The evidence so far points to a U.S. election cycle that results in a divided government and policy incrementalism, rather than sweeping near-term change.
Fiery speeches, raucous rallies, radical proposals to change policies, and political drama on a national stage that can capture the global spotlight: It’s the stuff of U.S. presidential election cycles.
For risk-averse markets and investors, the rhetoric can be hard to put in context. While the road to the polls in November will no doubt be winding, the evidence so far points to a divided government and policy incrementalism, rather than sweeping near-term change, according to Morgan Stanley Research’s recent report, “US Election 2016: Fighting the Fear of the Unknown.”
The stakes are high, particularly with fiscal stimulus, trade protectionism, and tax reform. Both presidential candidates have proposed policies that, if implemented, would alter the underpinnings of the U.S. economic outlook for equity, rates, currencies, housing, and corporate credit markets. “Yet incrementalism lessens the risk of transformational policy changes that could unsettle key markets,” says Michael Zezas, head of municipal strategy and lead author of the report.
Before Brexit, there was Grexit and the European sovereign debt crisis, Scotland's independence referendum, and the U.S. legislative gridlock over its debt ceiling in 2011, which threatened to, out of whole cloth, create a default in the global benchmark risk-free asset.
Take fiscal stimulus, for example. It may pick up modestly, given bipartisan support for infrastructure spending. However, unless the U.S. economy falls into a recession, lawmakers are unlikely to be motivated enough to enact stimulus that is meaningful to the economic outlook, given the difficulties of reaching agreement on either tax cuts or spending increases in a divided government, Zezas concludes, based on the joint-analysis of Morgan Stanley’s strategists and industry analysts.
Elections have consequences. “As financial market practitioners, we live with this political risk with increasing frequency in the wake of the financial crisis,” Zezas says, with the UK's vote to leave the EU as the most obvious, most recent example. Yet, it’s only the latest in a string of events that risk fundamentally altering norms that have dictated economic behavior for the past 70 years. “Before Brexit, there was Grexit and the European sovereign debt crisis, Scotland's independence referendum, and the U.S. legislative gridlock over its debt ceiling in 2011, which threatened to, out of whole cloth, create a default in the global benchmark risk-free asset,” Zezas adds.
Investors certainly seem concerned. Morgan Stanley’s own survey of 650 institutional investors found that more than 70% believe the U.S. election outcome will meaningfully impact their market over the next two years.
Morgan Stanley’s current analysis may offer some reassurance. Using a mix of polling data, third-party models, betting-market probabilities, and academic studies, the analysts developed and ranked likely election outcomes based on three key principles: 1. Republicans should maintain House control; 2. The electoral map isn’t being remade, and favors Democrats; 3. Policy transformation is hard. Their conclusion: “Current evidence suggests the U.S. elections in November won't yield outcomes that substantially change market fundamentals in the near term.”
Zezas admits that this may seem a surprising statement given the mix of vitriol and policy proposals that likely feel radical to investors, which have so far characterized the campaign season. “The strains of nationalism and mercantilism that have emerged within campaign proposals, for example, the opposition of both candidates to the Trans-Pacific Partnership, seem anachronistic and at odds with the generational trend toward economic liberalism and globalization,” he says, adding: “We place no judgment on the value of these policy changes, but simply observe that they represent a break with the standards that have driven macro and micro fundamental norms across key U.S. markets.”
In that sense, the candidacies themselves introduce the possibility of greater uncertainty for U.S. asset classes and, therefore, require understanding and monitoring by investors.