William Riegel, Head of Equity Investments
October 16, 2012
U.S. equity investors always take a keen interest in the outcome of presidential elections. In the last 30 years in particular, Republican and Democratic candidates have tended to offer starkly different views of what measures will bolster the economy, particularly in the areas of tax policy, spending and the national debt. The conventional wisdom—that stock markets do better under Republican administrations and worse under Democratic ones—has not always been borne out.
William Riegel, head of equity investments at TIAA-CREF, offers his perspective on the link between presidential policies and stock market performance, the outlook for various industries under each of the candidates, and whether we can expect to go over the fiscal cliff.
There’s been a lot of talk lately, as there is in advance of every general election, about which candidate would be better for the stock market. Do presidents get too much credit—and blame—for what happens with the economy and with stocks during their tenures?
They do, yes. The buck may stop with the president, as Harry Truman famously said, but in most instances the way the economy actually behaves is completely out of an individual president’s control. From a short-term perspective, the far more important determinant of activity is the Federal Reserve and whether or not it’s providing liquidity, in hopes of jump-starting activity, or withdrawing it.
In the long term, a president’s agenda and policies can offer an extended benefit—or downside. For instance, there are some persuasive analyses suggesting that the very strong growth we saw in the 1990s, and for which Bill Clinton got credit, was largely due to policies enacted during the Reagan Administration. Those policies included a reduction in the capital gains tax, smaller government payrolls and less regulation.
In the case of the candidates running for president now, how easy is it to see a link between their policies and the likely performance of the stock market?
It’s not easy at all. Look at what has happened this year. Health care reform is moving forward, Dodd-Frank is starting to have implications for financial firms, and an empowered Environmental Protection Agency is setting up new hurdles for certain kinds of businesses. These all reflect policies put in place by the Obama administration. These policies have produced a lot of uncertainty and explain why businesses, despite soaring profits and massive amounts of cash, are doing so little hiring and investing.
And how has the stock market reacted? By going up! The S&P 500 Index is up 13.6% for the year to date. Why? Because the uncertainty has led the Fed to continue its policy of monetary stimulus, most recently with its September commitment to “QE3,” a major new round of quantitative easing. QE3 will likely keep interest rates low and the economy flush with cash, until at least mid-2015.
Would the stock market’s reaction to a Romney presidency be any more straightforward?
On the surface, Governor Romney’s policy platform—including tax reform and lighter regulation—would seem to be positives for the stock market. Governor Romney has said "the markets will be happy" if he prevails,1 and he may be right since—as of this writing—his election would be a surprise and could lead to the expectation of lower taxes. But to get the lower taxes, Romney would probably have to eliminate loopholes such as the mortgage interest deduction—which could have real implications for the housing and finance industries.
Are there individual industries that will do better under one president versus the other?
It’s possible. President Obama’s policies have given a boost to hospitals, HMOs and alternative energy. A second Obama term would be positive for those industries. It would be less positive for exploration energy companies, since it seems clear the president is going to attempt to impose controls on companies’ use of "fracking" to extract natural gas. It might not have much effect on the financial industry, but it wouldn’t have a positive effect. And then lastly, the SEC has been tinkering with the regulations related to the Internet, which has created uncertainty for telecom companies.
If Romney is elected, on the other hand, the finance group might benefit from less harsh regulation, defense companies could do well thanks to less budget-cutting in that area, energy companies would be boosted by fewer limitations on drilling, and lastly, multinational technology companies could also gain with the likelihood that tax repatriation on foreign earnings would be reversed. This change in tax law could allow overseas cash to be repatriated.
Conversely, investors might not want exposure to alternative energy under President Romney, since that industry has only been able to move forward because of tax-related subsidies. And they might want to avoid hospital stocks, where there would be new uncertainty even though it’s very unlikely at this point that Romney and the Republicans would be able to repeal the Affordable Care Act. Finally, Romney comments about tariff barriers aimed at China may lead to underperformance by companies that are dependent on trade with China—such as certain manufacturers of luxury goods.
There’s been a lot of anxiety about "the fiscal cliff," as Ben Bernanke called the automatic spending cuts and tax increases scheduled to kick in at the beginning of 2013. What impact will the upcoming election have on those provisions, which are designed to reduce the $1.3 trillion budget deficit?
The key question is which party wins what and by how much—in other words if we see a split Congress, with the House dominated by one party and the Senate by another. History has seen many cases in which a split government provided the basis for compromise on our fiscal imbalances. This reflects the fact that each side can blame the other for the very tough medicine that’s needed.
Now, you can say we’ve already had an environment conducive to a bargain, without actually striking one, and that instead of cooperation we’ve had a food fight. Despite having the conditions necessary for a compromise, a deal fell apart in 2012, but both President Obama and Speaker Boehner came very close indeed. It is also important to note that after the S&P downgrade led to a sharp market reaction, the deal that expires on January 1, 2013, was agreed upon. In other words, although disagreement may lead to temporary fiscal cuts, market reactions have proved to be wonderful motivators to Congressional agreements. Again, without a deal, you get sequestration—automatic spending cuts—which could cost us between 4% and 6% of GDP. The last time we did that, in 1970, we triggered a pretty sharp recession and a market correction.
The likely case remains that some form of agreement will be reached. It would likely include some entitlement cuts, higher taxes, and the expiration of the payroll tax. The net effect on GDP would be perhaps a 1% or 2% drag—which is a slope but not a cliff.
1 Business Insider, Sept. 18, 2012: http://www.businessinsider.com/live-full-romney-fundraiser-video-2012-9
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Past performance is no guarantee of future results.
TIAA-CREF Asset Management provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®). Teachers Advisors, Inc., is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA).