After a long campaign season, with key policy points discussed ad nauseum, the following serves as a status update of several more economically-oriented issues. Considering that major policy changes tend to require Congressional approval, the outcomes of the Senate and House races are just as important as the Presidential, if not more so. One caveat is that final tallies are still in progress for a handful of close races, but as it stands currently, there is the potential for a Republican sweep for the executive branch, Senate, and House—which the narrative below implies, for simplicity’s sake. (Topics are listed alphabetically, not in order of importance.) This is important, in that a sweep paves the way for purer and more expedient policy transmission, while a split House and Senate creates far more hurdles to fast/easy policy, requiring compromise and diluted policy, or even disagreement to the point of minimal new legislation being produced.
Deficit/debt. Ironically, models of the early Republican plan showed a larger government fiscal deficit than did the Democratic plan. The math from tax cut extensions and additional corporate cuts results in lower incoming revenue, even if including new tariffs, as those have tended to be less effective in raising money than traditional income taxes. This has been countered by Republicans, noting that stronger economic growth from lower taxes and an easier regulatory environment would ultimately bring in more revenue over time. In recent weeks, rising Republican presidential odds and possible deficits were seen as at least a partial catalyst for pushing U.S. Treasury yields higher. Regardless, the high deficit/debt load remains a problematic issue that will have to be dealt with in some form in a bipartisan way. There has been little interest on either side of the aisle to tackle the debt problem, let alone the related budgetary issues with Social Security/Medicare/Medicaid, which are coming to a head over the next decade. If/when ‘bond vigilantes’ win out and yields tick even higher along with these considerations is impossible to determine, but the U.S. remains in better shape than other developed countries—which keeps some immediate concerns at bay.
Earnings. Watchers of top-down and bottom-up stock fundamentals note that higher corporate tax rates (as proposed by the Democrats) take a direct bite out of revenue, which, absent other effects, results in lower net earnings. As stock prices have tended to follow earnings over the long-term, higher taxes are thus seen as a negative input to valuations. The Republican win is assumed to maintain the status quo, or perhaps even enhance certain financial inputs, based on what’s decided for expensing/deductions, etc. In short, the removal of a potential negative is seen as a positive.
Energy/infrastructure. In line with the party platform, Republicans have encouraged full utilization of America’s petroleum resources, including further production/transportation. A rollback of green legislation is also proposed, with intense feelings on both sides over environmental policies that have only deepened over the years. However, there is bi-partisan agreement about the need to upgrade America’s aging infrastructure, which also ties into the ‘America first’ focus on re-shoring and re-industrialization, so specific policies could become more nuanced. An interesting irony is that green energy stocks outperformed traditional energy stocks during the Trump administration, while traditional energy outperformed green in the Biden years so far. (This is just another example that politics and ‘obvious’ first-derivative investment outcomes don’t always coincide. Part of this is due to restrictions on any given segment creating unanticipated supply/demand imbalances, which ultimately affect company revenues and earnings.)
Inflation. This isn’t a direct policy issue per se, but a talking point fraught with voter confusion. Some assume that high inflation is a continuing problem, which it would be if the annualized rate of change were still in the 5%+ range, for example, but the real beef is not with the present rate of change but with high price levels—the result of past inflation. Aside from a few outliers, current inflation rates have moved back toward normal, but that doesn’t alleviate the post-pandemic frustration with that higher price level plateau, where we essentially saw ten years’ worth of pre-Covid consumer inflation compressed into about three years. Central banks and economists appear to have settled on a consensus of roughly half of the cause being supply chain disruptions (the term ‘transitory’ being correct to some degree) and the other half from massive government fiscal stimulus that created excess money supply in the system and buying demand (much of which consumers benefited from). Inflation is a difficult phenomenon to navigate and solve, let alone explain in a politically workable way. Looking ahead, more extreme tariff policy does run the risk of raising costs and stoking inflation in either a focused or more widespread way, as does higher wage growth if immigration rules are changed, but the total net effects are to be determined.
Interest rates. This becomes more complex with a variety of cross-currents. As noted earlier, long-term rates have risen recently with the expectation of wider fiscal deficits. How much this becomes persistent is a question bond markets are wrestling with. The debt ceiling was suspended until 1/1/2025, after which it will need to be agreed upon yet again. Any political stalling could again potentially affect the U.S. government credit rating negatively, as it did via the S&P downgrade in 2011. More normal factors influencing rates include economic growth and inflation. If either or both remain high, yields could be pressured upward, or vice versa, if growth decelerates to lower levels. There has been some discussion of Republicans wanting more input into the Federal Reserve’s monetary policy process, which is a lower-probability wildcard, but still out there and could undermine some of the Fed’s prized independence. (Politicians almost unanimously want low and consistently-stimulative interest rates, although such policy runs the risk of being imprudent at the wrong times.)
Immigration/labor markets. These two have become intertwined, with the Republican administration seeking broader immigration restrictions, particularly as related to the Southern border. This has been one of the most contentious issues of the election, with the final result dependent on immigration reform legislation through Congress. Mass deportations of undocumented immigrants were suggested, but don’t appear overly feasible due to operational complexity and high cost. On one hand, labor force growth/demographics is one of the key drivers of a nation’s GDP growth (the others being productivity and capital spending), so the influx of foreign labor has fulfilled a strong demand for workers at both the higher-income (STEM) and lower-income sides and has helped keep wage growth contained. It’s also a primary reason the unemployment rate has remained low. Dramatic/rapid immigration reductions could have side effects such as creating a deficit of workers and/or raise required wages, which has tended to affect less flexible small businesses especially negatively. (A source of problematic wage inflation, seen during the pandemic, is an insufficient supply of workers, creating a smaller labor pool, giving them additional bargaining power.)
