Blog
Election Preview: Gridlock is Best Possible Outcome for
Markets
October 26, 2016
With the U.S. presidential election just weeks away, it’s instructive to examine how election outcomes influence market
returns. There has been a big difference in stock performance depending on who occupies the White House and who controls
Congress. However, it doesn’t matter which party is controlling which branch (Executive or Legislative). What matters is whether
the same party controls both. As of today, the markets are pricing in a Hillary Clinton victory with a Republican Congress – a positive scenario for the markets.
Going back to 1901, political gridlock has historically been the best outcome for stocks.
Why would that be the case? The answer is simple. Certainty. Markets hate uncertainty more than anything and a divided
government provides a level of comfort due to conflicting agendas for each party. For example, if you have a Republican president
and a Democratic Congress, there is not a high probability for sweeping changes in tax code or industry regulation. In such
instances, the gridlock creates an environment where corporate managers are more comfortable spending capital and investors
can more accurately gauge profitability of a particular company or industry. The devil that you know is better than the devil that
you don’t.
More specifically, this scenario is positive because there would likely be no agreement on health care, energy and financial
legislation or regulation, or on tax issues. Clinton’s projected budget would increase the net deficit by $200 billion over ten years.
Her $1.3 trillion planned spending increase would be roughly offset by tax increases. A Clinton victory would also continue Democratic control of the White House, a scenario which has historically produced much
better performance during the first year of a new President than when a Republican unseats a Democrat (Exhibit 1).
Exhibit 1: S&P 500 Price Performance During First Year of Presidency (1929-2013)
Source: Strategas.
A Trump victory would likely be negative for financial markets, at least initially, as markets are largely unfamiliar with Trump in a
political role. The U.S. Dollar, Treasuries and multinationals could see some additional pressure as well. Multinationals, in particular,
could struggle due to protectionism and the potential for future trade tariff retaliations. Energy would be a big winner in this
scenario as both Trump and the Republicans in Congress support the American energy revolution.
However, market valuations could be much higher a year from now if the Republican candidate’s tax plan is enacted. Trump’s
current tax plan would be closely modeled on the tax plan proposed by House Republicans in late June and would have three tax
rates for individuals (12%, 25% and 33%). Trump would also reduce the corporate tax rate to 15%. The revenue loss would be $4
to 5 trillion and would result in a substantial increase in the federal budget deficit.
Trump’s plan cuts both ways in terms of its economic impact. On one hand, it would provide a massive fiscal stimulus. By lowering
personal and business tax rates, people would have more money to spend and U.S. businesses could be more competitive
internationally. On the other hand, an increase in the deficit of this magnitude could cause bond yields to rise and reduce
confidence in the dollar because it would put the U.S. on a less sustainable path. This new plan does have the ability to pass
Congress with the revisions much closer to the Republican tax plan.
The last scenario is a Democratic sweep of the Presidency and Congress. This would be negative for markets with the health
care, financial, and energy sectors being the hardest hit. The tax hikes likely under this scenario would also probably weigh on
valuations.
If you’re keeping score, two out of three scenarios would put some additional pressure on the markets. However, unless a change
in policy causes a recession, a prolonged market drawdown is unlikely.
With the U.S. presidential election just weeks away, it’s instructive to examine how election outcomes influence market
returns. There has been a big difference in stock performance depending on who occupies the White House and who controls
Congress. However, it doesn’t matter which party is controlling which branch (Executive or Legislative). What matters is whether
the same party controls both. As of today, the markets are pricing in a Hillary Clinton victory with a Republican Congress – a positive scenario for the markets.
Going back to 1901, political gridlock has historically been the best outcome for stocks.
Why would that be the case? The answer is simple. Certainty. Markets hate uncertainty more than anything and a divided
government provides a level of comfort due to conflicting agendas for each party. For example, if you have a Republican president
and a Democratic Congress, there is not a high probability for sweeping changes in tax code or industry regulation. In such
instances, the gridlock creates an environment where corporate managers are more comfortable spending capital and investors
can more accurately gauge profitability of a particular company or industry. The devil that you know is better than the devil that
you don’t.
More specifically, this scenario is positive because there would likely be no agreement on health care, energy and financial
legislation or regulation, or on tax issues. Clinton’s projected budget would increase the net deficit by $200 billion over ten years.
Her $1.3 trillion planned spending increase would be roughly offset by tax increases. A Clinton victory would also continue Democratic control of the White House, a scenario which has historically produced much
better performance during the first year of a new President than when a Republican unseats a Democrat (Exhibit 1).
Exhibit 1: S&P 500 Price Performance During First Year of Presidency (1929-2013)
Source: Strategas.
A Trump victory would likely be negative for financial markets, at least initially, as markets are largely unfamiliar with Trump in a
political role. The U.S. Dollar, Treasuries and multinationals could see some additional pressure as well. Multinationals, in particular,
could struggle due to protectionism and the potential for future trade tariff retaliations. Energy would be a big winner in this
scenario as both Trump and the Republicans in Congress support the American energy revolution.
However, market valuations could be much higher a year from now if the Republican candidate’s tax plan is enacted. Trump’s
current tax plan would be closely modeled on the tax plan proposed by House Republicans in late June and would have three tax
rates for individuals (12%, 25% and 33%). Trump would also reduce the corporate tax rate to 15%. The revenue loss would be $4
to 5 trillion and would result in a substantial increase in the federal budget deficit.
Trump’s plan cuts both ways in terms of its economic impact. On one hand, it would provide a massive fiscal stimulus. By lowering
personal and business tax rates, people would have more money to spend and U.S. businesses could be more competitive
internationally. On the other hand, an increase in the deficit of this magnitude could cause bond yields to rise and reduce
confidence in the dollar because it would put the U.S. on a less sustainable path. This new plan does have the ability to pass
Congress with the revisions much closer to the Republican tax plan.
The last scenario is a Democratic sweep of the Presidency and Congress. This would be negative for markets with the health
care, financial, and energy sectors being the hardest hit. The tax hikes likely under this scenario would also probably weigh on
valuations.
If you’re keeping score, two out of three scenarios would put some additional pressure on the markets. However, unless a change
in policy causes a recession, a prolonged market drawdown is unlikely.
Jeffrey Schulze, CFA
Investment Strategist
12 Years experience 3 Years at ClearBridge
Past performance is no guarantee of future results.
All opinions and data included in this commentary are as of October 24, 2016 and are subject to change. The opinions and views expressed herein are of Jeffrey
Schulze, may differ from the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This
information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but
the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments nor its information providers are responsible for any
damages or losses arising from any use of this information.
ClearBridge Investments
ClearBridge.com