What if Trump wins? Risks and impact on markets

This post was co-authored with my colleague Mike Ryan, Head of UBS Wealth Management Research Americas.

A Donald Trump presidency is no longer as “unthinkable” as some had initially believed. The gap separating the two candidates within the national polls is now within the margin of error. With Trump having wrested away some of Hillary Clinton’s Electoral College advantage, he has now moved within plausible striking distance of victory. 

Although Clinton arguably won the first presidential debate by most assessments, her performance was largely in line with expectations. There was no “knockout punch,” and Trump also scored some key points while avoiding devastating gaffes. 

If Trump can maintain his recent momentum and convert some of the larger-than-normal pool of undecided/independent voters, he can capture a lead in the “battleground” swing states (where he has closed the gap) and chart a path to the presidency. 

What are the risks? 

The prospect of a Trump presidency poses two primary sources of risk:

1) Outcome unease. The market is currently pricing in a near-certain Clinton victory, with the Iowa Electronic Markets implied probability at 69%. If this lead narrows, growing insecurity could create a short-term, “shallow” risk for markets, and could be the catalyst for a stock market correction.

2)  Policy uncertainty. After markets have settled down following the initial surprise of a Trump victory, the focus of investors will likely shift to the policy implications of the result. Trump’s lack of governing experience and unpredictable style widens the range of potential policy outcomes. This is a deeper and more pervasive risk, because markets tend to demand a higher risk premium for stocks when the policy outlook is murky (see chart). This would hamper equity markets, resulting in a lower equity market valuation. 

How would markets be impacted?

Currencies. The initial reaction to a surprise Trump victory could well be a rise in the dollar, as risk-averse investors turn to the US currency as a safe haven. But any dollar appreciation would likely revert amid worries over economic stewardship, trade policy, the abandonment of fiscal restraint, and the potential loss of Federal Reserve independence. While this would strengthen developed market currencies, emerging market currencies could face pressure due to the threat of trade wars.

Stocks. Separately from the dynamics noted above, the sector impact would be mixed; healthcare would face significant uncertainty over Obamacare reform, while the prospect for fiscal stimulus and regulatory relief would boost several other sectors on a relative basis (technology, financial services, energy, consumer discretionary, consumer staples, and industrials). 

Bonds would likely suffer from the higher perceived risk of inflation, higher budget deficits, and uncertainty surrounding the conduct of monetary policy.

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