A win for the Republicans in next week’s US election could result in an all-out crash in US equity markets, according to Lombard Odier’s Stephanie Kretz, who believes the removal of Ben Bernanke as chairman of the Fed would be a grave mistake.
Mitt Romney has voiced his disdain for president Barack Obama’s loose monetary policy, and many believe Bernanke’s “unlimited” quantitative easing (QE) could be reversed if the Democrats fail to hold onto office.
Kretz (pictured right)
, investment strategist in the private banking arm of Lombard Odier, thinks this could have catastrophic consequences regarding the equity market.
"Although the link between the numerous easing programmes successfully implemented and the real economy is very tenuous, they do affect asset prices," she said.
"This is perhaps where the biggest uncertainty lies: if Mr Romney wins the election and he decided not to reappoint Bernanke at the end of his mandate in January 2014, and if the new chairman were to be less aggressive in his monetary policy, that could trigger a collapse of overvalued and liquidity-addicted US equities."
Kretz says these fears are strong enough to warrant an underweight position in the US, even though the election is still very much in the balance.
"As long-term investors, we favour cheap regions such as Europe and the UK where underlying risks are priced in; in the US, downside is significant and upside is limited," she continued.
FE Alpha Manager David Coombs, who heads up multi-asset portfolios at Rathbones, says a Romney win would force him into reviewing his entire investment process.
"The biggest risk is whether or not Bernanke is replaced as chairman of the Fed," he commented. "If he were to leave, this could be a real game-changer, as his monetary easing has been a support to a number of different areas – both in fixed interest and the equity markets."
"If Romney was to be much stricter in his monetary and fiscal policy in general and he brings in a hawkish chairman to replace 'helicopter Ben', the end to quantitative easing and Bush’s tax cuts would come about at the same time."
"In this scenario, we would be likely to see interest rates go up higher and earlier than expected, which would have a particular impact on fixed interest."
"If the QE tap is switched off, equities are likely to take a hit, which would be felt just as much in the UK in the short-term. We could see the dollar strengthen, and emerging markets, which have been a big beneficiary of QE, could also come under pressure."
"We’d have to review the core thesis of the entire portfolio."
Coombs believes Treasuries – particularly those that are inflation protected – would be hit especially hard, and he says this would probably be the first area he would look to sell out of.
He also thinks rising interest rates would put even more pressure on investment grade bonds, including those issued by sovereigns.
"In equities, the emphasis would once again have to be on quality," he added. "We’d most probably avoid high yield and highly indebted companies and focus instead on companies that look to grow their dividend."
"I’d stress we wouldn’t change our holdings overnight, because politicians say a lot of things during election time. However, we’d look at the rhetoric in the immediate aftermath of the election very closely and act accordingly."
Darwin Investment Managers echoed Coombs’ sentiment, warning: "Romney has increasingly been playing the populist protectionism card."
David Jane, founder of the multi-asset boutique and former head of equities at M&G, says that the narrowing of the race is causing increased uncertainty in the markets.
"We have highlighted before how scarcer growth might lead to increased protectionism," he commented. "Distorting free trade is likely to negatively impact aggregate growth and, potentially, this is what markets are picking up on."
As a result, Jane has been adding to his positions in domestic cyclicals in the US and avoiding multi-nationals. This will help him to reduce exposure to global trade at the margin in the event of an adverse reaction to the election result.
While Kretz is far from complimentary of Obama’s current economic policy, she believes Romney’s proposals are fatally flawed and could completely derail the US recovery.
"While Mr Obama favours spending in the hopes of boosting growth through a fiscal multiplier effect, Mr Romney prefers lower taxes, for example of the corporate side, in an attempt to impact growth via higher investment and a business-friendly environment supportive of growth creation."
"Evidence shows that fiscal multipliers in open economies with excess debt levels and flexible exchange rates are close to zero, thereby revealing the futility of Obama’s choice."
"However, Romney’s choice is flawed too; not only do corporate tax rates and real growth over a five-year cycle have no correlation, but lower tax rates have historically been associated with weaker growth, and hence worsening deficits.”
"As long as total debt is not reduced, all we can expect is continued weak growth, whoever is elected," she finished.