Speaking last week at Pro-Manchester, Head of Private Client Research John Goodall discusses the US election.
First of all I am going to provide a brief overview of the US economy as we head towards the vote. I will discuss the policies of the leading candidates, Trump and Clinton, and how I would expect them to impact the economy and the financial markets.
We can break that down to consider the following:
Currencies: (the largest and ultimate indicator of confidence in a country’s economy. All other markets are subservient because their values depend on currency.)
Bonds: (reflects the ability of the government and corporates to raise money, long-term interest rate expectations, political risks. A healthy bond market is crucial to the health of any economy.)
Equities: (reflection of confidence in future prospects of individual companies. More prone to speculation.)
As we approach the vote, Clinton is the bookmakers’ favourite, with betting markets currently suggesting the probability of her winning at about 70%. Trump is probably surprised he got this far, having beaten 16 other candidates to win the nomination. But don’t rule him out for the same reasons that Brexit won: namely disenfranchisement of the middle classes (the odds seem quite similar too!).
GDP is still growing in the US, although the rate of growth is slowing down. 2016 is expected to see growth of 1.5%, the slowest since the Financial Crisis. Leading indicators, such as Industrial Production and Durable Goods Orders, point to stagnation in the economy. Much of the growth there has been is down to an increase in debt. According to the Congressional Budget Office (CBO), public debt to GDP is expected to rise to 77% by the end of this year, the highest since 1950. It is forecast to increase to 141% by 2046 due to the rising cost of health care alongside an aging population. It’s a similar story with Corporate and Private debt too, rising signficantly over time.
Before we look at Trump it is worth considering what explains his popularity? And other anti-establishment movements such as Brexit? Gains have not been shared equally with wealth inequality growing: the top 1% earn 20% of all income in the US. (According to a report from Oxfam, the 62 richest people in the world are in total as wealthy as the bottom 50% (i.e. 3.6 billion people), down from 388 in 2010.) Much of the rising inequality can be explained by exceptional growth in asset prices, helped by low interest rates, which has encouraged speculation in property and stock markets, disproportionately benefitting the wealthy.
Trump broke down his economic policies into five sections: Tax Reform, Regulatory Reform, Energy Reform, Trade Reform and Other Reforms. Through these, he is aiming to boost the global competitiveness of the US.
Tax Reform: Trump is proposing the biggest tax reform since Reagan, reducing personal income tax dramatically, taking 73m households out of income tax, reducing the top individual rate from 40% to 33%, and lowering corporate tax to 15% for every business from a highest marginal rate of 35%. It would transform the US from one of the highest tax regimes in the world to one of the lowest. A lower tax rate is certain to make the US a more attractive place to do business for international firms. It is likely to result in increased consumer spending, industrial production and GDP in the short term at least.
Regulatory & Energy Reform: He is looking to review regulations which inhibit jobs specifically in the coal and natural gas industries. Make land available in Outer Continental Shelf (Alaska, Pacific, Gulf of Mexico and Atlantic areas) for oil & natural gas production, the majority of which Obama had put out of service. Despite being the largest oil producer in the world, the US is not yet self sufficient as demand exceeds supply. Focusing on domestic production may help to reduce demand for overseas energy sources. Trump would cancel the Paris Climate Agreement and limit global warming to 2 degrees Celsius as opposed to 1.5 degrees. If his policies are effective, we could see the supply of US oil increase and the price fall to reflect this. More generally, this is likely to have a deflationary impact, reducing the pressure on the Fed to make further interest rate hikes.
Trade Reform: Trump will be tough on trade tariffs and try to enforce existing agreements with the aim of increasing domestic production and employment, helping to reduce the trade deficit. He will renegotiate the North American Free Trade Agreement with Canada, Mexico and withdraw from the Trans Pacific Partnership (12 Pacific Rim countries including the US, Canada and Mexico). He also plans to label China a currency manipulator which he says gives Chinese exporters an unfair advantage: a controversial claim and not necessarily true. These policies are not certain to work though. In terms of value-added manufacturing (e.g. electronics, machinery, aircraft, autos), China does not compete effectively on a global stage so it unclear what Trump will achieve. This policy could backfire if China decides to retaliate by selling down its large holding in US Treasuries. It could also lead to a global trade war where countries impose high tariffs, harming trade like in the 1930s. A breakdown in free trade will outweigh any potential domestic gains and could cause unemployment to rise sharply.
