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How will the US presidential election affect the
markets?
With US election day looming on 6 November, we look at the
likely impact of the election on the US economy and the
markets.
The economy will be a central issue in the forthcoming election
race between President Barack Obama and Republican nominee Mitt
Romney and is one of the key dividing lines between the
candidates.
Key issues
Broadly speaking, Obama believes in the power of big government,
while Romney thinks a smaller state empowers individuals. When it
comes to closing the deficit, this means that Obama favours tax
increases alongside spending cuts, whereas Romney believes in
deeper cuts and lower taxation.
Obama now owns the economic situation, and the election may be
determined, to a large extent, by how Americans feel about the
recovery on Election Day. Particularly important are the
unemployment rate and the price of gasoline, and more specifically
the direction these are travelling come November. The election may
be won or lost for Obama four days before polling day with the
release of the October employment figures. The one unknown is the
risk of a major geopolitical event that could dramatically change
the dynamics of the election.
What happens next?
As well as the presidential election, the whole of the House and
a third of the Senate is up for election. The smart money is on the
Republicans holding the House and winning control of the Senate
from the Democrats. Therefore the most likely outcome is divided
Government, with a Democrat in the White House and the Republicans
in charge of Congress.
Whoever wins, before Inauguration Day, Obama and the incumbent
Congress will have seven weeks to deal with the socalled
'fiscal cliff'. Unless the two sides can agree on
corrective action, on 1 January 2013 massive but largely arbitrary
tax increases and spending cuts will be automatically implemented.
This could knock anything up to 4% off 2013 GDP.
After the inauguration, if Obama wins the hope is that he and
the Republican Congress will cooperate and tackle the big fiscal
issues facing the country in a measured way. However, the lesson of
the past four years is that compromise is a dirty word in
Washington. If Romney wins, and assuming the Republicans also win
the House and Senate, he will have a much freer hand. Policy will
clearly have a more right-wing flavour, and spending reductions and
tax cuts will be the order of the day.
Impact on investors
Academic research suggests that no party is 'better' for
investors. However, the historical impact of the presidential cycle
on the markets suggests that the second half of presidential terms
is generally much better for equities than the first. The average
return of the S&P 500 in the first year of presidential terms
is 5.9%, versus 17.5% in the third (source: Global Financial Data,
Inc). 2008, which saw the collapse of Lehman Brothers and the
height of the global banking crisis, is an exception to the general
rule that the fourth year of presidential terms tend to be good
ones for the stock market.
Tackling the deficit
The best case scenario is that the politicians show a bit of
courage and seek to tackle the problem of the country's debt
– and the other issues facing the country –
without the usual petty point scoring.
The worst case scenario is that nothing really changes and the
gridlock continues. In that case, it may be that only a big
external shock, such as the meltdown of the eurozone, or panic in
the bond markets, will finally focus minds.
The huge current and future debt burdens mean that very serious
decisions on fiscal priorities are needed, but the politicians have
proved wholly incapable of making these under the current
system.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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