A roadmap of possible US election outcomes and their context versus market fundamentals.

Key points:

• A benign US election process with a quick and clean result would be the least disruptive outcome for capital market but this appears to be a relatively low probably scenario.
• Given that parts of the market look abnormally stretched, we think it’s prudent that investors should have a plan should market uncertainty and/or volatility escalate.

History shows that US equities in the very short term tend to trade flat into elections but then rally out the other side as investors have more certainty on forward policy and leadership. US equity markets appear to be in a mood to do the same in 2024, with typical seasonal strength into Christmas likely to become the market narrative should the election go smoothly. However, the current circumstances look less than typical.

History shows that US equities in the very short term tend to trade flat into elections but then rally out the other side as investors have more certainty on forward policy and leadership. US equity markets appear to be in a mood to do the same in 2024, with typical seasonal strength into Christmas likely to become the market narrative should the election go smoothly. However, the current circumstances look less than typical.

First let’s consider what a win might look like on either side. There is a mountain of opinion about what election outcomes might mean for the US. The reality is that no matter who becomes President, investors will face ongoing uncertainties about policies which have potential to mould the US economy. Should Harris prevail, it looks unlikely the Democrats would control the US senate, making the passage of reformative legislation more difficult. The “status quo” might actually be the most benign outcome. Should Trump prevail, there is greater uncertainty about whether pre-election policy rhetoric – particularly on high potential impact policies around trade tariffs – are actually enacted.

At this point it does look like the policies of both parties though would entail more Government spending than capital markets currently expect. This could re-assert upward pressure on US inflation and might mean that the pace of US rate cuts could be slower than markets currently hope.

It’s quite notable that the pricing of US Treasuries have reflected this very potential in recent weeks, with yields trending higher. It’s equally notable that equity market behaviour looks to be in disagreement with bonds, arguably disregarding risks around the US rates trajectory. Other market valuation metrics also look somewhat dislocated.

US credit spreads have narrowed to levels not seen since June 2007. This decline mirrors the strength in equities but also reflects expensive valuations and can indicate some complacency in the market's assessment of credit risk. Absolute US equity valuations are at decade highs. Equity valuations relative to bonds as measured by the equity risk premium look the most stretched, with the ERP at multi-decade lows below 1%. Stretched valuations does increase the market’s vulnerability to unforeseen events or uncertainty.

It's prudent to be prepared

The US is among the biggest success stories in the global economy. To achieve disinflation without much disruption to growth or employment is no mean feat. US corporate earnings have also been strong and resilient, projecting compound growth of 12-15%, which is really important here. However, several measures of capital market strength are looking stretched and/or abnormal with the disagreement reflected in bond yields the most notable. Getting US elections out of the way is typically good for markets. However, several various potential scenarios around the election could easily lift uncertainty and spike market volatility at current levels. Confirmation of the election process itself could include material delay, challenge, dispute and/or unrest. We think investors should prepare accordingly.

Domestic stocks, themes and opportunities that we have recently be advocating for investors include: trimming banks exposure, rotating exposure into resources (BHP & RIO), value in energy (Woodside), US rates leverage via James Hardie and opportunities in stocks on weakness in Lovisa and Eagers Automotive.

International stocks currently on the Morgans US focus list include Meta Platforms, Nike, Coca Cola, Starbucks, Honeywell and Berkshire Hathaway.

Morgans clients receive exclusive insights such as access to the latest stock and sector coverage featured in the Month Ahead. Contact us today to begin your journey with Morgans.

Jensen Huang, the rockstar CEO of NVIDIA, recently described Artificial Intelligence (AI) as ‘the most transformative technology of the 21st Century’ which ‘will affect every industry and aspect of our lives’. The CEO of Alphabet, Sundar Pichai, went further, saying AI is ‘probably the most important thing humanity has ever worked on’. Amid all this hyperbole, it can be daunting to know where to start as an investor looking to get exposure to AI. We offer one framework for thinking about this in the Month Ahead for November. We recommend investors start making sense of AI by considering stock opportunities in these three distinct areas:

Artificial Intelligence Providers

It is no coincidence that the world’s leading Cloud Service Providers (Microsoft, Amazon, and Google) are leading the race to commercialise Artificial Intelligence and Large Language Models (LLMs), alongside that technological shapeshifter Meta Platforms. These companies are also known as ‘Hyperscalers’ due to their technical expertise in operating computing infrastructure at levels of complexity that would make your head spin.

The Hyperscalers are typically well funded and cash generative. Their ‘ownership’ of business and personal data puts them at the forefront of building, training, and ultimately monetising LLMs. Collectively, these companies are expected to spend a staggering US$700bn in capex over the next three years, the bulk of which relates to AI.

