If there's anything the market hates, it's uncertainty, and the US presidential election is creating plenty of it.
Last week, I discussed the "polarization principle," as delineated by Citi's Matt King. The idea, in a nutshell, is that all traces of heterogeneity are rapidly disappearing from the economy, markets, and politics. This manifests itself in greater wealth inequality, rising cross-asset correlations, and a perceptible shift among both voters and candidates towards the poles of the political spectrum. The latter dynamic is best exemplified by the rise of Donald Trump and Bernie Sanders.
There are those who will take issue with the characterization of Trump as a "far-right" candidate. Indeed, there are those who would even go so far as to argue that it's unfair to characterize anti-immigration parties in the EU as such.
First, I would note that these arguments assume there's something inherently pejorative about the term "far-right." It's not clear why you would assume that unless you yourself saw some truth in it. For instance, no Bernie Sanders voter would object to someone calling the Senator a "far-left" candidate. Anyway, what can be safely said, I think, is that Trump-ism (whatever that ultimately turns out to mean) has a nationalistic feel to it, and that has real implications for the economy and thus for financial markets. We just don't know for sure what those implications are.
Sticking with the polarization theme, Bernie Sanders has garnered an astonishing amount of support for his socialist platform. In short, the Vermont Senator has metamorphosed into a household name over the past nine months. But much like Trump's support base, it isn't clear that Sanders' supporters (or Sanders himself for that matter) have thought through what the Senator's policy proposals entail. For instance, Politico notes that according to a new study by the Tax Policy Center, Sanders would add $21 trillion to the debt "even after accounting for his $15.3 trillion in tax increases."
"That could be very damaging to the economy," the center's director Len Burman said, dryly.
But the uncertainty doesn't end with Trump and Sanders. There are also real questions surrounding the implications of a victory for Hillary Clinton - the one remaining "establishment" candidate.
While the former Secretary of State has attempted to incorporate some of Sanders' disdain for Wall Street into her purportedly liberal message, a long list of paid speeches and the campaign donation record seem to suggest that Clinton has a rather cozy relationship not only with the bulge bracket, but with the shadow banking complex as well. One might fairly ask the following: Can someone who makes nearly a quarter of a million dollars per speech at engagements sponsored by the likes of Goldman Sachs truly be expected to "create an economy that works for everyone?"
As Bloomberg reported on Thursday, "hedge funds, private equity and insurance executives, who could face greater oversight under Clinton's plan [to rein in shadow banking], have given a combined $24.9 million to Clinton and the super- PACs supporting her."
The point here is that there's an enormous amount of ambiguity surrounding this election, and that's starting to affect sentiment. "[Businesses] may even like the Trump policies," Nicholas Bloom, a Stanford University professor who specializes in the study of political uncertainty and economic outcomes, told WSJ this week. "It's just that Trump is so different from Clinton and he's so unknown that there's a big black cloud of uncertainty hanging over the horizon and that will make them pause."
Indeed. WSJ also highlights the Philadelphia Fed's Partisan Conflict Index, which, according to the bank, "tracks the degree of political disagreement among U.S. politicians at the federal level by measuring the frequency of newspaper articles reporting disagreement in a given month."
The index is useful because "increased partisan conflict increases uncertainty among firms and households [and] has been shown to slow economic activity by delaying business investment and consumer spending." Consumer spending accounts for some three quarters of US economic output, which, in Q1, grew at just 0.5%, and the ZIRP regime (where the hunt for yield creates demand for IG credit) encourages debt-funded buybacks at the expense of capex.
In other words, any dynamic that discourages spending and business investment is decisively unwelcome in the current environment. Here's a look at the index over the past 10 years:
(Chart: Philly Fed)
WSJ goes on to cite Wells Fargo, which notes that equity returns (NYSEARCA:SPY) have averaged just "1.2% in open election years versus a 9.7% return in a re-election year." That relative underperformance is likely tied to investor uncertainty.
(Chart: WSJ w/ data from Wells Fargo)
But does the policy rhetoric from the two front-runners justify market jitters? In other words, have Trump and Clinton failed to deliver a clear message to the market? In a word, yes.
Citi is out this week with a look at the growth and fiscal policy implications of a Trump presidency versus a Clinton presidency. The bank's analysis focuses on how the respective candidates' pick for Treasury Secretary would influence debt and growth outcomes. Citi's conclusions are not encouraging. Here's the takeaway:
Given limited information and the shifting nature of campaign rhetoric, it is difficult to say definitively whether Federal finances will worsen or improve after the elections. Neither Clinton nor Trump has released estimates of future Federal budget deficits and debt under their respective administrations.
