Global Macro Strategy Report: Special Election Report
A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.
Paul Christopher, CFA®, Head Global Market Strategist
Craig Holke, Global Research Analyst
2016 Elections—Market Implications as the Race Narrows
- The state party primaries have winnowed the presidential candidate field, but there is still significant uncertainty on how the three branches of government will work together.
- Legislation and policy on tax reform, health care, immigration, trade and other issues still depend on the congressional races and how the open seat on the Supreme Court is filled.
What it may mean for investors
- Effective collaboration between the White House and Congress may be market positive, especially on tax reform, but until the Nov. 8 elections, we pose several questions for investors to evaluate.
The state party primaries have winnowed the presidential candidate field, and investors are right to focus on the potential market implications of a President Trump or a President Clinton. These two front-running candidates strengthened their claims on their respective party nominations by winning across regions and demographic categories in multiple state primary contests on March 15.
Yet, the path of policy and legislation depends on how the next president exercises his or her executive prerogatives and collaborates with the other branches of government. In our view, the degree of collaboration should not be presumed, especially as a deepening political divide complicates the task of predicting who will lead—not only from the White House, but from the Capitol and the Supreme Court. As a rule, financial markets prefer predictability, and so this next installment in our series of election reports is intended to help investors see whether uncertainty about leadership is rising or falling as the election season unfolds.1
The Unique Character of this Election Cycle
The usual uncertainties about how a candidate may lead seem unusually sharp, especially when viewed through the prism of public dissatisfaction with government. Polls suggest that voters generally agree on the main issues—terrorism, the economy, and health care—but few voters seem satisfied with Congress’s responses. Congressional approval is low among self-identified Independent, Democrat and Republican voters and is now below its average rating of the past four decades.2 Moreover, a poll by The Economist magazine and YouGov (Feb. 24-25, 2016) showed that across income levels, gender, and age, between 59 percent and 68 percent of respondents believe the country is off on the wrong track.3
Rising public dissatisfaction correlates with turnover in Congress. Since 2006, voters twice have removed the majority party in each chamber of Congress. As Charts 1-A and 1-B indicate, the average number of Senate and House seats changing political party since 2006 roughly matches the turnover of the late 1940s and early 1950s—and nearly matches the level during the Great Depression of the 1930s. These were all periods of economic weakness (Chart 2). Perhaps just as interesting, the late 1940s also threatened overseas danger from the Cold War, which dismayed voters and cost some congressional leaders their seats. Today’s overseas political instability also likely stokes voter dissatisfaction with Congress.
(Five-year average annual economic growth rates, in percent) Sources: Strategas Research Partners and Wells Fargo Investment Institute, 3/11/16 Note: Turnover denotes the change in a congressional seat from Democrat to Republican, or the converse
The rise of so-called “non-establishment” candidates like Mr. Trump, Senator Sanders, and Senator Cruz has coincided with this wave of voter dissatisfaction. For financial markets, these candidates generate market uncertainty, because their policy preferences do not necessarily align with those of their parties’ leadership.
Limited Clarity on Issues So Far
On issues where candidates such as Mr. Trump and former Secretary of State Clinton agree, we see some financial-market implications. For example, broad support across parties to restrict prescription drug price inflation should be negative for pharmaceutical companies.
On trade, there is also some agreement. Secretary Clinton and Mr. Trump oppose the Trans-Pacific Partnership, President Obama’s proposed 12-nation trade zone. Mr. Trump would go further and impose large tariffs on Chinese goods. In our view, both approaches would tend to support smaller, domestic companies at the expense of larger, multinational firms and agriculture. Anti-trade policies also carry a macroeconomic risk, in that scuttling trade pacts or heavy use of tariffs to protect U.S. industries may provoke tariff retaliation and reduced trade, a risky step at a time when global economic activity is already soft.
The policy implications on many other issues are more difficult to predict. On perhaps the most important issue for the economy, the Democratic and Republican candidates do not even define tax reform the same way. The Democrats outline reform in terms of decreasing income inequality, while the Republicans emphasize lower rates and a simplified tax code. Thus, tax reform seems a good example of an issue that may develop slowly because of political polarization. A President Clinton may struggle to implement her preferences over a Republican-controlled Congress. By contrast, lower rates and a simpler code may be a reasonable prediction under the scenario of a President Trump and a Republican Congress.
