First we need to understand have a quick understanding of how the Australian economy and the share market functions. 1) Feelings of investor uncertainty leads to share market volatility. 2) Feelings of investor fear lead to a share market crash. 3) In the short-term, the Australian share market can be impacted by events impacting the US share-market as a spillover effect. 4) In the long-term, the Australian share market is underpinned by the national economy 5) The national economy is underpinned by (ii) Export market (ii) domestic consumption. a) Export market is driven by your top 5 exports and your top 5 trading partners b) Domestic consumption is driven by the size and age of your population. 6) The US share market is still a bellwether for the global economy, but this is changing with the rising of China as a global player. 7) Australia is a unique democratic continent-country as it is underpinned by the following diverse characteristics: a) Culture - European b) Defense/International Security - American c) Economy - Asian 8) Australia has to carefully manage this diversity given the interplay and tensions between being diversified interests being European, American, and Asian. 9) As we can see below, Australia’s top exports are to Asia (almost 50%) and the US only constitutes 3.7% of the export market. Therefore, the Australian economy is quite disconnected from the US economy as we have experienced during the aftermath of the Global Financial Crisis of 2007-2009 where the Australian share market took a steep dive, but recovered thereafter due to healthy trade relationships with China. 10) Australia’s top export products are education & travel which are severely impacted by the COVID-pandemic. The top three exports of iron ore, coal, and gas are sold to countries that are still developing/expanding (i.e., China) or energy poor countries (i.e., Japan, South Korea). 11) Therefore, the US elections will have a short-term impact on the Australian stock market, but a minor role in the long-term impact on the Australian stock market. 12) The Australian stock market will be heavily impacted by the pandemic & trade relations which its top export markets.
Australia’s Top Export Markets
Australia’s Top Import Markets
Australia’s Top Exports (Goods & Services) China 32.7% China 19.4% Iron ore 16.4% Japan 9% US 12.3% Coal 14.8%
South Korea 5% Japan 6.4% Natural Gas 10.6% UK 3.8% Germany 4.5% Education-rela ted services
US 3.7% Thailand 4.1% Personal travel services
● What impact does the US election pose for the sharemarket and investors in Australia? Share markets and investors hate uncertainty. The primary impact of the US election will be short-term volatility on US equity markets that will spillover to the Australian share market. The US election will have a short term effects on the Australian share market, but in the medium to long-term Australia's share market is driven by it's top 5 major trading partners and Top 5 exports (see the explanation above with tah table) If the presidency is won by Trump, businesses feel that there is more consistency in terms of his economic policies to minimize taxes, reduce ESG investments, and a 'smaller' government although these may be implemented in a haphazard manner. The uncertainty about a Trump win are the geo-political risks and the US commitment to being a global hedgemon. If the presidency is won by Biden, there will be more uncertainty surrounding the US domestic economic policy. Although it is hoped that Biden will have a conciliatory approach to geo-politics, how he can successfully implement domestic economic and foreign policy if congress continues to be under Republican control remains an unknown. The worst outcome for investors is any delay in the transfer of power. These will extend the magnitude and time of the US share market volatility that will impact the Australian share market. ● How has this been the case historically? There are only 23 election events from 1920s to 2016 where by the market has been positive 19 times, and there have been negative returns four times on the US share market. As there is a strong short-term correlation between US equity an Australian equity markets we know that any volatility on US equities will spillover on to Australian equities too.
● Can you explain what systematic trading strategies are an how an event (like the US election) can play out for strategic investors?
Quantitative systematic trading strategies largely depend on historical data to train the mathematical models that make trading decisions and minimize human influence in the investment trading process. If the present scenario does not reflect historical events in the past, quantitative systematic strategies will behave poorly. In that sense, fundamental strategies can be more forward looking during periods of high uncertainty as they factor greater humans have a greater influence in the investment decision process. Quantitative systematic strategies have performed poorly in 2019/2020 months as several of the events such as the pandemic and geo-political risks are unprecedented. As it is widely agreed that there will be volatility on the US and Australian market regardless of whom wins the US presidential election, a strategic investor may hedge himself against volatility by purchasing ETFs that are long the VIX. ● What action should investors be taking to minimise any risk in their portfolio as a result of this election? (list steps here where possible please!) It will be a risk-off strategy for the rest of the year. For conservative investors, it would be best to switch a majority of your investments to fixed income (bonds) or cash. When the dust settles around the beginning of 2021, reallocate towards equities towards countries that are managing the pandemic adequately. For investors willing to take more risk, it is better to position towards defensive sectors such as utilities and healthcare. As the pandemic is likely to continue throughout 2021, investments in medical equipment are strong bets. Likewise with technology companies that are enablers for remote working & remote entertainment. For medium risk investors, geo-political uncertainty is likely to increase and central banks are struggling to contain the effects of a recession and the pandemic in a low interest environment with quantitative easing. Therefore diversify a small amount of your investment portfolio into digital assets (i.e., cryptocurrency). Digital asset markets continue to grow and more institutional investors are taking interest, therefore allocating a minor portion of your portfolio to purchase major cryptocurrencies (i.e., Bitcoin, Ethereum) is an increasingly prudent decision. For investors who are aggressive risk takers, they can consider hedging their investment positions that the market will crash by purchasing ETFs that specialize in shorting the US or Australian market such as the ASX BBOZ (Australian Equities Strong Bear Hedge Fund) or the ASX BBUS (US Equities Strong Bear Hedge Fund) from BetaShares.
21 Oct 2020
Impact of US elections on Australian share markets