Citi goes on to describe a Clinton Treasury as "an institution friendly to US factories and Main Street," while Trump's Treasury is labeled as "an institution that promotes 'fair trade' and debt reduction." Here's an excerpt from the section on Clinton:
Hillary Clinton largely advocates free trade, as long as it does not "harm" domestic businesses, manufacturing, or US workers. Clinton is for "clear-eyed" capitalism, and does support behaviors that bolster the financial system, protect small investors, and encourage credit extension to small businesses. However, Clinton does seek to punish corporations and nations that stifle US competitiveness, as well as those that impede upon what presidential candidates have called "fair" trade, including currency manipulators and firms that engage in US tax avoidance.
US Manufacturers Win Under Clinton: Key metrics underpin Clinton's penchant for corporate tax and international trade policies that support US manufacturers. Clinton estimates that factory jobs pay 8 to 12 percent more than jobs in other industries, like retail, hospitality or health care, and employ 12 million Americans directly and 17 million indirectly. We acknowledge that while manufacturing's share of the economy has narrowed to just 12 percent of GDP, factory activity has been a small contributor to real GDP growth in recent quarters (especially away from energy-related subsectors, and even amid erosion from the strong US dollar). Moreover, manufacturing has been somewhat supportive of employment growth since the crisis.
And a bit from the section on Trump:
Presumptive Republican Presidential nominee Donald Trump's views on tax policy are still evolving, but he remains adamant about strengthening the nation's global competitiveness and reducing debt. Trump has publicly stated that he would desire a US Treasury who is focused upon promoting policies that hold other nations accountable for creating a "fair" international trade environment, and quelling the swell of public debt via a combination of tax and spending reform. Trump's latest hints about his prospective tax policies, at the time of this publication, suggest somewhat larger deficits and greater debt than those advocated by Congressional Republicans, but might nonetheless be smaller than under a Democratic administration.
Finally, here's a look at debt and growth projections from the Tax Foundation and the aforementioned Tax Policy Center:
Citi calls the think tanks' results "inconclusive" and concludes with the following assessment of the current situation:
Unfortunately, with just six months to go before the election, we see limited evidence from the leading Presidential hopefuls that their policies may avert or even ameliorate the United States' looming Federal budget deficit and debt crisis.
So that's obviously a rather grim assessment and serves to underscore not only the notion that the market is correct to be nervous about the upcoming election, but that it is also right to be pessimistic about the prospects for a return to some semblance of fiscal sustainability.
In any event, Barclays has also looked at the economic implications of the US elections. Here's the bank's (amusingly deadpan) take on tax policy:
Trump aims to lower federal government revenue as a percentage of GDP to ~14%, levels never seen in modern history. Since eliminating large entities, such as the Department of Energy, is widely seen as campaign fodder, it is often not calculated in debt held by the public to GDP calculations. Therefore, given the tax proposals, as expected, Clinton's proposals would slightly lower this ratio, while they would substantially increase under Trump. Since these calculations do not take into account any feedback to the economy, they are often overly optimistic. Further to that point, Trump said his plan would allow the US to pay off the $19 trillion national debt within eight years by growing the economy and the "power of trade." This would require US GDP growth of 13-24% every year, according to a recent analysis.
Clinton's plan, being close to current policy, would have very little effect relative to our baseline of no policy change. The Trump and the Cruz plans seem unrealistic in their current form. We see a very low probability of either passing Congress in their current form.
The bank goes on to assess the impact of trade agreements on the US economy, and summarizes the remaining candidates' opposition to TPP as follows:
... the general move against the TPP by the three remaining major candidates is a manifestation of the populist voter upswell, a group whose concerns have been validated and reinforced by the anti-establishment campaigns of Sanders and Trump, both of whom actively oppose further international integration of the US economy. This population believes they have been harmed by past trade agreements.
Contributing to anti-trade view, the US economy has shed more shed more than 5 million manufacturing jobs since 2000. Some of these have been lost to Mexico, a loss to which NAFTA may have contributed, but many more of them have moved to China. Adding to the problems of the sector and the belief that trade is harming US manufacturing, real wages of these workers have risen at about half the pace of those for the economy as a whole.
To be sure, most of the Street's "research" amounts to summaries of sound bites that have appeared on the main wires. But it does say something about the state of American politics when whole teams of ostensibly intelligent people with decades of capital markets experience between them are unable to divine much of anything in terms of concrete policy prescriptions from candidates less than six months before the election.
Then again, it's hard to blame Trump and Clinton for not having a clear vision on how to revitalize the economy. After all, developed market central bankers and G7 finance ministers have been trying to solve the post-crisis slow growth/sluggish trade puzzle for eight long years, to no avail.
Speaking of central bankers, given the recent hawkish Fedspeak, one wonders how a stronger USD (tied to a presumed rate hike between now and the election) and the expectations of rising rates will interact with the uncertainty surrounding the fraught political environment in the US.
On that note, I'll close with two interesting graphics from BofAML, which notes that, in fact, spreads (NYSEARCA:TLT) tend to come in and FX (NYSEARCA:UUP) vol actually subsides in the lead-up to elections. Will this time be different?
(Table, Chart: BofAML)
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.