An election of extremes - but a government of moderation



In brief

We are in the midst of a very unusual US election campaign. But for markets, the impact of the election is likely to be more muted than the campaign hype might suggest.

While imperfect, the US system of divided government helps to ensure that no leader can implement his or her policy ideas unfettered. With our base case one of de facto divided government, markets may well be facing a largely status quo outcome.

Historical analysis suggests that markets tend to favour incumbent candidates in the months leading up to presidential elections, likely because they represent less uncertainty to investors. However, political considerations have proven to be less of a driver for markets over longer periods.

Regardless of who wins the election, investors should expect a recession at some point during the next four years. While long-term investors should continue to capitalise on the ongoing expansion for now, it will also be important to establish a plan for the next downturn as the cycle matures.

This US election cycle has been unusual from the start, most notably for the unexpected rise of non-establishment candidates Donald Trump and Senator Bernie Sanders. However, the impact of the election on markets is likely to be far more muted than the intensity of campaign rhetoric might suggest.

In this paper, we consider:

How we got here: Why economic angst has contributed to a frustrated US electorate

Why our base case of de facto divided government is what ultimately matters most for markets

What history tells us about market behaviour before, during and after presidential elections

Why either a President Trump or Clinton will likely face a recession in his/her first term, and how investors should think about their portfolios given where we are in the economic cycle

Not out of nowhere: The rise of populism and the legacy of the Great Recession

More than seven years after the end of the Great Recession, the fallout from the downturn continues to shape the American economic and political landscape. Despite substantial economic progress, in many ways the mood of the public is sour and distrustful. An average of polls compiled by RealClearPolitics (RCP), for example, shows that 63% of Americans believe the country is on the “wrong track,” vs. less than 28% who say it is on the “right track."1

It is not hard to understand why. The pace of recovery has been conspicuously slow - around half that of a typical cycle - real income growth has been anaemic and, while wealthy households have enjoyed a boost from rising stock and home prices, middle-income households have been disproportionately penalised by ultra-low interest rates.

Moreover, structural changes in the economy, including the ongoing shift from manufacturing to services, technological innovation and increasing globalisation, have created a fertile ground for populist candidates who rail against a “broken” or “rigged” system.

These and other frustrations have fuelled the success of anti-establishment candidates. As highlighted in Exhibit 1, when surveyed, supporters of Donald Trump pointed to immigration as being among the most important issues to them, a sensitivity that is likely driven by economic anxiety and the fear that increased immigration represents competition for jobs. Economic issues were also important to Bernie Sanders’ supporters, who cared most about income inequality, education costs and jobs.

1 “Direction of Country, RealClearPolitics Average.” RealClearPolitics. RealClearPolitics Average. August 1– September 6, 2016.

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