The U.S. and world markets are in the midst of another presidential election year, as of this writing (August 2016). The election-year rhetoric from candidates and their partisan supporters has ramped up to a din capable of bringing confusion to all but the most attentive and dispassionate observers.
Analysts like to note that investors don't like uncertainty. However, with a divided U.S. electorate and candidates disposed to fight tooth and nail for votes, clarity about candidate positions and what they may mean for the policies of the next U.S. administration could be the first casualties of the campaign battle. Both voters and investors may find themselves hard-pressed to confidently arrive at a conclusion about what the next government administration will bring to bear for their investment portfolios and for markets in general.
A Big Deal?
The U.S. is the world's largest economy, with a gross domestic product (GDP) equal to approximately US$18 trillion annually, or about 16% of the global GDP. It's also a military superpower, with one of the largest military structures around the world.
Considering the country's economic and military significance, the U.S. presidential election every four years is seen as one of the most important recurring political events globally. As such, a survey of the conditions in which the U.S. electorate and the U.S. and global economies find themselves ahead of the election can be helpful in understanding voter tendencies and the challenges that lay ahead for the next administration.
Where We're From, Where We're Going
Since the global financial crisis of 2008 and 2009, U.S. and global markets have gone through a long period of recovery. Some critics of U.S. government policy have argued that in addition to being a long period of recovery, it has also been a time of unusually slow and weak recovery.
There is little doubt, however, that financial markets nonetheless enjoyed steady gains from 2009 through 2016, regardless of what may have been happening with underlying U.S. and global economic activity. Major equities indices—the Dow Jones Industrial Average, the S&P 500 and the NASDAQ—have all tested record highs and have not succumbed to the volatility that might seemingly be characteristic of nervousness and uncertainties among investors.
How Is The Economy Doing?
One popular gauge of expected sentiment among voters is the health of the economy. The U.S. economy has grown at an average pace of 2.1% in the past four years, while the global economy has grown by 2.5%. Unemployment in the U.S. fell to 5.3% in 2015 from 8.1% in 2012, while it fell around the globe to 5.9% from 6.0%. At the same time, income per capita in the U.S. has risen to US$55,805 from US$51,385 while income globally has fallen to US$12,843 from US$14,197.
Meanwhile, the labor force participation rate in the U.S. has fallen to a 40-year low of 62.6%, while it has risen slightly globally to around 63.5%. The figures in the U.S. and around the world seem to suggest both a gain in general prosperity alongside increasing disparity of wealth that may have alienated some participants in the U.S. electorate.
Still, a general improvement (in the States, at least) seems to be confirmed by recent readings of the misery index, a measure including unemployment and inflation. The index, invented by economist Arthur Okun to determine the mood among the population, has dropped to less than half of what it was four years ago (as of August 2016). Inflation and unemployment, meanwhile, have also fallen slightly around the globe over the past four years.
The Issues: What's At Stake?
In addition to growth and employment, voters and investors will be paying close attention to other policy matters that will affect those indicators going forward. Chief among these are government spending and taxes, government debt, regulatory policies, foreign trade and interest rates.
The U.S. has doubled its public sector debt over the past eight years to US$19 trillion, or 104% of GDP, under the impact of heavy military spending abroad and increased government spending domestically amid an effort to stimulate the economy. Tax collection as a percentage of GDP, meanwhile, has risen since 2008 to 18% of GDP from 17%. The U.S. foreign trade deficit has narrowed in the last eight years to US$531 billion from US$708 billion.
Potential changes in Federal Reserve interest rate policy may have the largest potential impact on the global economy and markets under a new administration. The president does not have direct decision-making power over Fed policy. However, the executive branch's decisions regarding the federal government budget and other matters that may influence interest rates will likely alter the conditions under which global markets operate.
Under the government's struggles to stimulate the economy following the 2008 and 2009 global financial crisis, the Federal Reserve brought U.S. interest rates to near zero and has held them there ever since. An increase in U.S. interest rates under a new administration could have several simultaneous and significant effects on asset values in differing markets.
A rate increase would encourage investors to buy U.S. Treasury securities as they seek rising yields. As bond investments become more competitive, investors may migrate to them and away from stocks, promoting selling in equities markets. Increasing interest rates would also raise the cost of borrowing for U.S. companies, which would weigh against share prices.
