How Will the US Presidential Election Affect the Markets?

Washington, DC at the White HouseThe presidential race is likely to turn much more conventional as it moves forward, with Hillary Clinton and Donald Trump as nominees for the Democratic and Republican parties, respectively. Both candidates remain deeply unpopular, with Trump less popular than Clinton. While the Democrats have a decisive Electoral College advantage, President Barack Obama’s small positive net approval rating suggests a close contest, similar to what we saw in the 2004 and 2012 election cycles.

US Presidential Election Blog chart 1

With party affiliation roughly equal between Democrats and Republicans, a slight change in voting preferences could mean the difference between victory and defeat for each candidate.

Election Scenario Analysis

I believe the general election could result in one of three possible scenarios, with varying outcomes for the markets:

US Presidential Election Blog chart 2

Scenario 1: Clinton Presidency/Divided Government

My base case scenario is that Clinton wins the presidency, which will give her the momentum to turn the Senate over to the Democrats. The House will remain under Republican control. The Democrats need only four seats to tie, but would take control of the Senate if they retain the presidency, since the vice president breaks the tie. Five seats are needed for an outright majority. The Democrats have favorable prospects to take control of the Senate since there are seven races that are deemed “toss-ups” and Obama won all seven states in the last two elections.

Scenario 2: Trump Presidency/REP Sweep

Under this scenario, Trump convinces enough voters he’s not a threat and has the temperament to be president. He successfully pivots to the center and manages to do well with nominal Democrats in the rust belt (Michigan, Ohio, Pennsylvania and Wisconsin). This should ensure the Senate remains in Republican hands while they also retain control of the House, albeit with a reduced majority.

Scenario 3: Clinton Presidency/DEM Sweep

This is the least likely scenario, but could be a dark horse worth monitoring. Under this scenario, Republicans fail to unify and party ideologues sit home or vote for a third-party candidate. Key Democratic constituents turn out in large numbers, similar to 2008 and 2012. With a downturn in Republican turnout likely to be large, the down ballot candidates suffer and lose nominally Republican seats in the House to the Democrats.

Market Implications

Scenario 1: Clinton Presidency/Divided Government

Under the base case scenario, this development will be neutral to positive for markets and the economy at large. In the Senate, Clinton showed the ability to work with Republicans to get legislation passed. She’s not an ideologue and therefore would be willing to cut deals with Republicans to get things done. I would anticipate a grand budget deal between Clinton and Republicans where we see increases in defense spending in return for more infrastructure spending. Given the divided government, Clinton’s tax plan and overall tax reforms are unlikely to pass. There is also likely to be a stalemate on alternative energy, climate change and financial regulation legislation.

The economy is likely to benefit from the increase in infrastructure spending that will boost contribution from government consumption and public fixed investment spending. The likely above-trend US growth rate could prompt the Federal Reserve (Fed) to speed up its protracted tightening cycle, pushing up Treasury yields. Equity markets are likely to respond favorably to signs that the US political system is not broken and is beginning to work again. Defense and infrastructure sectors should be the big winners under this scenario. The financial sector should also gain from the lack of further regulations and the prospects of higher interest rates. Finally, the US dollar should begin to appreciate, as Fed hikes should resurrect the G-4 monetary policy divergence theme once again. 

Scenario 2: Trump Presidency/REP Sweep

This scenario potentially presents the greatest risk to financial markets and the US/global economy. While Trump’s policy stances can and do change frequently, there are two issues on which he has been most consistent: building a wall between the US and Mexico and promoting fair trade policy.

According to Cornerstone Macro, the president has unilateral power to:

  • Start a trade war without Congress – Trump has talked about slapping a 45% tariff on Chinese goods and jettisoning international trade agreements
  • Devalue the US dollar (USD)
  • Threaten the independence of the Fed by appointing a malleable replacement a year after being sworn in

These are just a few examples of what Trump could do as president.

Trump’s potential follow through on trade policy would have negative consequences for the US economy and financial markets. A potential trade war would hit US growth due to weaker net exports and fixed investment. In addition, personal consumption weakens as the cost of imported goods rises. Not surprisingly, equity markets would come under pressure led by multinational corporations. It is not obvious how US Treasuries would perform. On one hand, concerns about US and global growth could see Treasuries gain a safe haven bid; on the other hand, diminishing faith in US policies could see a selloff in US Treasuries. Finally, the USD would see a big bear market as protectionist policies have always been a massive negative for the currency markets.

A potentially interesting part of Trump’s economic agenda is his tax plan. His plan proposes a broad-based cut for individuals within the top marginal income tax rate capped at 25%, reducing the corporate tax rate to 15% and lowering the capital gains tax. According to the Tax Foundation, Mr. Trump’s tax plan would not be revenue neutral since taxes would be cut by $11.98 trillion over the next decade, leading to a tax revenue base dramatically reduced by $10.14 trillion.

According to the Tax Foundation’s Taxes and Growth Model, the plan would significantly reduce marginal tax rates and the cost of capital, which would lead to an 11% higher GDP over the long term, provided that the tax cut could be appropriately financed.

There remains a big question whether the likely Republican controlled legislature would approve Trump’s tax plan without significant changes. Most probably, a greatly modified revenue-neutral tax plan would be approved. Should this occur, it would be positive for the US economy and equity markets, but bearish for fixed income. The outlook for the USD would remain unchanged given the high likelihood of a protectionist trade agenda.

Scenario 3: Clinton Presidency/DEM Sweep

This final scenario is likely to be neutral for the US economy, but negative for financial markets. The economy is likely to benefit from the increase in infrastructure spending that would boost the contribution from government consumption and public fixed investment spending, but that positive is likely to be mostly offset by Clinton’s tax policy hitting private fixed investments. The likely trendish US growth rate could prompt the Fed to speed up its protracted tightening cycle, pushing up Treasury yields. Clinton’s tax policy (hikes in capital gains and personal income, inversions, overseas profits, banks, MLPs) would hurt equity markets. In addition, the financial sector takes a hit from the possibility of further regulations. Overall, according to Cornerstone Macro, pharma, biotech, banks, energy, restaurants and retail sectors would be the big losers while infrastructure and alternative energy sectors would be the winners. The USD should begin to appreciate, as Fed hikes should resurrect the G-4 monetary policy divergence theme once again.

To read more of Paresh’s election coverage, please click here.

About Paresh Upadhyaya

Paresh Upadhyaya is Senior Vice President, Director of Currency Strategy, U.S. at Pioneer Investments. He joined Pioneer in 2011.
This entry was posted in Economy, Industry Insights, Markets and tagged , , , . Bookmark the permalink.

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