In many ways, Microsoft (NASDAQ: MSFT) is the most uniquely positioned. As the key supplier of business productivity tools in the world, it has the vast technical expertise, data and customer base best suited to benefit from the rise of AI. As more and more businesses embrace AI we expect they will embrace Microsoft’s AI offering and both parties should benefit. Microsoft reported its September quarterly result on Wednesday and indicated Microsoft AI is on track to be its fastest ever product to reach $10bn in annual recurring revenue (less than three years).

Digital Infrastructure

Digital infrastructure companies power the data centres, cloud computing and research activities that are integral to the digital ecosystem and the rise of AI. Internationally the best-known name in the space is AI chip supplier NVIDIA, which is widely held to be best in class and a unique value proposition.

Enjoying all the benefits of the AI growth opportunity with less volatility are the operators of data centres. Data centres are facilities that store, process, and manage the vast amounts of data foundational to AI, ensuring secure and efficient data flow, backup, and recovery. The largest operators in the world are Digital Realty and Equinix. Digital Realty recently reported a record sales quarter during which it sold double the data centre capacity of its previous high and about four times more capacity than it usually sells in a quarter. This reinforces our view that the significant demand for cloud computing and AI-related digital infrastructure is going to unpin attractive returns and long-term growth.

Here in Australia, the data centre space gathered recent attention following the recent $23bn purchase of private data centre operator AirTrunk. In the listed arena, NEXTDC and Goodman Group are the largest data centre operators on the ASX. Our preferred exposure is NEXTDC (ASX: NXT). It has 17 operational data centres in Australia and nearly a dozen under construction or about to be built across Australasia and Asia.

Data Networks

AI needs a combination of technical expertise, computing power, data centre space and data. An extremely large amount of data is needed to train an AI agent or LLM. Once the training is complete the AI agent also needs to be given regular up-to-date data in order to remain relevant and useful. This is where traditional data networks (such as telcos like Telstra, TPG Telecom, Superloop and Megaport) come into play.

Traditional telecommunications companies will benefit from the astronomical growth of data around AI. Telstra for instance is building a specialist inter-capital network with a A$1.5bn capital budget to fund this project. However, our preferred exposure is through the more specialised and capital-light Megaport (ASX: MP1). Megaport is a global cloud connection network and the leading Network as a Service provider. It operates the largest data centre connection business in the world, connecting to 850 data centres through a fully automated, on-demand telco network. We think it is uniquely placed to help business move data globally and benefit from the growth of data related to both cloud computing and AI.

Morgans clients receive exclusive insights such as access to the latest stock and sector coverage featured in the Month Ahead. Contact us today to begin your journey with Morgans.

There's been much discussion regarding Donald J. Trump's intention to increase tariffs on imports into the United States. Many economists have commented on how this would raise prices in the US and drive up inflation. However, few have examined the strategy behind Trump's comments, which can be found in a book by his trade adviser, Dr Peter Navarro, titled *The New Mega Deal*. Released a few months ago in conjunction with the Republican Convention, it's surprising that so few economists discussing Trump's tariffs seem to have read it.

Navarro, who taught at Harvard before joining Trump’s first administration, previously ran the White House Office of Trade and Manufacturing Policy. His recent book lays out Trump's trade policy in detail, particularly between pages 26 to 29. Navarro highlights how countries trading with the US operate under the World Trade Organization's most favoured nation rule. He starts with the example of automobiles imported into the US, where the tariff is just 2.5%. In stark contrast, when US cars are imported into the European Union, they incur a 10% tariff—four times higher—and a 15% tariff in China. In Brazil, the tariff reaches 35%, despite all these countries facing a mere 2.5% tariff when exporting cars to the US.

Navarro then examines the case of rice. When rice from Malaysia is imported into the US, it pays a 6.2% tariff, whereas US rice entering Malaysia faces a hefty 40% tariff. He also notes that European milk imported into the US incurs a 15% tariff, while US milk going to the EU faces a staggering 67% tariff. From a strategic game theory perspective, Navarro argues that the WTO's most favoured nation rule provides little to no incentive for high-tariff countries to lower their tariffs, allowing them to maintain their tariffs while benefitting from lower US tariffs.

According to Navarro's analysis during his time in the Trump White House, there are 132 countries whose tariffs on products imported from the US are higher than the tariffs imposed by the US. He suggests that if these countries reduced their tariffs to match those of the US, it could lower the US trade deficit by nearly 10%. This insight is crucial for understanding Trump's negotiation strategy. Should these countries refuse to reciprocate, the US could increase its tariffs to match theirs, resulting in a similar reduction of the trade deficit.

This approach could potentially create hundreds of thousands of new manufacturing jobs in the US, thereby strengthening its industrial and defence sectors. Trump aims to pursue this strategy through the proposed US Reciprocal Trade Act, which was initially introduced in the House of Representatives on 24 June 2019 but was blocked by Democrats. If Trump is re-elected, his administration will likely attempt to pass this bill again. Interestingly, Trump has claimed that he does not actually need this legislation, which might be his way of setting the stage for negotiations, suggesting he could use the threat of higher tariffs to encourage other countries to lower their tariffs on American goods.