A migration towards rising yields in the U.S. could also have a strong impact on global currency markets, bidding up the price of the U.S. dollar. Global markets anticipated such a move in 2014 and 2015 as the dollar gained value around the globe in reaction to signals from the Fed that it was preparing to hike rates. The Fed raised them a quarter point at the end of 2015. Since then, however, it has given signs that it could continue to remain on hold, and it's unclear how soon it might be prompted to raise them further. U.S. inflation and economic growth have remained tepid, both discouraging the possibility of a rate hike in the near term.
Where The Candidates Stand: Reading Tea Leaves
It's difficult to project how closely candidates will stick to their campaign promises in the future given the conditional quality of most political rhetoric and the dynamic nature of U.S. and global economic conditions. However, some inferences can be made about candidates' policy leanings considering their stances taken during the presidential campaign.
Democratic candidate Hillary Clinton, for much of her talk on raising taxes and leveling the playing field, is considered by many in financial markets to be a moderate. They see her as willing to compromise where it may mean an incremental improvement for the U.S. economy and markets.
Holders of this opinion cite the two presidential terms of her husband, Bill Clinton, in the 1990s as evidence of the Clintons' willingness to compromise and take a moderate stance where economic policy is concerned.
They note that Mr. Clinton was willing to work with a Republican-controlled Congress in order to reduce a federal budget deficit, and that he also agreed to ease financial regulations in an effort to stimulate investment.
Additionally, Mr. Clinton's administration was seen as a promoter of free trade, signing off on the North American Free Trade Agreement that opened up increased trade with Canada and Mexico. At the same time, Mrs. Clinton in her presidential campaign has signaled she is intent on raising taxes on corporations and high frequency traders and high-income earners, in addition to penalising companies that seek to move their operations abroad.
Regarding the federal budget, Mrs. Clinton has indicated she is in favour of raising both taxes and spending in a plan that could possibly increase debt by more than US$200 billion. On Federal Reserve policy, the candidate indicated she favours a "dual mandate" that requires the Fed to consider growth targets alongside inflation control.
Although U.S. interest rates were allowed to rise to as high as 6% during the administration of Mr. Clinton, most analysts discard the possibility of a precipitous rise in interest rates during a possible second Clinton administration because of the negative impact it may have on economic growth and the U.S. debt.
2016 Republican presidential candidate Donald Trump has built his campaign proposals on improving employment and income in the U.S. by encouraging a return of industry to local operations and a subsequent renewal of the country's manufacturing base. Regarding the federal budget, the candidate has proposed both cutting taxes and increasing spending by as much as US$650 billion.
The rationale behind the proposal is that tax cuts would help promote economic growth and raise revenues that would help offset any increases in debt. While criticising the Federal Reserve's near-zero interest rate policy, Trump has also hinted he is a fan of low interest rates and that he would work in favour of keeping them low if elected. Low interest rates, he says, will help maintain the manageability of U.S. government debt and also favour a weaker dollar, which would help make U.S. manufacturing and exports more competitive.
Cycles And Volatility: The Calm Before A Storm?
Markets have behaved calmly in the run up to the 2016 election and there appears to be little incentive for either of the current top candidates to promote abrupt changes in policy. However, investor jitters before or after the election may still shift the market trend. Curiously, historical data shows that presidential election cycles have tended to encourage market gains in the last year of a presidential term. Just as the law of gravity says that what goes up must come down, however, the current long-running bull market may quickly collapse if candidate positions before or after the vote give investors a reason to start a selloff.
The current state of the U.S. and global economies (August 2016), and policy preferences of the presidential contenders, will have a significant influence on the decisions that will be made during the next administration and what they will mean for markets.
A new administration's significant change in U.S. budget policies and economic growth incentives would likely have a strong influence on the possibility of interest rate increases by the Federal Reserve and subsequent knock-on effects for major global markets, such as debt, equities, currencies and commodities. However, there has been a tepid pace of growth with a continued fragility of the U.S. economic recovery. This mean that, regardless of who wins the election, the next administration will likely remain hesitant to make abrupt changes in policy. As a result, any corresponding changes in the interest rate stance by the Fed should remain gradual.
However, investors should be prepared for the possibility of a short- or longer-term shift in the current market sentiment before or after the vote should markets suddenly show any unforeseen uncertainties about the candidates' positions.
Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…