Regulatory environment. In general, Republicans prefer lighter regulatory, pro-business, and smaller government policies, which have been unsurprisingly cheered by financial markets. This is the essence of a push for smaller government. This trend has already begun, with some help from the recent ‘Chevron deference’ reversal by the U.S. Supreme Court that narrowed government agency regulatory powers. A looser regulatory environment could reduce company compliance costs, freeing up cash for other activities. In the financial sector, one drawback is that historical episodes of financial system breakdowns have arguably occurred after looser periods when cross-checks have fallen away; it’s hard to find an agreeable balance here. Another element in recent years has been the potential impact of anti-trust activity, where FTC Chair Khan has taken a bit of an independent and populist stance, perhaps less tied to party lines. Uncertainty remains in the area of technology. The U.S. is home to several of the world’s most dominant companies, particularly vital in the evolving world of artificial intelligence. At the same time, perceptions of media bias and authenticity of political content have been troublesome (hampered by influences from foreign bad actors, which ramped up during election season). While policymakers would ideally like to keep monopolies in check, staying in front of U.S.-China competition in the technology sector is a critical economic and national defense consideration.
Taxes. Republicans favor extending the 2017 tax cuts, with perhaps other added elements. This removes the threat of higher tax brackets on higher-income personal filers over $400,000, as it does the Democratic plan of taxing unrealized capital gains for the ultra-wealthy. The platform includes a standard pro-business stance, and to encourage re-shoring efforts, it includes lowering corporate taxes below the current 21% level, targeted to encourage further ‘Made in U.S.A.’ domestic production. Some economists question the benefit in lowering taxes even further than current levels, showing diminishing benefit, but lower taxes in general have tended to be a tailwind for corporate sentiment and investment.
Trade/tariffs/industrial policy/deglobalization. The Republican platform includes announced punitive 60%+ tariffs on China and 10% on everyone else, including specific tariffs like a 100% rate on autos made outside the U.S. This could either be some semblance of a final intended policy or a first draft bargaining chip. Tariffs on China of that level could prove to be quite damaging to their already-fledging GDP growth. At the same time, China could retaliate in several ways, including limiting American business activity or access to critical resources such as rare earth minerals or in steel production, a segment they now dominate. High tariffs for non-China nations are especially punitive, although a variety of countries apply larger tariffs to U.S. imported goods than the U.S. does for their exported items. Economists have been busy running a variety of potential scenarios if these were to go into effect, with a complicated set of outcomes for growth and currency exchange rates, which is not unusual when global trade pros-and-cons are involved. It may end up being a series of complex one-on-one negotiations, based on the products, industries, and countries involved. Economists tend to overwhelmingly dislike tariffs as a rule, or any restrictions to free trade, except in targeted situations to protect certain industries. Tariffs as a broader policy tool are assumed to reduce overall growth for both sides and raise costs (often borne by consumers), that could end up ultimately raising inflation. It’s also noteworthy that the President has the ability to apply ‘temporary’ tariffs for the purposes of national security, unfair trade practices, and/or potentially other emergencies, but longer-term commerce regulation is under Congressional and WTO mandate, which might limit the chances of more extreme action. This overall policy could benefit non-China trade partners, such as India and Mexico, in addition to enhancing U.S. manufacturing (by design) in order to regain global competitiveness and self-sufficiency, and further de-coupling from Chinese manufacturing upon which the world has become significantly reliant over the past 30 years.
While election results have been a poor long-term tracker, in the short term, some companies do postpone plans until post-election to get a sense of what policies they might be dealing with—that wait is now about over. Politics aside, the economic outlook is favorable. While this is not a prediction of asset class or sector returns (which tends to be futile), markets have continued to either celebrate and/or climb the proverbial ‘wall of worry,’ as November and December seasonal effects have also historically been positive. The U.S. economy is growing at an above-trend pace, high pandemic inflation distortions have been tamed, and both business and consumer balance sheets are showing a lack of distress. In addition, the Fed is continuing to ease monetary policy, which provides a general tailwind.
As interesting as that is, data shows that those investing a lump sum into the S&P 500 stock index in the mid-20th century, and kept in place only based on their preferred political party in charge, Democrat or Republican, would have experienced dramatic underperformance compared to the exponentially higher returns from a politically-agnostic buy-and-hold strategy over the entire period. That might be the most important story in all this.
Ryan M. Long, CFA
Director of Investments
FocusPoint Solutions, Inc.
Sources: FocusPoint Solutions, Morningstar, U.S. Bureau of Labor Statistics.
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Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.
Sources: Ryan M. Long, CFA; Director of Investments; FocusPoint Solutions, Inc.
FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, First Trust, Goldman Sachs, Invesco, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, PIMCO, Standard & Poor’s, StockCharts.com, The Conference Board, Thomson Reuters, T. Rowe Price, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. Index performance is shown as total return, which includes dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.
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