Other Reforms: Obamacare repeal and replacement. According to the CBO, costs of major healthcare programs are expected to double from $1 trillion in 2015 to $2 trillion in 2026. Trump is opposed to this government-run medicine system which has pushed prices up due to less competition. He will aim to broaden healthcare access and make it more affordable. Trump would change the laws re. the sale of insurance across states, allowing full competition to lower costs. Aim for lower drugs prices by removing barriers to entry, focus on the cheapest providers, not just the US suppliers but internationally. He also has plans to boost infrastructure spending, citing deficient and substandard roads and bridges for example.
Moving on from the economics, it is worthwhile talking about some other key policies:
Immigration: Trump’s policy is to control immigration not to prevent it with the purpose of putting US jobs first, boost wages and women’s workforce participation. His immigration policies are highlighted by his attitude towards Mexico, asking them to pay $5-10bn to build a wall at the border with the aim of deterring illegal immigrants into the country. If Trump is successful, he may reduce immigration from Mexico and even send some illegal immigrants back home. The impact will probably be greater on Mexico. $24bn a year is sent back in remittances, equal to around 2% of GDP, money which will be converted to pesos and spent in the local economy. If even a portion of this flow is threatened, we would expect the Mexican economy to be threatened and the currency to weaken. However, it is questionable whether US citizens will take on the low paying jobs invariably filled by immigrants. Restricting immigration will over time create a poorer demographic picture with an aging population.
Monetary Policy: the President can only influence policy, as Federal Reserve is “independent” but the Chair is chosen by the President. Trump has talked about replacing Janet Yellen as chair of Federal Reserve or even auditing the Fed. He has openly called stock market “artificial” and described the economy as “false” due to low interest rates. He has talked about raising rates to help savers.
Now let us examine Clinton’s economic policies. She has three main policy goals: Boost Economic Growth, Create Fair Growth and Support Long-Term Growth.
Boost Economic Growth: Clinton would increase federal infrastructure funding by $500bn over five years, paid through tax reform (i.e. higher taxes on the top 10% of taxpayers) and the launch of a national infrastructure bank in order to create decent jobs and drive up wages. Investment would improve productivity. Investments would be across the board: in energy (e.g. pipelines), water systems (drinking and wastewater), roads (provide intelligent transportation systems), bridges, ports (deeper port channels), public transport (expand offering, making it more affordable), rail, airports (which are operating beyond their original design), upgrade the national airspace system from radar to satellite-based navigation. Some of the existing infrastructure is over 100 years old so there could be interesting opportunities for investors if Clinton is to deliver on these promises.
Create Fair Growth: The aim is to benefit the average worker and not the executives. Clinton will fight for unions in order to strengthen collective bargaining. She intends to increase the minimum wage to $15 an hour from $7.25. This sounds like a positive move, but it may erode the competitiveness of US companies on a global stage. That said, provided that companies do not cut staff or reduce hours, it will help increase tax payments and consumer spending. Clinton would reform the tax code to ensure that the rich do not pay a lower tax rate than middle income earners by ending tax loopholes for the wealthy.
Relief on the middle class is seen on child care, health care and education due to rising costs. She would cap prescription drug costs, prevent exorbitant drug pricing by pharmaceutical companies, and aim to make housing and homeownership affordable. On drug prices, the method by which the government buys drugs needs to be reviewed as currently there is little room for negotiation with the providers enjoying effective monopolies.
Clinton would ease the burden of student debt (for over 40 million Americans, owing around $1.3tn, around $30,000 on average). Much of the student debt is to the government which subsidises it, although some of the banks (e.g. Citizens, Wells Fargo) have exposure to the market and would potentially be hit by changes. She will aim to improve education standards across the board from preschool onwards through to workforce education programs.
Support Long-Term Growth: Invest in research and technology with the intention of reaffirming the US’ global leadership and creating good-paying jobs too. Technological progress will create challenges and opportunities; increasing investment will help prepare for this transition. Areas highlighted include smarter transportation networks and widely-deployed digital infrastructure with the aim of connecting all households to broadband by 2020, using fiber, fixed wireless and satellite technologies.
Clinton will increase investment in science based education to boost participation rates at universities. She would encourage immigration from skilled overseas workers and entrepreneurs, allowing green card status to international students in certain degree subjects (e.g. PhDs). This positive approach to immigration should pay dividends in the long-term for growth.
Other Policies: Establish the US as a clean energy superpower: aiming to install half a billion solar panels by the end of her first term with enough clean renewable energy to power every home within 10 years. This could make alternative energy an attractive investment but economic theory shows that alternative energy prices follow oil closely as they are considered substitute goods. Lastly, she will pursue tougher trade policies to protect US job creation, opposing the Trans Pacific Partnership, being tough on China, surprisingly sharing common ground with Trump on this issue.
