US Election: A defining moment for markets?
With the political and economic ideologies of the Republican and Democratic candidates worlds apart, November’s US presidential election is the most significant in generations, argues Michael Grady.
The outcome of US presidential elections has in recent times rarely been seen as a defining moment, either for the global economy or financial markets. However, this year’s contest has the potential to be far more significant, with Donald Trump arguably the most controversial candidate in living memory.
While some of Trump’s policies are consistent with the Republican Party’s traditional advocacy of laissez-faire economics and small government, his views on trade and immigration represent a dramatic shift from the past.
Assessing the economic implications of a Trump win is challenging. He is proposing the largest tax cut in US history. Independent estimates of the cost of those tax cuts amounts to between $6-7 trillion over the first decade and over $20 trillion by 2036. Trump claims the cuts would be self-financing via stronger economic growth. No independent analysis has been produced to validate that claim.
At the same time, Trump has pledged to spend up to $500 billion on infrastructure projects. All told, his fiscal plans are estimated to raise Federal debt to 127 per cent of GDP over the next decade, compared to 86 per cent of GDP on current proposals. In effect, if Trump’s tax and spending plans were to pass, he would deliver a massive debt-financed fiscal boost. The big question is whether the increase in uncertainty associated with a Trump presidency would more than offset that effect.
Similar to the initial reaction to the UK’s ‘Brexit’ vote, we believe business and consumer sentiment would likely fall sharply if Trump were to triumph. However, as in the UK, that may not necessarily translate into an immediate weakening in economic activity. The biggest risk is likely to come from a sharp fall in business investment.
Of course, in assessing the potential impact of the presidential vote, it is important to consider the outcome of the congressional elections too. The Republicans currently control both Houses of Congress. Their margin in the House of Representatives is sufficiently large that it is unlikely they will lose control. However, the Senate race is much closer. It is likely that whichever presidential candidate wins will also carry the Senate.
In the case of Hillary Clinton, this would mean a split in Congress and the increased likelihood of gridlock. In the case of Trump, it is likely to mean a clean sweep of Congress, which would make it easier to enact his policies, particularly his proposed tax changes, which are essentially aligned with Republican proposals. However, Congress would also have to immediately raise the debt ceiling, which may prove extremely difficult given the Republicans’ use of it as a political tool throughout the Obama presidency.
For that reason, Trump’s infrastructure spending plan is unlikely to be approved, at least on the scale he envisages. In the event Trump won, we would expect the US Federal Reserve to delay any further rate hikes until there is more clarity on the economic outlook.
It is difficult to gauge both the immediate and longer-term investment implications of a Trump victory. In the short term, we would expect to see risk aversion rise. That would likely result in a sell-off in equities, a rally in fixed income and a mildly stronger US dollar. Over time if his economic policy platform were passed by Congress, and his more extreme trade policy views shelved, we would expect to see higher inflation, a sharp increase in US government debt issuance, further dollar strength, while US rates would be expected to rise faster and the yield curve steepen.
The main risk from a Trump victory would be if his tax and spending plans were to get stuck but he carried through his threats on raising tariffs. With elevated uncertainty, no fiscal boost and a potential trade war, the US could quickly slip into recession, dragging the rest of the world with it.
According to the World Trade Organisation, protectionism is already on the rise. A Trump victory would likely accelerate this trend. For example, he has advocated withdrawing from free-trade negotiations with Europe and the Pacific-Rim countries and promised to repeal the North American Free Trade Agreement. He has also threatened large unilateral tariffs on goods from Mexico and China and vowed to force US businesses to repatriate production.
As such, a Trump victory could prove extremely destabilising and poses a material risk to global economic growth over the medium-term. It would be particularly damaging for countries with small open economies and larger emerging nations, especially Mexico.
In the past few months, the one asset that has been most closely correlated with Trump’s position in the polls has been the Mexican peso. Given his rhetoric towards both Mexican immigrants and manufacturing imports – exports to the United States account for around 30 per cent of Mexican economic output – the peso would likely be a big loser should Trump win.
Clinton’s policy stance is much more in keeping with the Democratic Party’s traditions. Her economic platform is mildly stimulatory, with some new programmes aimed at boosting productivity and improving the social safety net. Over the next two years, those plans are unlikely to impact growth sufficiently to change the course of monetary policy.
Given the relative continuity in policy likely under Clinton, we would expect financial markets to react in relatively muted fashion to her winning. US equities would likely receive a modest boost reflecting reduced political risk, while we would not expect much reaction in either the US dollar or Treasury bond market.
That said, as far as the US equity and corporate bond markets are concerned, the election result potentially has some major ramifications for individual sectors. Trump’s proposed cut in corporation tax is potentially beneficial to all sectors if implemented, especially multinationals in the IT sector that hold large cash balances overseas.
Construction and infrastructure companies are likely to be the beneficiaries of a big increase in public spending whoever wins – Clinton has proposed spending $275 billion on infrastructure projects over a five-year period. We would expect spending to focus on areas such as highways, public transport and airports.
By contrast, sectors such as agriculture, hospitality and retail, which employ large numbers of low-wage workers, appear vulnerable regardless of the outcome. Clinton is in favour of a big rise in the federal minimum wage that threatens to push costs up sharply. While Trump is pushing for a smaller increase, his plans to curb illegal immigration threaten to boost labour costs further than he might wish.
Healthcare is another sector that will be in the spotlight. Healthcare reform is an issue both candidates agree is necessary but their proposed solutions differ. Clinton has been very vocal about ‘price gouging’ within the drugs industry: if she wins we are likely to see greater pressure on drug manufacturers to cut prices. But at the same time, since she has vowed to continue Obama’s Affordable Care Act, a Clinton victory should be good for health insurers and other healthcare services companies. By contrast, Trump plans to repeal the Affordable Care Act, which would be bad news for those same insurers and services companies.
Trump’s vow to slap 45 per cent tariffs on all Chinese goods threatens any US sector or company that relies on imports. But at the same time, tariffs could benefit domestic manufacturing businesses that have suffered from increased competition from China and elsewhere, such as the steel and automobile sectors. Trump has also called for military spending to double, which would be positive for defence contractors and military hardware and aerospace manufacturers.
Clinton is a strong advocate for renewables and tightening climate policy, claiming she wants the US to generate enough renewable electricity to power every home in America in the next ten years. Her policies will benefit the clean energy sector – particularly solar and wind. Trump, by contrast, is a self-declared “non-believer” in man-made climate change and has pledged to cancel the Paris Climate Agreement and scrap the Clean Power Plan, which was unveiled only last year. That would provide a boost to energy and coal stocks.
While a July 2015 survey by Alan S. Blinder and Mark W. Watson, “Presidents and the U.S. Economy: An Econometric Exploration,” Woodrow Wilson School and Department of Economics Princeton University, found that both the US economy and stock market tended to fare better under Democratic presidents than Republicans, it failed to prove a causative link.
 See Tax Policy Centre estimates: http://www.taxpolicycenter.org/publications/analysis-donald-trumps-revised-tax-plan
 Committee for a Responsible Federal Budget: http://crfb.org/blogs/scoring-clinton-and-trump-different-growth-assumptions
Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 20 October 2016. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.