by Tom Stevenson, Investment Commentator at Fidelity International
May 2016
So it’s all but settled. The US election in November will be a stand-off between Donald Trump and Hillary Clinton. It’s shaping up to be a grubby scrap between two unloved candidates. But what does it mean for investors and markets?
There’s a plausible argument that the US political system has been designed to neuter the power of the president. The US emerged when despotic monarchs were the norm in the Old World so Americans chose to limit such power. The president has significant power in foreign policy but getting things done on the domestic front can be harder work.
That’s not to say that presidents haven’t made a meaningful difference economically and financially. Roosevelt’s New Deal programme, Johnson’s Great Society reforms, Reagan’s tax cuts, Clinton’s re-integration of commercial and investment banking, Bush’s foreign wars and Obama’s healthcare reform had significant market impact.
Often, though, the consequences were not clear for many years after these presidents left the White House. The escalation of the Vietnam War by Kennedy, Johnson and Nixon, for example, sowed the seeds of the inflation which scarred the US economy long after the evacuation of Saigon.
The US presidential cycle is predictable in one important way. The elections happen at the same time every four years. This means we can analyse the stock market data for quadrennial patterns, although it is far from clear that these stand up to much scrutiny as a predictive tool.
What the long-term stats do suggest is the old truism that markets dislike uncertainty. The S&P performs better in years two and three of the cycle and less well in the run up to an election and in the first year of a new presidency. Markets also perform badly in years when the two-term cap means that voters are obliged, as this year, to select a new, unproven president. Overall, however, election years are pretty run of the mill – typically gaining about 7% versus a 7.5% average for all years.
Does it matter which party wins? On the face of it, yes. The Dow Jones Industrials Average has generated an average return of 83% during Democratic administrations compared with 45% for the Republicans. But the averages are skewed by whether the White House and Congress are run by the same or different parties. A Republican Congress tends to be good for the stock market.
Turning to this year’s contest, do the two contenders’ policies matter and what are the key themes? Clinton’s position has clearly shifted to the left, as she has wooed supporters of her Democratic rival Bernie Sanders. She has spoken out against the free trade deals she supported as a Washington insider and threatened higher taxes for companies and the rich.
Trump’s policies are harder to predict, as he is far from being a traditional Republican. On tax, he favours big cuts for individuals but largely paid for by corporations. He is more protectionist than Clinton and even cooler on trade deals. What is hard to know with Trump is the extent to which his intemperate rhetoric would be moderated if he were to reach the Oval Office.
At the sector level, drug pricing, defence spending and financial services reform look like key themes. Pharmaceutical and biotech stocks have been hit hard by Clinton’s assault on what she saw as price-gouging. Much will depend on the make-up of Congress where the Republicans are likely to be unsupportive of reduced drug prices. Defence spending is controversial given the US’s budget deficit but plans to quadruple the budget for European defence in the face of Russian ‘aggression’ suggest that a big squeeze is unlikely. In financial services, while Clinton has been a major recipient of donations from Wall Street, banks remain the US public’s pantomime villain so the regulatory pendulum will probably continue swinging towards stricter curbs.
Whether its Trump or Clinton who wins the election in November, they will be under pressure to meet the aspirations of an angry electorate that is worried about rising inequality, lower real living standards and a long-run shift in power from labour to capital. More regulation, less trade, higher corporate taxes and rising wages doesn’t sound like a recipe for a stock-market boom.
But come the end of 2016, one thing will have moved very much in investors’ favour. Two of the known unknowns that are hanging over the markets will have cleared. We will know where the UK stands on Europe and we will know the identity of the 45th president of the US. Investors can then focus on what ultimately drives share prices in the long run – the trajectory of corporate earnings. And if you thought the election was uncertain….
