The U.S. Presidential Election: What Does It Mean for Your Portfolio?
The Trump-Clinton race is too close to call. Prepare for more volatility.
With populist and anti-establishment fervour driving the conversation, the 2016 race for the White House has stirred up more rhetoric, and uncertainty, than perhaps any other presidential election campaign in recent memory.
Should the showdown between party nominees Democrat Hillary Clinton and Republican Donald Trump do anything to change how you manage your money? Here’s what could be in the cards for the economy, financial markets and your portfolio as America picks its next president.
Trump vs Clinton: how the choice could impact Canada
While Mr. Trump, the political “outsider”, has been roundly criticized for a decided lack of policy detail, his direction’s clear. Expect tax reform – including substantial cuts to corporate tax rates – paying down of the national debt, an unwinding of Obamacare, and more support for the military if he is elected to office. On the other hand, Ms. Clinton favours new spending on infrastructure, education and clean energy, as well as higher taxes for the wealthy and a boost to the minimum wage.
The sobering reality for the Democrats is if they retain the White House, odds are they’ll be met once again by a Republican-controlled Congress, which is certain to stand in the way of any move to take Democratic policy further left. So, while a Trump presidency would be a true wildcard, life under a Clinton administration would probably look much the same as under President Obama.
What’s striking is how both presidential candidates have embraced rising protectionist sentiment which threatens to pull the U.S. off a decades-long path of championing globalization. A loss of high-paying jobs and stagnating incomes have led Middle America to seek a scapegoat – namely liberal trade.
The attitude shift is a potential problem for Canada, if campaign bluster becomes policy. The United States continues to be our number-one market, with the volume of Canadian merchandise going south of the border up four-fold since the establishment of the Canada-US free trade agreement.1
Based on comments from the campaign trail it’s likely any tweaking of the United States’ economic relationship with Canada would be more pronounced under Trump. But, both Trump and Clinton oppose the proposed Trans-Pacific Partnership trade deal in its current form, and each has expressed dissatisfaction with NAFTA. And while Trump backs the Keystone XL pipeline, ever the deal-maker, his endorsement appears to hinge on the U.S. receiving a healthy chunk of the profits. That said, it’s questionable how far either nominee will go to disrupt the status quo once elected.
Which party does the equity market favour?
While presidential races and market volatility often go together, it’s uncertainty which investors hate the most. With polls showing a close race, uncertainty is something there’s plenty of.
How would financial markets respond to a Clinton victory? Bets would be on business-as-usual, which investors would take in stride.
It’s the impact of a Trump win that’s the greater unknown. The potential economic jolt from tax cuts would be welcomed. On the other hand, questions over trade, plans for aggressive deficit reduction and his lack of experience in public office could undermine post-election confidence, at least in the short term.
Looking ahead, does history have anything to say about how equity markets behave under Republican and Democrat administrations? The numbers reveal some interesting patterns.
In theory, the stock market and economy should do better under business-friendly Republican presidents. Surprisingly, the facts say just the opposite.
A recent study from Princeton University found that between 1949 and 2013, gross domestic product grew an average of 4.4% annually with a Democrat in the White House, but only 2.5% under a Republican. Even when Republicans have controlled Congress, Democrat presidents have presided over better GDP growth than Republican presidents working with a House and Senate from their own side of the aisle. It’s been a similar experience for the stock market. With Democrats in charge, the S&P 500 Index has achieved a superior average annual return: 8.1% compared to just 2.7% for the GOP.2
CIBC Capital Markets notes that since 1962 Democratic administrations have been associated with a more robust economy on this side of the border as well.
If the Democrats win, should you jump into stocks with both feet?
What’s less than clear is whether the Democrats’ success has as much to do with luck as smart policy. According to the Princeton University analysis, on average, Democrats have enjoyed more global stability, productivity growth and consumer optimism during their time in office.
Take the example of Bill Clinton who occupied the Oval Office through much of the 1990s. He had the good fortune of overseeing an economy lifted by the arrival of the internet, post-Cold War globalization, a declining interest rate environment and favourable energy prices. The equity market advanced by an average of more than 16% annually during his two terms in office, the best performance under a president since the 1930s.
