Presidential elections are extremely consequential but their impact on economics has been far overstated.
FROM BARRON'S | MARCH 28, 2016
In this election cycle, will investors be winners or losers?
Let’s just get this out of the way: the bulk of this year will be consumed by election noise. There is no way around that. That noise, in turn, will drive out other stories, unless there is a major disruptive event (a terrorist attack, such as the recent one in Brussels, a natural disaster, unexpected political upheaval in the world, or expectations of a possible Brexit coming to fruition). That noise also will subtly influence investors’ behavior, or at least how they view the world. There is no way to avoid that.
But, we can be diligent about how much to connect the dots of campaign rhetoric and expectations, and whether to extend them into actual policies that might dramatically alter the trajectory of economic growth, markets, and investing.
We are in a year of election mania, very modestly rising short-term interest rates, and unresolved questions about the price of oil. The net effect has been intense volatility at the beginning of the year followed by a month of recovery and placidity. It’s highly unlikely that volatility has dissipated, but it is also likely that its intensity may have been exaggerated. In truth, we’ve had almost a year of markets adjusting, not to elections, but to the changed dynamics of oil and commodities and to the prospect of a soft end to highly accommodative U.S. central bank policy. Markets shifted—often wildly—as that happened, but year over year, we are essentially flat: The S&P 500 in late-March 2016 is almost exactly where it was in late-March 2015. With the impending election noise, we may be in for more of the same—lots of arm waving and skittishness, but not much actual movement.
How elections affect markets
As is the wont of Wall Street analysts and mavens, many attempts have been made to discern a historical pattern that offers clues of what to expect in an election year. Those patterns suggest that the fourth year of a second-term president (i.e. an election year where the incumbent is not standing for re-election) is among the worst years for equities over the past century, with an average decline of -1.2%.
That would seem to be a rather emphatic pattern, except that the declines are rarely major, and the pattern is not all that it seems. There have been only six times when a second term president did not run for reelection since 1920 (or seven if you count Lyndon Johnson): Calvin Coolidge in 1928; Harry Truman in 1952; Dwight Eisenhower in 1960; Ronald Reagan in 1988; William Clinton in 2000; and George W. Bush in 2008. That is hardly a significant number of data points, and insufficient to come to any actionable conclusions about the arc of markets this year.
Also unclear, by the by, is how a modestly rising rate environment affects equities. There, too, attempts have been made to find clear and discernible patterns. It’s often said that rising rates lead to declining stocks, as investors flock to higher returns with lower volatility that higher-yielding fixed income seems to provide. But although there is some evidence of that investor behavior at certain periods in the past, the relationship between rates and equities has been tenuous, at best, in more recent periods.
Then there is the issue of what candidate X might do should he or she become president. In any given presidential cycle, analysts take the various policy promises and platforms and try to assess what the sector and profit implications might be. These implications tend to be particularly acute when it comes to the health care sector, where government policy dictates Medicare/Medicaid rules and reimbursement rates. Other favored areas include gaming the implications of tax policy and environmental and financial regulations.
Here as well, however, you would be hard pressed to show that any of this analysis has been especially helpful. You can certainly attempt to trade the expectations, but a few points should be considered.
First, there have been remarkably few pieces of legislation that substantially changed the landscape of an entire industry. As Congress has become more polarized, there have been fewer bills of major consequence to entire industries. With the political landscape now shaping up as it is, it would take a radical shift to foresee any major legislation in the next three years akin to the Affordable Care Act.
Yes, Congress continues to authorize considerable spending, and for sure, the details of the Pentagon budget affect the revenue of the major defense companies such as Boeing, Lockheed, and General Dynamics, just as medical reimbursement rates have an impact on Pfizer, et al. But even so, it is very hard to gauge exactly how that impact will shape overall earnings.
In addition, some regulations do, of course, shape businesses. The fiduciary standard emerging in the financial services world looks to accelerate the shift away from commission-based and more towards fee-based business, but even here, the precise revenue implications for publicly traded financial service firms are extremely difficult to model, given the number of variables and unknowns.
It is vital to keep these realities in mind as analysts start to issue reports gauging how a candidate’s promises, if enacted, will alter earnings of companies or overall economic activity. Take Donald Trump’s assertion that he will strive to slap a 35% tariff on goods imported as a result of U.S. companies outsourcing production, whether that is Carrier air conditioners or Apple iPhones. Certainly, that would have a major effect on the domestic price of those goods. But it is almost impossible to imagine a scenario in which Congress would implement such a tax, and hence modeling that scenario is in many ways a waste of time.
Elections matter, and they don’t
Presidential elections are among the most consequential decisions we collectively make in the United States. But their impact on the arc of economic life has been vastly overstated. Never say never, and this year is certainly shaping up as an odd and atypical one. Even so, until there is more than rhetorical evidence and speculation about how the outcome will shape the future, it is wise to distinguish between the campaign and the markets.
For now, Wall Street and global investors appear sanguine about the election, and that is for the best. Markets have seen a major rotation out of energy and commodities and a sell-off in industrial and financial names that are directly exposed to those negative trends. Even that appears to have abated, which leaves us in a remarkably static position juxtaposed against ongoing political drama. In short, it’s a good time to think in terms of the longer-term future, to see which companies are poised to benefit from the continued evolution towards services and technology, and to adjust to a low-rate, low-inflation world. It’s theoretically possible that the outcome of the election will change those calculations, but it’s also very unlikely.