On many other important issues, polarization-even within parties-may delay or block progress. On immigration, health care, and other issues, a Democrat-Republican power split—or even a split between Mr. Trump and other Republicans—obscures the policy directions. The candidates’ personalities and promises matter, but the ultimate legislative direction depends on negotiations yet to be held between a new Congress and a new president, and possibly adjudicated by a different balance of views on the Supreme Court.
To that point, voters rarely have such an opportunity as this one to directly shape the Supreme Court if the vote is delayed. The late Justice Scalia was among the Court’s most conservative members. It is difficult to predict how Mr. Trump might see the replacement. If Secretary Clinton wins the presidency and nominates someone closer to the Court’s liberal members, there is a chance for an ideological shift in that seat and on the Court. Arguably, the last large ideological change in one seat occurred when Justice Clarence Thomas replaced Thurgood Marshall in 1991. Such shifts have been infrequent but can produce a protracted confirmation debate in the Senate, as in 1991, and can change the Court’s liberal-conservative voting balance.
Even apart from collaboration with Congress, the potential for a political outsider in the White House poses new uncertainties for investors wherever the new president can act with executive prerogative. One area is around the potential for executive orders. Almost all presidents use executive orders. Many are routine or symbolic, but some create restrictions, or binding, legal obligations. A new president could issue executive orders to bypass a legislative impasse with Congress. For example, in his first term, President Obama used fewer executive orders per year in office than any president since at least President George H.W. Bush. Yet, a study by George Mason University’s Mercatus Center found more restrictions in his orders than in any administration back to 1990, aside from President Clinton’s first term.4
A second area of presidential initiative is on foreign policy. In recent decades, existing relationships—NATO and other alliances—afforded a new president some foreign policy guidelines and, therefore, some predictability for investors. Today, global instability has increased, and the new president likely will have important foreign policy choices to make. Yet, the alliances that guided past decision making have changed, perhaps irretrievably, so foreign policy may seem less straightforward for investors to predict. Secretary Clinton has worked in the system and may be more predictable, while Mr. Trump has offered few details on his foreign-policy perspectives.
How Should Investors Focus Attention Next?
Predicting the direction of policy for the key issues of tax reform, health care, immigration, and foreign policy seems premature. Legislation and policy on these and other important issues still depends on the congressional races and how the open seat on the Supreme Court is filled. Although we can make predictions on some issues where the front-runner candidates agree, the likelihood of strong disagreement between the new Congress and the new president— not to mention the uncertainty about the next Supreme Court justice—should generate financial-market volatility until Election Day, and probably into 2017.
In general, the longer the uncertainties persist, and the more unpredictably U.S. foreign policy develops under the new administration, the greater the discount is likely to be for equity prices and the U.S. dollar’s exchange value around the world. But efforts at collaboration could be positive for equities and the dollar, especially on the issue of tax reform. In the interim, we will be evaluating several questions:
- By September: If indeed Mr. Trump and Secretary Clinton win their nominations, how business-friendly will their platforms be?
- By November 8: In the elections, who wins the presidency, and what will be the combination of Republican and Democratic leadership in Congress? Can the Republicans hold the Senate majority and even take a super majority of 60 seats? If Secretary Clinton wins, will Democrats also control the Senate? If the Republicans control the House, how much will factions in the party impede legislation?
- Early 2017: Who will fill the Supreme Court vacancy if it is still open prior to the election, and how much of an ideological shift will this new Justice introduce? Also, how aggressively will the new president push an agenda of executive orders and changes in U.S. foreign policy?
1 Please see “Global Macro Strategy: Special Election Report,” Wells Fargo Investment Institute, February 10, 2016.
2 “No Improvement in Congress Approval, at 13%”, Gallup, March 9, 2016, http://www.gallup.com/poll/189848/no-improvement-congress-approval.aspx?g_source=Politics&g_medium=newsfeed&g_campaign=tiles
3 Please see https://d25d2506sfb94s.cloudfront.net/cumulus_uploads/document/wc6j9n44s9/trackingreport.pdf
4 Patrick McLaughlin, “Measuring the Content, Not Just the Number, of Executive Orders and Proclamations,” Mercatus Center of George Mason University, October 16, 2014.
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