The Impact of the 2016 US Election on Investors

election-2016

Whilst the US election results are becoming harder to predict below are some of the likely economic impacts of the upcoming US election results.

 

Summary

  • Washington decision making is likely to become more fractious regardless of the election result. Divisions between and within the Republican and Democratic Parties have been growing, and an outcome whereby neither party would have a significant majority in the House of Representatives is a possibility.  This could make it harder to reach consensus on legislation, potentially heralding another return to dramatic showdowns over budget issues.
  • Corporate tax reform and increased spending on infrastructure appear to have some bipartisan support and would be a ripe area for negotiation in a divided Congress. Infrastructure spending should boost growth more than usual amid rock-bottom interest rates.
  • A growing backlash against free trade and immigration threatens to make economies more insular at a time when economic growth and productivity in many countries are barely above stall speed. Emerging markets have the most to lose, especially under a victory by Republican nominee Donald Trump. Mexico is a clear potential loser given its heavy reliance on exports to the US.
  • The US election campaign suggests rising populist sentiment is likely here to stay. We also see potential changes to income taxes, with ripple effects on US municipal bonds. We focus on two sectors that could be most affected by the election: financials and health care.  Mergers and acquisitions are set to face increased scrutiny if Democratic nominee Hillary Clinton prevails, as the Democrats appears to view anti-trust enforcement as a tool to boost competition and address inequality.

The 2016 US election campaign has been unique in many ways, but the underlying dynamics are not. These are partly driven by widening income inequality across the world,  a trend that has accelerated after the financial crisis and subsequent policy responses. Related is a growing perception that the benefits of trade and globalisation have only accrued to a few. Whoever moves into the White House will have to address these issues,
and we could see fiscal expansion directed at improving infrastructure and measures aimed at redistributing prosperity. Similar themes and outcomes to play out in key European elections next year.

The candidates

This is also a most unusual election. Both candidates are unpopular, and Republican nominee Donald Trump is running with a populist agenda that departs from decades
of Republican tradition.  He has promised to implement tax cuts, deport millions of illegal immigrants and withdraw from or renegotiate the North American Free Trade Agreement (NAFTA) and other trade deals. Tapping into a backlash against the Washington status quo, he has often appeared at war with his own party.

Hillary Clinton, by contrast, looks to build on the legacy of President Barack Obama’s two terms. Yet she has leaned to the left after a bruising primary battle with Bernie Sanders for the Democratic nomination. She supports increasing the minimum wage and making college tuition free for lower-income students, and plans to pay for it by raising taxes on the wealthy. She also has pulled her support for the Trans-Pacific Partnership (TPP) trade deal.

Trump: high uncertainty
donaldTrump’s policy agenda at face value comes with many economic and market uncertainties. If fully implemented, it could lead to a slowdown in cross-border trade and capital flows, a large deterioration in the US budget and sharply slower growth, according to ratings agency Moody’s.

A lot hinges on Trump’s ability to carry out planned income tax cuts. These could initially boost consumer spending, but might soon lead to a large deterioration in the budget and rising rates. Similarly, a plan to deport more than 10 million undocumented immigrants could lead to labour shortages and rising wages. The likely result: rising inflation and US Treasury yields. If the Fed responded by sharply raising rates, it might tip the economy into recession.
Yet inflation levels and the Fed’s actions are hard to predict in reality. And the Fed’s board could change significantly over during the next president’s term, including the
chair and vice chair. Trump’s ability to carry out his stated agenda also would be restricted by traditional Republicans.

There is a tail risk: any move to raise tariffs on Chinese goods as Trump has threatened could lead to Chinese retaliation, including a possible yuan devaluation.  Ensuing trade and currency wars would hurt commodities and Emerging Markets.

Clinton: details matter

hillaryMoody’s sees growth improving under a Clinton scenario, with the budget deficit rising slightly as a share of GDP. Clinton plans to finance infrastructure spending and other priorities partly by raising taxes on the wealthy. She could face pressure from within the Democratic Party to spend more, which could result in very different budget outcomes. Clinton’s agenda includes detailed policy proposals on everything from early childhood education to clean energy. Washington gridlock may however constrain Clinton’s ability to implement her agenda.

