The greatest show on Earth

Key Points:

• The forthcoming election in the US looks to be close, a Trump or Harris victory would not surprise markets.

• Historically, it hasn’t really mattered for markets or the economy which party has been elected to power in the US. Other factors have been the major cause of memorable financial events.

• The major policy proposals from Trump and Harris aren’t (in our opinion) very good. However, it is rare for all election promises to actually make it into legislation.

• The biggest risk is that Trump manages to push through his proposed tariff increases in aggregate. We think that would have a significant negative market and economic impact. Otherwise, Trump’s isolationist policies may embolden China to take control of Taiwan, though this is a very low probability (but high impact) outcome in our view.

• Ultimately, most of the time, elections in the US don’t matter much for the economy or markets and we expect that this year’s election wont deviate from that trend.

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Do elections really matter in major economies? Voters normally choose between a centre left and a centre right party, often with a policy platform that is for the most part pretty centrist (with proposed changes rarely implemented when in power anyway). Then, following a period of time measured by the number of voters the government annoys, the electorate re-votes and installs the opposition. With that in mind, in this month’s Market Insight, we review the upcoming US election, and what it means for the economy and markets. Perhaps this time will be different?

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Predicting the Winner

After starting out as a relatively benign race with Trump looking like a clear winner versus an opponent in apparent significant cognitive decline, the US Presidential Election race heated up in July, with the assassination attempt on Trump widening the gap further with Biden. Then, as Biden withdrew and Harris emerged as the presumptive Democrat nominee, Trump’s apparent easy win slipped from his fingers. Since Biden left the race, polling has suggested that Harris will be the outright winner in terms of the popular vote. However, the US Electoral College system complicates matters. Betting markets have Trump slightly ahead of Harris for the Presidency. At any rate, the reliability of polling and odds markets seems to have faded materially in the past decade, with a number of major misses (Brexit, Trump V1 etc) suggesting anything can happen. With this in mind, and the polling tight at any rate, it is effectively a coin flip who wins from the market’s perspective at this point.

Do Republicans Cause Recessions?

What about the historical record? Many voters have well ingrained views around which party is the better economic manager, which party is better for workers, which is better for markets etcetera. However, over the last fifty years, most recessions have occurred during Republican administrations, as have most increases in unemployment. Looking at this raw data, is it pretty clear that Republican administrations cause recessions and higher unemployment rates. Either that, or perhaps recessions are actually caused by factors largely out of the control of government and all the arguing around who is better at managing the economy is marketing spin in the lead up to elections. It may be the case that Trump didn’t cause Covid, Bush 2 didn’t cause the Financial Crisis and Tech Bubble, and Bush 1 didn’t drive interest rates higher prior to the 1990s recession. If it is not clear, we are in the latter camp – governments and their supporters overstate their impact on the economy in their electioneering pitches.

What about market impacts? Equity market returns have been on average higher during Democrat administrations. This is almost certainly because there have been fewer recessions during these periods. Clinton enjoyed the Tech Bubble and Obama rode the lows of the Financial Crisis higher. Bush 2 was unlucky enough to start his Presidency while the Tech Bubble was blowing up and finished it in the depths of the Financial Crisis.

The point of the above is not to argue that every government is the same, they clearly aren’t. Rather, we think that the major market events that people remember decades after the fact are almost always caused by factors outside of a government’s control. The various policy agendas and platforms of different administrations will impact the economy and markets at the margin, however, can also go a long way to creating winners and losers within various cycles.

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Policy Platforms

What about what the candidates are actually proposing? From a market perspective, the areas of potential policy changes which matter the most are tariff increases, changes to corporate tax rates, migration changes and industry policy. The highest impact specific proposal is from Trump in the form of higher tariffs. While there have been a number of different plans floated by the Trump team, it is clear that he will push for some degree of tariff increases, particularly on imports from China. Tariffs are in general a terrible idea. They increase the cost of goods for consumers and businesses at a net negative cost to economic growth. Tariffs redirect economic activity towards inefficient industries. The US workforce is highly productive relative to poorer countries. Why move them away from where they create the most value? Studies measuring the impact of Trump’s tariffs in his first administration showed a net loss to the economy. Government and business revenue rose, but this was more than offset by higher consumer prices for items whose tariffs were imposed/increased.

Otherwise, Harris’s proposal to increase corporate taxes will weigh on equities at the margin. She is proposing to unwind a portion of the corporate tax cut Trump legislated in his first term in office. Harris is also proposing higher taxes on wealthy families and higher income earners. This will be offset by tax credits for childcare, healthcare and home purchases. Some of her proposals are a bit whacky - taxing unrealised capital gains is not very practical, removing taxes on tips doesn’t make much sense either. That said, airing whacky proposals are what election campaigns are for.

On the immigration front, Trump is pushing for a much lower rate. Given immigration is much higher now in the US than it was pre-Covid, and that immigration is arguably in part to blame for the currently rising unemployment rate, the net economic cost to this will probably be minor. On the industry policy front, the most significant change is a proposal from Trump to repeal the inflation reduction act – which has been a significant source of US fiscal stimulus in recent years.

Below is a table summarising the key economic policy positions of Trump and Harris going into this year’s election.

Regardless, it is important to note how little of this platform will actually get implemented in the four years following the January 2025 inauguration. The track record of politicians delivering on their campaign priorities is pretty woeful. As has typically been the case in recent years, a divided government seems the most likely outcome. In this instance, either Trump or Harris will struggle to legislate much of their agenda.

Case in point - the chart below shows the impact of legislated budget changes during the Trump presidency versus his proposed agenda. Spending was tracking well below (gap between the dashed line and the red line) than initially proposed as Congress blocked change. Then, spending escalated dramatically higher due to unplanned fiscal stimulus during Covid. Even following Biden’s blue sweep in 2020 (where the Democrats held the House, Senate and Presidency), actual policy change was hamstrung and not a great deal was implemented prior to the Republicans taking back control of the House in 2022.

Wild Cards

While most of the above appears relatively benign, we see two potential wild cards emerging from this election, both involving a Trump presidency. The first is if Trump wins in a red sweep – that is the Republicans taking control of Congress as well as the Presidency. In this scenario, there is a chance that Trump manages to push through his proposed tariff agenda in its entirety. This proposal involves 10% tariffs on all imports into the US, 60% tariffs on all imports from China, reciprocal tariffs on all tariffed US exports, and potentially substantial tariffs on European and Mexican car imports. If fully implemented, we think the impact of this would be a substantial shock to global equity and bond (due to higher inflation) markets.

Other than tariffs, Trump has been very vocal on his desire for the US to adopt a more isolationist global foreign policy. If China is waiting on a window to invade Taiwan, a US President who opposes getting involved in foreign conflicts seems as good a time as any. If Trump announces that the US will not support Taiwan in the event of a conflict, the risk of a conflict would rise (relative to the current policy of strategic ambiguity). The important caveat to this is Trump’s high level of support for Taiwan (arms sales and a post-election phone call to winning President Tsai Ing-wen) in his first administration. A China-Taiwan conflict would be more significant to global markets than Russia’s invasion of Ukraine or the ongoing Israel/Gaza conflict.

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Portfolio Positioning

With the election a coin flip and the most likely outcome no major change in actual policy from either party, we have not adjusted the portfolios to account for the US election. If one party manages to gain control of the Presidency, House and Senate, allowing them to legislate the more extreme elements of their agenda, it may be prudent to adjust portfolios in response, but that will be a 2025 story.

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