Monetary Policy: Appoint Fed Governors to promote the full employment part of the Fed’s dual mandate (not purely price stability). This would not appear to be very different to what happens already given the amount of accommodation. It appears to indicate an endorsement of Janet Yellen and that we can expect more of the same, with the potential for higher inflation as interest rates are kept low.
It would be helpful to recap some of the main ideas at this stage before we move on. For Trump, I see positive points with regard to Tax, Energy, Healthcare and Monetary Policy. On the negative side, Trade and Immigration. For Clinton, positive points include Investment in Technology and Education, Immigration. On the negative side, Monetary Policy.
So what about the implications for the markets?
Currency: There are conflicting factors at play which make predicitons complicated. Looking at Trump first of all, if he is able to influence the Fed to follow through and push interest rates higher, this will be positive for the dollar. Despite the rhetoric, there is limited scope for aggressively raising rates due to the high levels of debt in the economy, although we are likely to see some progress. Lower taxes will arguably harm the budget deficit in the short run. However, economic theory demonstrates that a lower tax rate does not necessarily mean lower overall tax collections. There is an optimum tax rate where collections are maximised. Lower taxes will stimulate growth by increasing the incentive for companies to invest and individuals to work: tax collections may actually increase, although it may take time to feed through. If Clinton wins, with the focus on the full employment aspect of the Fed’s dual mandate, scope for interest rate hikes will be lowered and will be negative for the dollar. It is important to recognise that interest rates at historically low levels are unhealthy for any economy. Historically, investment has been funded by savings but low rates provide little incentive for savers and increase reliance on debt: this is not sustainable in the long run. A greater level of fiscal spending is also planned. Whilst theoretically this will be covered by taxes, there can be no guarantees it will work out in practice. On balance, the dollar should do better with a Trump win, although the market is likely to panic in the short term, say for a month or two, if he wins because of the increased uncertainty and likelihood of higher government spending and a lower tax take.
Bonds: A Trump win will create uncertainty. This is likely to lead to a sell off in bonds and higher bond yields. A Clinton win is likely to guarantee a continuation of the status quo in the short term at least. This means rates will stay low. Whoever wins, we are likely to see continued demand for Treasuries as rates are unlikely to spiral out of control. I would suggest that 10 year Treasury yields are unlikely to trade much higher than 2.5-3.0%. On a relative basis, yields look attractive and they offer a safe haven status in an uncertain world.
Equities: A victory for Trump would be a surprise and this could easily upset the markets in the short term due to the uncertainty this would generate and likely increase in bond yields. The danger is that this is not priced in at all by the markets. In the short term, the markets are likely to be happier with a Clinton victory. Longer term, it is difficult to say. Probably the opposite will be true: with Trump’s lower taxes, US consumption, the main driver of the economy, will be boosted, although there will remain the risk of weaker global trade if tariffs are instituted.
Looking at the impact on different sectors, infrastructure is likely to benefit whoever wins the election. Arguably much of this is already in the price, although some companies in construction and building materials or specialists in other areas such as industrials could benefit. The potential downside in healthcare has been widely publicised. There is still a risk if Clinton wins, although she is more likely to go after the operators of esoteric drugs who are guilty of taking advantage of customers through exorbitant pricing. Trump is also looking to reduce healthcare costs. Oil is interesting: it would seem that prices will fall if Trump wins because he will encourage further production. This will be negative for emerging markets, especially those heavily reliant on oil such as Russia and Brazil. Education services look well placed if Clinton wins. There could be an opportunity to invest in providers of education services: this will be not just at universities but across the board. Military spending looks set to increase whoever wins. This could make the world an even more dangerous place, one might argue particularly if Trump wins due to the unpredictable nature of his character. As for housing, without a massive building program, it will be difficult to see prices become more affordable if interest rates stay low. There is little indication that the current path of rates will change under Clinton. Prices are more likely to fall if Trump wins. As for the banking sector, Trump would be preferred because of the potential for higher interest rates. Clinton has also vowed to crack down on some of the riskier elements of the the investment banking industry.
How realistic is all this? It is important to understand that there are limits on the President’s power. Laws need to be approved by Congress, which is formed by the Senate and the House of Representatives. People will be voting on these houses too: whilst the House of Representatives is expected to remain Republican, the Senate, currently Republican could go either way. Whoever wins the election could find their power restricted: Clinton because she is unlikely to get a clean sweep and Trump because he is unpopular with many Republicans. We could even end up with the gridlock which has characterised Obama’s presidency.