Clinton favours immigration reforms that include a pathway to legalisation for undocumented immigrants. Other policy plans such as paid family leave and more spending on education could help boost productivity, but the effects are slow-burning and hard to estimate.  Corporate tax reform may have bipartisan support. A one-off ‘repatriation tax’ on profits parked overseas could generate revenues to pay for infrastructure spending.  Yet the details matter. Republicans want to slash the 35%
corporate tax rate, while Democrats are focussed on closing tax loopholes.

A Clinton administration may look to executive actions and other creative ways to advance its agenda. Democrats see antitrust actions as a way to raise competitiveness and address inequality concerns, for example. Corporate acquisitions may face greater scrutiny.

diverging-scenarios

Sector impacts

Sector plays.JPGTough times may be ahead for many financials as the sales practices of large banks come under greater scrutiny, especially under a Clinton presidency. Health care stocks could be hit by renewed pressure to curb price increases on drugs, a crackdown on large-scale mergers as well as uncertainty over a likely shake-up of the Affordable Care Act (ACA).

Presidential elections typically have little lasting impact on equity markets, beyond a fleeting rise in volatility that quickly subsides post-election. Yet policy shifts due to changes in government can ripple across sectors.

What have markets been signalling so far?   The consumer durables, transportation and capital goods sectors have been rising in tandem with Clinton’s poll numbers. Health care stocks have fallen as Clinton’s odds rise. By contrast, semiconductors, banks and insurers benefited whenever Trump’s poll numbers rose.

Beneficiaries of increased fiscal spending, such as construction and materials, have already rallied in anticipation of greater infrastructure spending post-election. Yet this outperformance may be premature, as new fiscal programmes take time to trickle down to corporate bottom lines. And any fiscal package could be stymied or watered down by a divided Congress.

Uncertainty is weighing on corporate behaviour already: capital spending is lacklustre and many companies are shying away from providing long-term guidance.

Financials: An old whipping horse

Banks.JPGBank bashing is back in vogue after a US scandal involving the setting up of accounts customers did not ask for. More scrutiny is expected on the sales practices of all financial institutions and more regulations for the sector in the case of a Clinton win. This would be bad news for mega-banks, even as they stand to benefit from economic reflation and steepening yield curves boosting their lending margins.
A Trump presidency would likely be friendlier to the financial sector but would involve greater uncertainty. Example: Republicans have called the post-crisis Dodd-Frank regulations a ‘legislative Godzilla’ and proposed to pare them back. Yet uncertainty surrounding potential changes may turn investors off. And the law may simply be replaced with simpler and blunter, but equally onerous rules.

Watch your health

health-careThe health care sector has been on tenterhooks ever since Hillary Clinton fired off a tweet in September 2015 accusing biotech companies of price fixing, sparking a $38 billion sell-off in just a day. Drug pricing is likely to remain a political target as consumer and insurer frustration rise. A Clinton presidency could pose more risk to the health care sector, particularly biopharma.
Fast-rising insurance premiums are likely to spur fixes to Obamacare, resulting in regulatory uncertainty. We would not expect direct drug price controls under a Clinton administration, yet we could see it implementing some long-term drug payment reforms. And the private sector could become more aggressive in negotiating drug prices and coverage.
Even under a Trump presidency, drug price increases would likely slow, we believe. Intense media and political scrutiny has made it tough for pharmaceutical companies and drug distributors to raise prices as fast as before. This is a global trend, but we see increased pricing pressures in the US having a disproportionate impact on global drug companies because the US tends to be the most lucrative market.

Any tax holiday on overseas earnings repatriation should benefit large-cap pharmaceutical, biotech and medical device companies that earn substantial revenues abroad.

Source:  Blackrock Global Insights, October 2016
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