Despite Donald Trump’s incumbency ‘premium’, the November 2020 elections could end up a very tight race. As the elections approach, political policy uncertainty could weigh on business confidence and therefore private capex. Because of this and a lack of pre-election fiscal boosts, our US growth outlook is cautious for this year.
Governments have a direct impact on economies via their monetary and fiscal policies. They also have a more indirect impact on business and consumer confidence that is more difficult to ascertain.
In the US, Congress plays an important role in economic policy. Which party controls the two chambers of Congress (the Senate and the House of Representatives) is of prime importance. While the House of Representatives is likely to remain in Democratic hands and the Senate in the Republicans’ after the November elections, the chance of a Democratic majority in the Senate cannot be fully discounted.
However, regardless of who takes control of the Senate, it is unlikely that the president-elect come November would be granted a blank spending cheque, no matter how progressive his or her campaign platform. Even a Democratic-majority Senate would likely rein in any ambitious plans for raising taxes and revolutionising the healthcare system. The party base is much more centrist.
Historically, a divided Congress (i.e., the Senate and House of Representatives ruled by two different parties) has been best for the US economy, at least in terms of GDP growth. This contrasts with the idea that a streamlined government provides better support to growth.
“Reversing the Trump corporate tax cuts could severely hit corporate earnings.”
General consensus and our working scenario assumes that Donald Trump will be re-elected and Congress will remain divided. This ‘regime continuity’ could support business confidence. However, if re-elected, Trump could well step up policy action against China again, especially as the ‘phase 1’ trade deal signed in January 2020 is likely to fall apart within the next two years—if only because China’s imports of US goods will fall well below the ambitious targets set under the trade deal.
Continued Republican control of the Senate would make middle-income tax cuts very likely, helping to support demand. Less positively, it would stretch the US budget deficit even further, indirectly putting further pressure on the Fed to cut rates to keep interest costs low. This could lead to another boom-and-bust cycle if policy were to become too accommodative.
Historical behaviour of stock market and US elections
Identifying patterns between equity returns and the four-year US elections cycle requires looking at long data series. Surprisingly, on average since 1900, annualised returns on the S&P 500 have been higher under Democratic presidents (+7.9%) than under Republican ones (+5.0%). Even excluding the 1929 crisis brings the average annual return under Republican administrations up to +7.1%.
While historical analysis illustrates that US presidential elections are a factor in stock-market returns, in general, other factors such as a recession, have a far greater impact. Yet the prominence that a number of left-of-centre proposals have gained could mean the 2020 presidential election has a significant impact on risk assets.
How to create a negative feedback loop in US equities?
Political events tend to impact perceived risks and confidence, regularly triggering spikes in stock market volatility. The increase in corporate tax rates proposed by Democratic presidential candidates could have a material impact on US earnings. An increase in the tax rate from 21% to 25% would mean virtually zero earnings growth in 2021 (applying current expectations of 10.9% earnings growth). A 30% tax rate could mean a 4% drop in earnings weighing on equity markets.
“Whoever wins, Modern Monetary Theory is likely to keep gaining ground, meaning prolonged low rates.”
US elections and investment
Whoever wins the November presidential election, we remain convinced that Modern Monetary Theory (MMT) will continue to gain ground, meaning prolonged low yields. Yields are more likely to go lower than higher under a Democratic president—even more so if a left-wing Democrat tempted by yield curve control at the end of his/her mandate is elected. The effect of a Trump re-election will largely depend on what happens in the House of Representatives. A full Republican victory (a Trump presidency plus Republican control of both chambers of Congress) is more likely to push yields higher, but mainly in 2021. Trump is already pressuring the Federal Reserve to lower rates.
MMT could still ‘percolate’ through monetary policy. To the extent that they lead to a continuation of low bond yields, the upcoming US elections could support equities and equity valuations going forward, as long as a markedly left-wing candidate is not elected. We continue to expect a weakening of the US dollar over the next four years, with a more pronounced depreciation in 2021 if either Elizabeth Warren or Bernie Sanders is elected. Only a full Republican victory would initially strengthen the USD in 2021.