As the Presidential election enters its final week, it is worth considering which parts of the stock market are helped by which political party. In the aggregate, the stock market has done better under a Democratic president than a Republican one. However, this statistic tells relatively little in terms of the environment that each party came into, and similarly, the environment each party left. Such environments often lay the groundwork for market increases or declines in the next four years.
Analysis of market sectors is a bit less difficult than the overall market, if only one can tie a sector to the goal of a given candidate. Assuming a candidate will follow through on their campaign promises, one can discern the areas of focus of the administration going forward.
The first area highlighted is infrastructure. There has been years of underinvesting in this area, in a misguided effort to hold down the federal deficit. Spending on infrastructure impacts future economic activity. Spending on transfer payments such as Social Security or Medicare have a less tangible future benefit. Given the cigar box accounting of the government, the two types of spending are equated.
Both candidates have come out in favor of infrastructure spending. Thus road repair, bridge building, airport construction and the like would seem to be a focus of the economy going forward. However, this was also proposed by the current administration up to eight years ago. An unwillingness to increase the gasoline tax (when gas prices were falling, no less) by congress led to nothing being done. At this time, many projects at the state and local level are being delayed due to a lack of matching federal funds. Perhaps this time things will go better.
Clinton has voiced support of increasing the minimum wage. Trump has been less specific in how to attain better paying jobs, beyond bringing them back from abroad. Regardless of the candidate’s position on this, wages are going up, spurred by labor shortages and stronger demand. Thus higher consumer spending seems to be a foregone conclusion, with the issue being how strong and when. Higher consumer incomes translate into higher demand for consumer products ranging from groceries to housing.
Both candidates are critical of companies moving their legal residences to other countries to obtain lower tax rates. Expect not only some sort of exit tax on such businesses, but also some secondary statutes when competing for government work.
Of course, one cannot have an election in this country without promises of tax reform. Both candidates have promised lower overall rates and both corporate and personal tax simplification. The problem is that eliminating tax deductions to gain a lower rate is more difficult than it sounds. One person’s tax deduction is another person’s reason for existing.
There was an effort, several years ago, to come up with a flat tax of something like 15 percent for all taxpayers. The problem was that it required the elimination of all deductions such as home mortgage interest, charities, and personal exemptions. In the exercise, even the recipients of transfer payments like Social Security and Medicare were taxed, and insurance premiums paid by employers were treated as income in kind. The ensuing brouhaha resulted in nothing being done. There is no reason to expect a renewed approach to be any more successful.
There are a few easy tax targets, like the use of carried interest, which is the domain of the hedge fund industry that may be eliminated. Even here, it will depend on how strong and focused public opinion is relative to the power of lobbyists whose job it is to preserve the status quo for the few at the expense of the many.
One industry that may be under pressure is health care. While millions of people use health care, only a few actually pay for it, with the Medicare program being the largest.
When Medicare added a prescription drug plan in 2004, there was a provision put into the law by the drug lobbyists to prevent the Federal Government using its buying power to negotiate down the price of drugs. Largely because of this, drug prices have been going up far faster than the rate of inflation since they plan was enacted.
Medicare has already negotiated down the price it will pay for hospital and nursing home stays and other non-prescription services. Drug prices are the only avenue left of meaningful savings. Critics argue that drug companies need the profits from existing drugs to fund research for new drugs. The problem is that some of the same drug companies have been buying up generic drug makers and charging several times more for what is in the public domain. This has created a backlash against the drug makers. Expect health care stocks to come under pressure next year.
One area of contrast will be alternative energy. If Clinton is elected, expect a continuation of the promotion of non-fossil sources of input. If Trump wins, coal will again be a growing source of electricity production.
Economic activity jumped 2.9 percent in the third quarter, as the purchase of homes and cars spurred on the overall economy. While consumer sentiment slumped, consumer buying soared, showing once again the therapeutic effect of shopping.
Whether this rate is sustainable depends on the buying power of consumers going forward. With business investment stalled and government spending treading water, it has been up to the consumer to drive the economy forward. Usually, it is government spending that drives an economy out of a recession, followed by consumer spending and then business investment. This time the order has been scrambled.
Just in time for Halloween, inflation has returned. Price pressures are almost completely coming from wages and to a lesser extent, the strength of the dollar. Labor force participation is rising, and in doing so, stalls out the unemployment rate. The unemployment rate only picks up on those wanting to work who do not have a job. As the job market improves, the number of people looking for work increases. This trend is captured in the labor force participation rate. It is not reflected in the unemployment rate.
Interest rates have moved up as well, albeit from largely negative territory in other parts of the world. There is a demand for loans from banks in many parts of the country, and this is leading to the first increase in CD rates in quite some time. Expect the Federal Reserve to be behind the curve, rather than leading the way.
The Stock Market
With divided government in the cards, the stock market should be in a place of historically great comfort politically. It has been shown that markets do best when one party controls the White House, and another holds at least one house of congress.
There will be several cross currents in the market as administrations change. There will be new priorities set, and this will drive sector performance.
Warren M. Barnett, CFA
October 31, 2016