We are currently in the middle of a global pandemic. The unemployment rate remains stubbornly high, the stock market recently hit a new high and a presidential election is less than 64 days away. Many investors, commentators and politicians talk about politics and financial markets as if they were dependent on each other. Yet our research suggests that the long-term stock market performance has almost zero correlation with political parties/government policies.
Recently, we talked with Vanguard’s government relations group to analyze the candidates’ platforms and agendas and how they might impact economic activity and financial markets.
COVID-19 and the election
Since early March, all activity has been framed by the pandemic and this continues into the election session. The energy and the focus around the pandemic are felt in both campaigns; however, each has a different way of viewing the same issue.
There is a risk of a second wave of COVID-19. One candidate is open to shutting down the economy while the other supports keeping it open.
Who will win the election?
No doubt the race will be tight. And many things can change in 60 days. The first fact to keep in mind is that, historically, it has been difficult to unseat an incumbent. In the past 20 presidential elections, when a president was seeking a second term, 75% won. For those that lost, the election was held in a recession. Voters tend to blame the president for recessions just as presidents take credit for expansions.
To handicap the outcome of the election you only need to look at two factors: the unemployment rate and the presidential job approval rating. The unemployment rate serves as a proxy for economic activity. It’s not the level that’s important, but rather the direction. If the unemployment rate is going down, economic activity is improving, people are working and there is more spending. Due to the pandemic and the short-lived economic shutdown, the unemployment rate spiked to 15% in April. Since then, it has improved dramatically, currently at 8.4%. This is good news for the incumbent.
The job approval rating needs to be around 50%. Today, according to Real Clear Politics, President Trump’s approval rating stands at 45%. It has improved since July, but currently supports a Biden victory.
The Senate race is just as important because the Senate controls a significant amount of the appointed personnel in a presidential administration and this can have a huge impact on the direction of policy during a presidency. What party controls the Senate legislative schedule can set the agenda and pace of change in the United States.
The impact of the economy and markets: Taxes and spending
The candidates have vastly differing ideas on taxes – one wants to increase taxes and the other wants to give tax cuts. Both, however, want to spend money.
Vanguard experts report that the Biden administration has not been shy about saying they will increase corporate tax rates from 21% to 28%. When it comes to individual tax rates, Trump is going to fight to keep in place the 2017 Tax Cuts and Jobs Act (TCJA) and potentially look for more cuts geared toward the middle class. Biden would raise the top marginal tax rates on individuals to pre-TCJA level of 39.6%. When considering capital gains, expect Trump to index capital gains for inflation if he can, which would reduce the rate and enact a capital gains holiday of some sort. Biden would be looking to tax incomes over $1 million at ordinary rates and in his campaign’s mind, level the playing field to equalize opportunity.
No one likes to pay more taxes; many think higher taxes mean poor stock market returns. However, this is not the case – 2013 is a perfect example. In the beginning of the year, the Bush tax cuts were made permanent, but a higher marginal tax rate (39.6%) was put in place for high income earners. The S&P 500 was up 30% in 2013.
The longer the pandemic goes on, the more government spending we expect. However, we are now starting to see some spending fatigue. In general, Vanguard experts have found Republicans to be more cautious about the debt while Democrats are more willing to pump money into the economy. Absent additional stimulus, both retail sales and GDP could turn negative – a double dip recession.
Monetary policy is paramount. Late in an election year, the focus turns to politics. Our research, however, suggests that the driver of stock prices is interest rates and monetary policy. Markets have done well during periods of easing financial conditions, regardless of which party is in the White House.
Foreign policy: Trade
Vanguard notes that President Trump has favored a more unilateral approach, speaking one country to one country. By comparison, former vice president Biden would favor a more multi-lateral approach like we saw during the Obama administration. He could potentially unwind some of Trump’s tariff policies, although doing so takes time.
Both parties are concerned about China’s influence over the U.S. In particular, policy experts are watching investment limitations and restrictions, as there is interest in de-listing Chinese companies that don’t comply with certain audit requirements. De-listing certain Chinese companies would impact whether U.S. pension and retirement funds are able to invest in them. This is a consideration that will likely have interest regardless of the outcome of the election.
Healthcare policy: Pharmaceutical prices
This will certainly be a key focus this election cycle. Both parties have tried to take on pharmaceutical and drug pricing issues; However, they disagree on how to solve these challenges. During the Democratic primary, we heard significant discussion about Medicare for all and Vanguard experts expect the candidates’ position on a public option for healthcare to be a key issue for both campaigns.
Is gridlock an issue?
Gridlock, meaning one party controls the White House and another party controls Congress, or a divided Congress, has significant implications. Vanguard experts agree that regardless of the outcome of the presidential election, the makeup of the House and Senate will have perhaps the most significant impact on legislative activity going forward. If there is a unified government, meaning a Democrat-controlled House and Senate, plus a Democrat in the White House (or vice versa), the administration would likely be able to accomplish significantly more of what it plans to do.
The financial markets don’t like uncertainty. Gridlock in Washington can be good for markets. Separation of control reduces the uncertainty, perhaps the way our founding fathers designed.
Politics matter on many fronts. However, history tells us that our system of checks and balances provides protection from radically re-engineering the economy, and thus shocking financial markets. The S&P 500 Index has averaged 11% annual return over the 75 years, through both Democratic and Republican administrations. As we mentioned, elections always involve uncertainty, so we do expect some volatility in risk-based assets
Most investors have a time horizon that is much longer than most political time horizons. There are elections every two years. Ultimately, politics creates a short-term noise but does little to impact long-term financial plans. Stocks go up because of earnings and historically that has happened whether we’ve had a Democrat in the White House or a Republican.
Many enjoy discussing, or complaining, about politics, but when it comes to the economy and financial markets, monetary policy is more important than politics. On the economic front, we are seeing some strong data points that support an economic recovery, with the focus being on COVID-19 and how the world handles it. At UMB, we expect to see a significant rebound in the second half of the year, with GDP up 16% in Q3 and up 12% in Q4. Even with a nice rebound in the second half, we anticipate that 2020 will experience a -5% contraction.
The equity markets have rebounded nicely, focusing on some type of economic recovery, regardless of magnitude and the Fed’s promise of low interest rates into perpetuity.
During this uncertain time, we want to assure you that UMB remains committed to providing the customer service that you have grown to know, while helping to ensure the health and safety of our associates and clients.
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