Spooked About Politics? How Worried Should You Be?
By. Dr. JoAnne Feeney, Portfolio Manager
Drama in presidential elections is nothing new, but this year’s show should win an Emmy for all the twists and turns and fiery dialogue. And last week, just as we thought we were headed towards a predictable ending, the plot thickened once again as the FBI announced a continuation of the infamous email probe. The probability of a Clinton win had peaked at roughly 85-90% in the middle of the week, but between concerns regarding the Clinton Foundation and the FBI bombshell, Clinton’s odds have settled back to 75-80%. This is still higher than any candidate has enjoyed in modern history, but for those fearful of a less predictable Trump regime, as investors appear to be, even the weakening in Clinton’s chances have some advisors and investors wondering whether to move to cash for the time being.
Most economists agree that presidents have little influence over economic growth or business cycles, no matter how emphatic their campaign promises. Recent research by two well-respected economists, Alan Blinder and Mark Watson, examines economic growth achieved under Democratic and Republican regimes since World War II. Some may be surprised to learn that the U.S. economy performed much better under Democrats than under Republicans: average annual real GDP growth under Democrats was 4.3%, while growth during Republican presidencies was just 2.5%. This 1.8% disparity is significant, but to what should it be attributed? During those regimes, the country went through markedly different periods of real innovation, wars, and global and domestic economic disturbances (such as oil price shocks). Blinder and Watson found that these shifts in economic and political fundamentals—basically the luck of the draw for the president—accounted for 70% of the Democrats’ higher economic growth. But what of differences in monetary and fiscal policy? What about the sharp increase in interest rates initiated by Volcker or different income tax rates? While we’d like to think our favored candidate can bring us better growth, Blinder and Watson’s empirical analysis does not attribute any of the growth gap to differences in policy.
The reason for the ineffectual efforts of presidents lies in the core drivers of economic growth (and cycles) and the luck associated with economic conditions when they started in office. Real GDP growth occurs when firms find ways to make more from less – by using raw materials more efficiently, by leveraging workers more effectively, and by developing new blueprints for building better and entirely new products that consumers will want to own (think iPhone versus the rotary Bell telephone). Government policy, no matter how well intended, can do little to help the designers, engineers, and the rest come up with the new ideas that ultimately lead to better blueprints for making new stuff. Certainly, around the edges, government policy can shift incentives – more regulations or higher taxes may discourage investment in R&D, for example – but the vast trove of historical analysis shows that this has had very little impact on the health of the U.S. economy.
Yet as we weather this tumultuous election season, it may seem that more hangs in the balance this time around. And it may. While Clinton is clearly viewed as the more stable and predictable candidate by Wall Street, she has been pulled left to appeal to the Sanders supporters (greater regulation of drug prices and financial institutions, for example) and favors more re-distributive policies (higher taxes on the wealthiest). But she also has expressed interest in the sorts of policies which can increase private sector productivity such as improving education (increases human capital) and rebuilding the nation’s infrastructure (increases the quality of physical capital). The Republican alternative, by contrast, would normally be expected to favor lower taxes, smaller government, free trade, and free markets. But Trump has not taken the typical Republican tack towards small government and has abandoned traditional stances favoring free trade. Wall Street’s greater concern regarding a Trump presidency would be a longer term elevation in uncertainty, given his wide ranging declarations to reverse trade agreements, undo global political alliances, and to penalize companies moving manufacturing abroad. He has also threatened the integrity of the country’s legal institutions–and strong institutions, unlike the party of the president, have been shown decisively to affect a country’s economic well-being. On the positive side of the ledger, Trump supports greater spending on infrastructure, like Clinton, and much lower corporate taxes–the latter would be helpful, were the likelihood of a substantially larger deficit not so great.
Regardless of who wins we are likely to see a more interventionist government, but either candidate’s government will be limited in its ability to drastically alter policy. The polls now indicate that the Congress stands a good chance to end up divided—probabilities favor the Senate going Democratic, while the House remains Republican. This would require bipartisan cooperation (dare we hope?) where deal-making tends to block the more extreme policies. A Trump win would create greater policy uncertainty, however, and that tends to dampen R&D and capital investments by firms. So while long-run growth is unlikely to be hurt too badly, the short run could be more volatile.
Earnings reports notwithstanding, the S&P 500 has traded in a narrow range since the Brexit rebound, held back by election uncertainty. While it’s tempting to run for the exits in the face of this uncertainty, remember that presidents matter little for economic prosperity and that real economic fundamentals ultimately win the day. Given current odds, a Clinton victory has become more likely to generate a relief rally as investors get off the sidelines and once again pay attention to earnings outlooks rather than to election coverage.
Source: Alan Blinder and Mark Watson, “Presidents and the U.S. Economy: An Econometric Exploration,” American Economic Review, forthcoming.
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