The truth is both Republicans and Democrats have had their share of good and bad times while in power. History suggests it’s technology, the broader global economy, international relations, or actions by the Federal Reserve and Congress which can have a much greater influence over the financial markets and domestic economy than who’s in the White House.
The Presidential Election Cycle and Equity Markets: Why 2016 is different
Is it true that the stock market moves in sync with presidential elections? There’s a theory that says it does.
The presidential election cycle theory argues that leading up to an election (years 3 and 4 of the cycle), politicians promote an accommodative agenda to win favour with voters, driving optimism and propelling equity markets higher. Once elected (years 1 and 2), the new administration doesn’t hesitate to put its policies to work.
It’s not unusual for the new measures to impose heavier taxation or regulation which weigh on the economy and corporate earnings. Since the stock market discounts future economic prospects, it weakens heading into mid-term elections. The public voices their disillusion just as equities hit their cyclical low. The pattern then repeats, as politicians scramble to again put voters in an upbeat mood before the next vote.
Statistics reveal that negative years for stocks have, in fact, occurred mostly during the first and second years of a presidential term, with average returns highest in the third and fourth years. While year two has suffered the lowest average annual returns in the presidential cycle, the stock market hasn’t experienced a loss in year three since 1939.
However, like most ideas based on market timing, the presidential election cycle theory doesn’t always hold up. An example? The behaviour of equity markets during President Obama’s current mandate.
Rather than stock market weakness in years one and two, the market rose by double-digits each year. Year three, typically the strongest in the cycle, only eked out a slight gain. In fact, 2015 was the third straight year three (along with 2007 and 2011) which saw subpar stock market performance.
One possible explanation for the significant break in the pattern is the stubbornly sluggish state of the world’s economy.
The positive catalyst of the Federal Reserve’s quantitative easing program, which fueled equity markets earlier in the cycle, gave way to concerns over global growth, China, emerging economies and crumbling commodity prices. Although a softer US dollar has helped resource markets rebound, recently the trouble’s been the "Brexit" vote on Britain’s EU membership and shifting bets over how quickly the Fed will continue to tighten interest rates.
Take charge of the things you can
A neck-and-neck election race and murky macroeconomic picture aren’t the only reasons why the second half of 2016 and 2017 may remain unsettled for equity markets and the economy. They’ll also face the headwind of history.
Since 1928, in election years where an incumbent isn’t seeking re-election, the S&P 500 has dropped an average of 2.8%. Those years that fall at the end of a two-term presidency, like 2016, have been the only ones to average negative returns in the four-year presidential cycle.3 And, of the ten recessions the US has seen since World War II, nine started during the first or last year of a presidency.
So, how can you navigate market uncertainty when it comes to your investment strategy? By focussing on the things you can control.
While you can’t determine who will be the next president, or the direction of interest rates, markets or the loonie, there are ways to take charge of your portfolio.
1. Maintain a proper asset allocation. A key to successful investing is finding the right mix of stocks, bonds and cash to deliver enough growth to meet your goals, at a level of risk that’s acceptable. But creating the ideal portfolio isn’t enough – you have to maintain it. It’s important to periodically rebalance your investments so the market’s ups and downs don’t push your portfolio to an overly aggressive, or conservative, position. Better still, turn market volatility to your advantage by regularly adding new money to your portfolio so you wind up buying more of an investment at better prices when the market’s down.
2. Maximize tax saving opportunities. Reducing your tax bill year-in and year-out can make a substantial difference to how much you’re able to save over time, no matter how markets behave. Work with your advisor to create a tax-efficient portfolio that lets you make the best use of RRSPs, TFSAs, the dividend tax credit, tax loss selling and other wealth building opportunities.
3. Keep your emotions in check. It isn’t always a lack of planning or the wrong investment choices that sink good intentions. More often than not, investors fail because their discipline falters, allowing fear or greed to cloud their judgement, ultimately leading to poor decisions. Ignore the headlines. Avoid trying to time the market. Sticking to your investment plan gives you the best chance of achieving your long-term goals.
No matter which way the political winds blow in Washington after the vote on November 8th, a well-structured portfolio will see you through whatever lies ahead.
If it’s been a while since you last reviewed your investments, speak with your BlueShore Financial advisor.