With the summer over and the presidential debates just around the corner, investor attention is increasingly turning to the U.S. election. In my travels and meetings, I frequently encounter two strongly held views about the election’s investment implications: First, no matter who wins there will be a market-moving increase in fiscal stimulus, and second, the election will be a source of volatility. I would question both views.
Many economists agree that the United States needs to shift from a reliance on monetary policy to more fiscal stimulus, but it is not clear that the political stars are aligning to do so, even though both candidates favor increased spending. At this point, the most likely election outcome appears to be a continuation of divided government, with polls showing Hilary Clinton ahead, but with a closely divided Senate and a diminished Republican majority in the House. It is not clear that a large fiscal package can emerge from this configuration. This is consistent with history; 2009 aside, the first year of an administration normally does not coincide with a big fiscal push. Since 1905, the median rise in federal spending in the first year of an administration is around 5.5%, almost identical to the other three years.
Even if spending does rise, will it matter for the stock market? While there will doubtlessly be some stocks and segments that benefit, over the past century there has been no consistent relationship between federal spending and equity returns, as defined by the Dow Jones Industrial Average. Nor has there historically been much of a relationship between transfer payments, i.e. direct payments to individuals through various government programs, and market returns. In short, even if the next administration can summon the will and means to ramp up government spending, there may be little discernible impact on the broader equity market.
What about the impact on interest rates? Here again, there is no consistent relationship between spending and interest rates. Looking at annual changes in federal spending against annual changes in the Fed Funds target rate, since 1956 there is no consistently significant relationship. It is just not clear that fiscal spending, even if we get it, will be the dominant theme of 2017.
Will the election be a source of volatility? Obviously, to the extent the consensus of a Clinton win is wrong, there will be a reaction. However, once you get past the shock of a non-consensus event, markets often settle down (think of Brexit). Even if elected, will a Trump administration be able to enact many of the policies he has proposed? Given the number of seats the Republicans need to defend, absent significant coattails the Republicans may wind up losing the Senate even in the unlikely event of a Trump victory.
Ironically, politics may still be a source of volatility––just not from the United States Today, I see a greater potential for volatility emanating from Europe. Populism is now starting to infect northern Europe. In Germany, Chancellor Merkel’s center-right CDU party lost a key state election to both the Socialists and the new right Alt Party. In Austria, a far right candidate is leading in polls for the presidency. In southern Europe, the Italian prime minister is facing a critical referendum which may determine his and his party’s fate, while Spain is still struggling to form a government. Finally, both Germany and France are facing national elections next year with insurgent, populist parties on the rise.
In short, politics may very well disrupt markets, but the shock may not be made in America.