It is a momentous time in terms of geopolitics. A plethora of major events with potentially significant investment consequences will take place this year. They range from the Brexit hurricane in the UK, to tectonic shifts in the oil economy abroad. Even ostensibly local conflagrations, such as political deadlock in Brazil, may impact wider markets. But the impending US election in November may prove to be the most significant event of all.
As it stands, Donald Trump and Hillary Clinton are likely to go head-to-head for the big prize. So what do the policy pledges from both candidates tell us about the prospects for the world’s largest economy and its financial markets?
On the economy, Clinton wants to put an end to “quarterly capitalism.” According to her, companies should plan for the long term. She wants to address the rising influence of the so-called activist shareholders who focus on short-term profits at the expense of long-term growth.
One way to do this is through capital gains tax reform. Moreover, she wants to impose accountability on Wall Street and defend the reforms put in place after the financial crisis. Finally, she wants to tackle dangerous risks in the financial sector, largely through appointing and empowering tough, independent regulators.
Clinton often claims that while corporate profits are near record highs, workers have not shared these through higher wages. Her tax policies centre on ensuring more workers share in these profits, partly through a 15 per cent tax credit for companies that share profits with workers on top of wages and pay increases. She also champions raising the minimum wage and strengthening overtime rules.
At the other end of the spectrum, Clinton has claimed she will end the “carried interest” benefit to private equity partners, enact the “Buffett Rule”, which ensures no millionaire pays a lower effective tax rate than their secretary, and close tax loopholes which benefit only the wealthiest members of society. All of this will help to pay for her plan to make college more affordable and to refinance student debt.
Thus far, Trump has given very few details of his policies, and what little he has stated tends to be prone to revision. Nonetheless, a few themes have become apparent. He has been exceptionally hostile towards free trade – in particular to the North American Free Trade Agreement and the more recent Trans-Pacific Partnership – and has repeatedly labelled China a “currency manipulator”.
He wants to force China to uphold intellectual property laws and stop the unfair practice of forcing US companies to share proprietary technology. Most importantly, he wants to slap huge duties on Chinese imports.
Some describe Trump’s economic plans as radical and long overdue; others describe them as outright impossible and naive. On spending, he has promised to not cut social security or Medicare, a large health programme. He promises to ramp up defence spending.
Crucially, he proposes to reduce marginal tax rates on individuals and businesses and lower taxes at all income levels without adding to the national debt.
Independent observers, such as the non-partisan Tax Foundation, estimate that Trump’s proposed cuts will lower government revenue by $10 trillion over 10 years. In other words, it is fantasy. However, Trump is paradoxically ahead of Clinton in the polls gauging who is best placed to run the economy.
History is on Clinton’s side
With so many unknowns, what can be inferred from previous presidencies?
Since 1948, 12 different presidents have held office, with an equal split between Democrats and Republicans. Although conventional wisdom would suggest the Republicans’ perceived business-friendly policies are more favourable for markets and the economy, the evidence does not support that.
Annual economic growth has been significantly stronger under the Democrats, at 3.7 per cent on average, compared with the Republicans at 2.8 per cent. It is worth noting, however, that Republican presidents have faced a recession in their first year in office, which can be attributed to the previous administration.
Recently, however, both have been poor. The weakest growth under a Republican presidency was in George W Bush’s years, with annual average GDP growth of 2.1 per cent. Barack Obama has had even poorer performance – the weakest of the Democrats – but much of that will be due to his takeover during one of the darkest periods in his country’s economic history. But even if long-term history favours the Democrats, they are coming off of their worst economic showing ever.
As for the stock market, the Democrats have the stronger record. Since 1948, the Democrats have presided over returns of 12 per cent a year on average, while Republicans can claim just half of that, at 6 per cent. However, historical equity returns are replete with idiosyncratic anomalies unique to their time and a degree of coincidence, and therefore offer limited guidance.
Take Gerald Ford, who had a reputation for not being the sharpest tool in the shed. His regime saw equity markets up 25 per cent a year on average (during these two years, inflation averaged 7.4 per cent). On the other end of the scale is George W Bush, who took office during the dot com crash and left office during the financial crisis. His administration is one of only two which oversaw negative equity returns. However, if you disregard the returns from his first and last years in office, his numbers become positive.
The run up to the US election will no doubt bring uncertainty to financial markets. A Trump presidency will likely leave financial markets scrambling to separate his bombast from his actual policy, something impossible to do at present.
As a result, a Clinton presidency may be more palatable to markets – the first time that has been said of a Democrat over a Republican in decades, even though history would suggest markets should cheer on the Democrats.
However, she will likely have to pivot to the left politically to appease the increasing clout of Sanders voters, given the recent surge of socialist feeling among Democrats. In more “normal” times, this would make her a market pariah. But these are not normal times.
Like any year, 2016 will be defined by its own unique events which will shape market sentiment. Although some of the noise may be relevant to the investment landscape in the short run, most of it should be ignored for long-term investors.