With four possible outcomes from the 5 November 2024 US election--two potential party sweeps and two split government scenarios--market stability and economic performance are at stake. The risk of rising inflation and stagflation increases if either party gains full control of Congress, say Raphael Gallardo, Carmignac’s chief economist, and Kevin Thozet, an investment committee member, who examined each scenario and its potential impact on the US economy.
They estimate a 54% likelihood of Donald Trump becoming the next president of the United States, compared to a 46% chance for Kamala Harris.
Current economic context
According to Gallardo, the US economy outperformed other major developed economies post-pandemic, benefitting from significant stimulus measures. However, the economic expansion has now entered a slowdown, as the effects of pandemic-related stimulus wane. High real interest rates, which had been necessary to control inflation, curbed demand in sectors like real estate. Despite a low unemployment rate, growth was driven primarily by wealthier households benefitting from stock market gains. Gallardo also pointed out that the US fiscal deficit had risen to 7% of GDP, a level typically seen only in recessions or crises.
The paradox, Gallardo noted, was that while the US economy and equity markets had performed well for years, voter dissatisfaction had shaped both main candidates’ platforms, leading to potentially destabilising policies. Regardless of the election outcome, the next administration would face significant economic vulnerability. Gallardo concluded that populist policies advocated by both candidates could have a substantial impact on financial markets.
“Given the high probability that the Senate flips Republican and the fact that the winner of the White House will probably also carry the House of Representatives,” said Carmignac, “we have narrowed down the outcome of the election to [the following] four scenarios.”
Scenario 1: Republican sweep
Gallardo noted that Donald Trump’s campaign, based on protectionism, tax cuts, deregulation (with Elon Musk allegedly to be made a ‘chief deregulation officer’) and fossil fuel promotion, would lead to mixed economic outcomes. While deregulation and tax cuts would boost economic supply and push down prices, these effects could be offset by higher tariffs and deportations, which would lower GDP and raise prices. Gallardo expected inflation to increase by 1.1 percentage points, with the fiscal deficit widening up to 10% of GDP. The US Federal Reserve would likely pause rate cuts in early 2025 and could even resume hikes by the year’s end. Gallardo warned that foreign capital could flee US markets if the Fed’s independence was compromised.
Thozet predicted that Trump’s economic agenda could initially extend the bull market and economic cycle through 2025, benefitting sectors like smaller companies, financials and fossil fuels. However, Thozet raised concerns that Trump’s ‘pro-business’ agenda could lead to higher real rates, introducing new risks to the global financial system, alongside rising bond yields, which would particularly affect growth stocks and high-duration assets. The US dollar, caught between Trump’s interference with the Fed and tariffs, could fluctuate significantly, with a potential foreign capital exodus causing the dollar to weaken and lead to a de-rating of US equities.
Scenario 2: Democratic sweep
Gallardo explained that Harris’s economic plan involved $5trn to $7trn in tax cuts and welfare spending over ten years, financed by corporate taxes. He noted that the most significant consequence of this would be a downward revision of US equity earnings, as equity wealth had been a major driver of private consumption. With weaker consumption and lower corporate earnings, Gallardo anticipated that the Fed would need to pursue aggressive rate cuts in 2025 to prevent an economic downturn.
Thozet added that Harris’s policies would include higher corporate taxes and increased regulation, which would lower returns on capital and pressure US equity valuations. He expected a 6% decline in earnings per share growth for 2025 due to a corporate tax hike from 21% to 28%. Thozet noted that such a tax rate would align the US with countries like the Netherlands and Canada, where average stock valuations were lower. He predicted that sectors such as consumer staples, healthcare and renewable energy could outperform in this scenario, while the real estate sector would benefit from increased housing initiatives. Thozet also foresaw a temporary rise in bond yields due to stronger growth but expected longer-term yields to decline as equity market weakness dampened consumer confidence.
Scenario 3: Divided government ( Trump as president, Republican Senate, Democratic House )
In this scenario, Gallardo suggested that Trump could still implement key policies like tariffs, border closures and deregulation via executive orders, but would face difficulty passing major tax cuts. He expected the combination of tariffs and deportations to result in a stagflationary outcome, with GDP falling by 1.6% from potential levels and inflation rising by 0.6%. Gallardo concluded that this environment would likely convince Trump to scale back some of his policies but financial markets would still reflect the increased risk of stagflation.
Thozet said that divided governments historically resulted in less market volatility and relatively stable outcomes. He noted that while a divided government could limit Trump’s ability to pass growth-oriented policies, it could also curb some of the more disruptive measures, leading to market stability. However, Thozet warned that Trump’s inflationary policies could push up asset prices, but markets would react to a period of higher inflation coupled with lower growth.
Scenario 4: Divided government (Harris as president, Republican Senate, Democratic House)
Gallardo noted that Harris’s redistributive policies would face challenges without control of Congress, limiting her ability to enact significant reforms. However, he expected a compromise between parties, leading to a renewal of the 2017 tax cuts in exchange for increased social spending. This compromise would slightly improve the fiscal stance and help the Fed engineer a soft landing by continuing rate cuts.
Thozet echoed the view that divided governments typically resulted in market stability, with little risk of extreme policy shifts. He believed the Fed would play a central role in supporting economic growth, particularly if fiscal stimulus was constrained. Growth stocks that were less dependent on economic cycles could benefit in this scenario, while sectors relying on government spending, such as financial services, could face headwinds.
Whether the result is a Republican sweep, Democratic sweep or a divided government, Gallardo and Thozet agreed that financial markets could face significant challenges. In particular, they emphasised the risks posed by inflationary pressures, higher bond yields and potential changes in corporate taxation. As a result, investors were advised to remain cautious and flexible, particularly in the face of rising market volatility.