishing themselves to have more control over the production of weapons at home.

Needing access to US technology – and often wanting the ability to work alongside US forces through alliances – other countries must often accommodate the US with their industrial and military requirements.

Approach to business

The US has a more “can-do” approach to business formation and development, with less fear of failure than countries with higher degrees of state involvement. It has strong universities with a tradition of spinning-off new businesses based on new ideas, and programmes to help small companies access government contracts and support.

It is also living through a substantial increase in state borrowing, boosting demand and allowing more growth. It must be careful about inflation whilst exploiting the trust the world has in the dollar and dollar-denominated debt.

The new president will inherit a strong economy that has got through Covid-19 lockdowns and a nasty bout of inflation. There is more continuity of policy between the two main parties than the angry rhetoric of the election would suggest. Either of the candidates in office will see an economy slowing, with likely further interest rate cuts to come from the Federal Reserve.

The central pillars of US success in recent years – based on technology, cheaper energy, onshoring policies and high public borrowing – are likely to continue. The differences over green energy, the extent of tariff imposition, and the appropriate level of taxes and welfare spending will dominate the political debate and will mean there are some differences in the investment outcomes.