What the U.S. Elections Mean for Global Financial Markets

05 Oct 2016

Introduction

As the political season in the U.S. reaches a fever pitch and voters prepare to cast their ballots on November 8, the world eagerly waits to see who will emerge victorious in one of the most closely watched political contests of the modern era. With plenty of surprises along the way, polls indicate a closely fought presidential race, leaving many to consider the impact that each candidate could have on both the U.S. and the broader international economy.

Very few areas stand to feel the effects of the ongoing speculation more than global financial markets, particularly as each candidate continues to articulate their respective platform. To help provide more clarity on the possible consequences of each outcome, three members of our investment staff answer key questions about how markets and investors could potentially react and identify other factors worthy of consideration.

Do you believe that the election will be viewed as having broad-based implications for financial markets or is it more just another event on the calendar?

Eric McLaughlin: It is certainly not just another event on the calendar. We would expect very different agendas from the two presidential candidates. Perhaps equally important is what could happen in the House of Representatives and Senate, where a sweep by either party would likely rattle markets. The current split in power between the Democratic President and Republican Congress has led to some compromise but also plenty of gridlock. I expect that one party holding both the White House and a majority in Congress will likely result in policy uncertainty and market volatility.

Ken O’Donnell: Uncertainty creates volatility in markets, which generally results in increased risk aversion by investors and a corresponding weakness among risk assets. Elevated uncertainty surrounding the expected outcome of the presidential election will likely follow this course. Historically, market returns have been uncorrelated with any specific political party, although this time may be different. A Clinton presidency would be considered less disruptive to the status quo, while a Trump administration could create a cloud of uncertainty, especially with regard to immigration policy, foreign relations and trade. It’s also important to recognize that the outcome of the congressional elections may be more pivotal than the presidential election. A split Congress, with Democrats retaking control of the Senate and Republicans maintaining leadership in the House of Representatives, would severely limit the powers of the executive branch regardless of the presidential election results.

Steven Friedman: I think there are some important implications for markets because this election is largely about voter frustration with a political order that is seen as out of touch, particularly in terms of economic well-being. The incumbent party asks voters to trust that it understands their frustration and has concrete proposals to improve opportunity and wealth, but it has been met with deep-seeded skepticism due to perceptions of deteriorating income inequality under President Obama. Over the past 15 years, the median household income has flat lined. Certainly from an economic perspective, voter frustration is entirely justified.

Under a Clinton presidency, I would expect some increased infrastructure spending and progress on health care and corporate tax reform. However, there is a legitimate question about whether any of her policies are truly transformative, particularly in terms of setting the stage for higher potential growth. Therefore, we could find ourselves four years from now with an equally angry, if not angrier, electorate.

In contrast, Trump has pledged a much more radical restructuring of the political and economic order. Some of his ideas about trade, immigration, foreign policy and fiscal policy are potentially disruptive and could weigh on sentiment in financial markets, as well as business confidence.

As a result, these two candidates represent starkly different visions of the country, with potentially significant implications for the economy, national security and markets.

Should we expect stock market volatility leading up to the election and immediately afterward?

Ken O’Donnell: Volatility in the pre-election period will depend largely on the evolution of voter polls. A reduction in the magnitude of Clinton’s lead in the battleground states would increase the potential for an upset by Trump on Election Day. While this appears to be an unlikely outcome, the prospect may be too large to discount. With less than two months to go, polls are narrowing; however, the results are highly sensitive to specific samples, including registered voters, likely voters, number of names on ballot and more.

In the post-election period, I expect that a Clinton presidency would be less volatile and have fewer unknowns than a Trump presidency.

Eric McLaughlin: Above all else, markets hate uncertainty, and many investors move to the sidelines to wait for clarity. With equity prices near all-time highs and relatively weak catalysts on the horizon, we would expect volatility in the weeks leading up to the election. For instance, we see headline risk for large banks during the campaign, with tougher regulation and taxes as a tail risk after the election.

Steven Friedman: I think we have already seen evidence of some increased market volatility as the race narrowed and attention turned to the first debate. If the race remains tight, and particularly if Trump pulls ahead, then I would expect some additional volatility. This is because Trump’s ideas represent a break from the policy consensus and, at least in my thinking, could lead to lower growth and higher inflation even if we wind up with watered-down versions of some of his proposals. For example, his plan to impose import tariffs on Mexican and Chinese goods would most likely lead to retaliatory tariffs on our goods. This trade war could result in higher inflation and job losses among U.S. exporters, as well as compressed profit margins for corporations that use Mexican and Chinese goods in their production processes. In addition, Trump’s plan to deport millions of undocumented workers would decrease the U.S. labor force and could boost inflation while lowering potential growth over time.

The president has quite a bit of leeway over trade and immigration policy, so Trump’s proposals in these areas would not require direct congressional approval. In addition, his plan to lower taxes without identifying spending cuts has two major consequences: 1) the tax cut benefits accrue disproportionally to the wealthy, so there would be a minimal spending multiplier associated with them, and 2) without identifying spending cuts, the loss of revenue would need to be financed through a significant increase in outstanding debt. The required increase in debt could pressure interest rates higher, impacting investment spending and consumer borrowing, with knock-on effects influencing the housing market.

Another issue is that many of Trump’s proposals are vague and fluid. The inability to pin down his thinking on a number of key topics could also be a near-term negative for stocks. It is one thing for investors to react negatively to the candidates’ policy choices, but it is a separate issue for investors to be highly uncertain about what the policy proposals actually are.

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